3 vital steps to paying less tax

The tax we hand over to the taxman has hit a record high - and so has the amount we waste in tax errors and unnecessary payments. Find out just where your tax goes - and how to pay less.

If you’re worried about future tax hikes following the General Election, relax - it’s probably too late to worry. We’re already set to pay HMRC significantly more in real terms than at any time since the mid-1970s, when high-earners were hit with an eye-watering 82% top tax rate.

New research from free market think-tank The Adam Smith Institute, shows that UK taxpayers will hand over every penny they earn during the first five months of the year to HMRC. This year’s ‘Tax Freedom Day’ - in effect, the first day of the year we work for ourselves rather than the Government - falls on May 30. 

This year’s date falls later in the year than at any time during the survey’s nine-year history and three days later than in 2009. Tax Freedom Day falls later this year primarily due to the reversion of VAT to 17.5% which came into force on January 1 - but the report also warns of swingeing tax hikes to come, whoever wins the Election.

The study estimates that - due to our spiralling national deficit - the gap between what the Government will spend (an estimated £704bn) and what it takes in tax receipts is at its widest level since 1976. This explains why our tax outlay is, in real terms, already at its highest level for a decade - and only set to rise even further.

The big ‘claw back’ 

In this year’s Budget, Chancellor Alistair Darling held off from introducing any new tax rises. Yet December’s pre-Budget report saw the scaling back or freezing of several tax bands and allowances over the long-term, which means that - thanks to ‘fiscal drag’ - more people will pay more tax in real terms.

Forget the high-rollers - more modest earners will be hit thanks to the Chancellor’s decision to freeze the inheritance tax threshold at £325,000 up to and including the 2014/15 tax year. The decision not to raise the threshold in line with inflation means that increasing numbers of families will be liable to pay 40% in ‘death duties’ as inflation and house price rises push up the value of their estates.

• Watch our video on Britain's most hated tax.

The freezing and scaling back of income tax allowances will also see millions pay out more to HMRC. The threshold for higher-rate income tax will be frozen at £37,401 until the 2012/13 tax year - meaning that, in real terms, any pay rises or wage inflation for middle-income earners will go straight in the taxman’s pocket.

Society’s highest earners will also be hit by this big claw back - in addition to trousering the new 50% income tax band. Those earning between £100,000 and £112,950 will pay more in real terms following the abolition of their personal tax allowances - meaning that, in effect, they too will pay 50% income tax on every penny earned above £100,000.

And even pensioners are having to stump up more. A study for financial services group MetLife Europe, shows that retirees are having to hand back 30% of their income to the Government through direct and indirect taxes, with income tax on retirement savings taking the biggest share.

The big tax waste

If the effects of the tax claw back weren’t bad enough, millions of taxpayers have already paid too much this year - through no fault of their own. This year saw HMRC send out hundreds of incorrect tax Coding Notices after installing a new computer - leaving it to taxpayers themselves to work out for themselves whether their code was right or wrong.

And we also pay out too much through our own inertia - research from professional advice body IFAP, estimates that UK taxpayers waste some £9bn in unnecessary and unavoidable tax payments through lack of adequate tax planning. Inheritance tax sees the biggest wastage, with taxpayers paying £2bn alone in unnecessary ‘death duties’, while families are losing out through failing to claim tax credits owed to them.

Recent question on this topic

• netforce911 asks:

  Why do I have to pay Council tax Twice if I move house

  • 
    champ69 answered "? contact them... 12 mths = 12 mths payments. N mths at one house, N (balance) at the new house..."
  • 
    MikeGG1 answered "You pay the appropriate proportion for each house. Your solicitor should have arranged that..."
  • Read more answers

Take tax action  

You can find more comprehensive help in managing your inheritance tax burden and paying less council tax but whatever your situation, there are three simple yet vital measures you can take to reduce your tax burden.

1: Check your tax code

It’s vital to know that you’re paying the right amount of tax - so check your Coding Notice, which is assigned to every taxpayer. Your code contains two pieces of information - a number that shows how much money you can earn before paying tax and a letter that shows your tax status. For a basic rate taxpayer this should read 647L - you can check your rate against the national income tax bands. To contest your band, contact your local tax enquiry centre or visit the HMRC website.

2: Plan for inheritance tax 

The only certain way to make sure your loved ones aren’t faced with an inheritance tax bill is to plan ahead. Making a valid will is essential and you can also reduce your total liability by giving ‘gifts’ ahead of your death. The annual tax-free allowance for these gifts is £3,000. It can also be prudent to see advice from an independent financial advisor and a solicitor.

3: Make pension contributions 

Basic rate taxpayers can in real terms extend their tax-free threshold by making regular pension contributions through pension tax relief. For example, you pay income tax on your earnings before any pension contribution, but the pension provider claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot.

Shelter more of your money from the taxman by opening a best buy tax-free ISA.

More: Why you should love paying tax! | How to slash your council tax bill