Take a look at your tax

Are you paying more than you really need to?

An economic slowdown could have considerable implications for most people’s taxes. Whatever your position, now is an excellent opportunity to take a look at your tax.

In some instances, people may be oblivious to the fact that they are paying more tax than they really need to and they subsequently never claim this sum back. Also, many will earn less and accrue lower investment income. Some self-employed workers could see profits all but disappear, while others will forego dividends from family businesses.

If you are employed and taxed under Pay As You Earn (PAYE), your personal allowance for the current 2008/09 tax year is £6,035, which is divided by 12 and then deducted from your monthly salary. However, if you do not work the whole year, you will have unused personal allowance which will be refunded to you. On that basis, you may also have paid too much higher rate tax.

Even larger sums could be at stake if you are self-employed or pay tax at the higher rate on substantial investments. If you pay tax in advance of finalising your returns and accounts by estimating what your income will be, you may have paid too much, given falling share dividends and the general economic slowdown.

If applicable to your situation you may be required to pay tax in two amounts, each amount being half of the previous year’s tax bill. In some cases, this could now seem too high, given that the credit crunch began during the middle of last year.

If your earnings dropped sharply in the second half of last year, or if you did not receive the dividends expected, it’s important to take action now to make sure you calculate your assessment correctly and claim any money back that is due.

In January, not only do your 2007/08 tax affairs have to be finalised, but you begin making payments on account in respect of the 2008/09 tax period. Due to the economic downturn, it may be prudent not simply to pay the usual required half of the previous year’s tax bill.

Before you make a payment, take a realistic look at your earnings and dividends and what they are likely to be by the end of the financial year. If they are lower, you can apply to make a lower payment than usual, but you need to request this by filling in a form SA303.

You should also keep a close eye on the dividends you receive, especially once they fall below £10,000, as HM Revenue & Customs (HMRC) may sweep them up into PAYE. Not only are payments made earlier this way, but shareholders may be overcharged. It is possible to apply for dividend tax to be kept out of PAYE, as HMRC cannot compel you to pay tax on dividends via your coding notice.

Pensioners benefit from higher personal allowances in the current 2008/09 tax year: £9,030 at age 65 and £9,180 at age 75. But if applicable to your situation, you lose 50p in every pound of income above £21,800.

However, this clawback stops once your income falls below this threshold. If a dividend slice means you fall below the £21,800 threshold, you will at least no longer suffer from the income clawback. But you should make sure you inform HMRC fully of dividend cuts, or you could be overtaxed.

There may be opportunities for small business owners to claw back overpaid tax. If small companies make a trading loss, it is possible to carry that loss back to the previous year and obtain a tax rebate, which could offer valuable cash flow advantages. Partnerships may be able to extend the current accounting year to, say, 15 or 18 months to reduce payments on account. This is a timing difference rather than an actual tax saving, which can give hard-pressed professionals a bit of breathing space.

In an economic downturn, falling asset prices can also benefit those planning for the future. If you wish to pass on assets, whether property or shares, to members of your family for inheritance tax planning purposes, there are opportunities presented by lower property and
share values.

You could opt to give the gifts outright. If you survive for seven years, they become tax-free. Alternatively, you could place them in a trust, which may still involve a 20 per cent charge. However, this can be circumvented by opting instead for a family limited partnership, which, although not as flexible as a trust, can still be worth considering.