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Guide to tax allowances

Introduction

There are few things more contentious than discussing the merits or otherwise of taxes. Everyone will have his or her opinions on taxation – and most will be opposed to anything they believe is skinning them alive.

Yet the overall premise, that of society collectively taking a proportion of everyone’s assets and using that money for the public good, is widely accepted. In that context, income tax is the most widely known-about tax of all.

But not necessarily the most understood. The UK income tax system is complicated, with incomes being subject to varying amounts of tax. Meanwhile, some people pay no income tax at all. So how does it all work?

Allowances

The starting point is that the tax year runs from April 6 to April 5.

Within that period, everyone is allowed to earn a certain amount of money without paying tax, regardless of how that income is earned.

Here are some basic pointers:

• Allowances are “personal”. That is, they apply to you and cannot be transferred to anyone, not even your spouse. Use it or lose it, as they say

• Men or women under the age of 65 pay no income tax if their earnings are below £6,035 a year

• A person aged over 65 pays no tax on earnings below £9,030, while the over-75s pay no tax on annual earnings below £9,180. There is a small sting in the tail here, of which more later on

• Anyone registered as blind with a local authority can claim blind person's allowance. A registered blind person must be unable to perform any work for which eyesight is essential. This allowance is in addition to the personal allowance

• Until a few years ago, married couples were also eligible for an allowance. This has now been changed, so that anyone under the age of 65 on 6 April 2000 is not entitled to an allowance. Those born before 6 April 1935 still qualify for an allowance

A list of tax allowances for the 2008-2009 tax year is set out below.

The allowance “sting” for over-65s

No government is unconditionally generous. For pensioners over 65, this applies to their extra allowance. As we saw earlier, they enjoy an extra amount of tax-free income, £2,995 in the case of the over-65s and £3,145 for the over-75s.

However, as soon as their earnings exceed £21,800, their benefits are progressively removed, at a rate of £1 for every £2 above that limit.

Income tax rates

Above the income levels we have described, income tax must be paid.

There are currently two main bands:

• 20 per cent on earnings between up to £34,600 above the allowance limit
• 40 per cent on earnings above the £34,601 allowance limit

The government abolished the previous 10 per cent tax rate in 2008, leading many in opposition to claim that the poorest and lowest-paid were worse off. However, it has been far from straightforward to calculate the true implications of the change in tax rules.

The “break-even” point, the level at which the benefits of the new 20 per cent rate outweigh the disadvantages of abolishing the 10 per cent rate is calculated at about £18,000 a year. This is how much you need to earn before the changes benefit you.

That said, the government claims that it is offsetting these potential losses by increasing tax credits for the lower-paid, as well as parents with children, by more than inflation. Except that not all people claim the credits they are entitled to.

If you are among that number, claim now. The place to start is on the DirectGov website, here.

To give you an idea of what these credits are and how they may help, read our article elsewhere in this section – See our [LINK]Tax Credits Fact Sheet.

How much tax do you pay?

Either way, to calculate how much income tax is payable in total, you work out how much of your earnings fall under each category and deduct the appropriate percentage from each slice – without forgetting the original allowance you are entitled to.

Interest on bank and building society accounts is paid with 20 per cent tax already taken off. Non-taxpayers can get interest paid gross by filling in HM Revenue & Customs form R85, available from bank branches. Anyone who has failed to do this in the last five years can reclaim the tax paid using form R40.

Higher rate taxpayers are liable to pay 40 per cent on their savings. This has to be declared every year to HM Revenue & Customs.

More pages

Page 1: Introduction
Page 2: How much tax do you pay?

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