Stop Paying Too Much Tax!

We're forced to pay taxes in order to live in a civilised society. Nevertheless, here's how to ensure that you don't pay a penny more than you owe.

"There is no such thing as a good tax." (Winston Churchill)

Although grumbling about taxation is an almost universal pursuit, the fact is that society can't survive without taxes, which are the glue that holds nations together.

Without taxation, every service which is currently provided by our government would have to be purchased privately. This would put people on low incomes at a severe disadvantage to higher earners, because they would struggle to afford healthcare, education, policing and so on.

Nevertheless, the UK's tax system doesn't necessarily favour the poor, because the wealthy go to extraordinary lengths to avoid taxes, as I revealed in How To Become A Tax Dodger. Hence, it seems that middle-income households take the brunt of tax rises, being squeezed between ever-rising taxes and household bills.

Now for some bad news: according to Independent Financial Advice Promotion (IFA Promotion), in 2006, almost five out of six people (82%) will pay more tax than they need to. In total, our overpaid tax comes to a whopping £7.6 billion, or over £300 for each of the UK's 25 million households. So, without further ado, here is a guide to trimming your taxes to the bone -- legally, of course!

(By the way, you'll find more information on this year's tax allowances and so on in Has The Budget Made You Richer?)

Capitalise on this £8,800 tax-free allowance

If you make a gain from selling shares outside of a tax-free ISA shelter, you could lose up to two-fifths (40%) of this gain to the taxman, thanks to capital gains tax (CGT). By making use of your personal CGT allowance of £8,800 for 2006/07, you can avoid this tax. What's more, by gifting assets to our spouses or civil partners, we could save almost £400 million a year.

"The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation."

(V I Lenin)

You can buy and sell shares cheaply via an online stockbroker.

Claim your tax credits

According to IFA Promotion, workers and families have failed to claim almost £3 billion of tax credits, including the Child Tax Credit, Working Tax Credit and Pension Credit. Although these aren't a 'free handout' (they are simply a redistribution of taxes), they are certainly worth claiming, with nine in ten families eligible for some contribution. Find out what you can claim at independent benefits website EntitledTo.

"Not one cent should be raised unless it is in accord with the law." (Napoleon Bonaparte)

Contribute more to your pension

For every £78 that you pay into a pension, the taxman chips in £22 in the form of basic-rate tax relief, so £100 is invested. What's more, higher-rate taxpayers can reclaim further tax relief worth £18 via their tax return or a PP120 form, so a £100 contribution costs a mere £60. So, by paying more into your company or personal pension, you can reclaim some of the tax that you've already paid. In addition, your contributions could move you to a lower tax bracket, which is no bad thing!

"I'm proud to pay taxes in the United States; the only thing is I could be just as proud for half the money." (Arthur Godfrey)

Visit the Fool's Pensions centre.

Let your employer enrich you

This article explains how workers can enjoy discounts and tax breaks when buying shares in their employer. This can be a real money-spinner, especially when firms hand out free shares via an approved Share Incentive Plan. For example, the 600,000 people who presently contribute to profit-related-pay share schemes save over £200 million a year in tax.

"The avoidance of taxes is the only intellectual pursuit that carries any reward." (John Maynard Keynes)

Save or invest using this tax-free shelter

We Brits waste £170 million a year by paying avoidable taxes on our savings interest. Then again, with a tax-free cash mini-ISA, you can squirrel away up to £3,000 per tax year in order to earn tax-free interest, safe from the taxman's grasp. Alternatively, if you prefer to invest in shares, funds or bonds, you can stuff up to seven grand per tax year into a shares maxi-ISA (but you can't open one of each in the same tax year).

"Collecting more taxes than is absolutely necessary is legalized robbery." (Calvin Coolidge)

Send your tax return and payments promptly

If you fail to complete and submit your tax return for 2005/06 by 31 January 2007 (or 30 September 2006 if you want the taxman to calculate your tax for you), then you'll be automatically fined £100. This happens to hundreds of thousands of taxpayers each year, who also face further penalties for late payment. In total, we cough up close to £500 million in tax-related fines. Ouch!

"Next to being shot at and missed, nothing is really quite as satisfying as an income tax refund."

(F J Raymond)

Take steps to avoid the dreaded death tax

If you own assets (including property) worth more than £285,000, your death could trigger a 40% tax bill on any excess over this nil-rate threshold for Inheritance Tax (IHT) for 2006/07. Imagine: you've never been a higher-rate (40%) taxpayer in your life, yet your heirs could face a 40% IHT bill on your estate. Criminal, isn't it? Hence, it's crucial to use Wills, trusts and other estate-planning techniques to avoid IHT, which could save UK taxpayers £1.3 billion a year.

"The wages of sin are death, but by the time taxes are taken out, it's just sort of a tired feeling."

(Paula Poundstone)

Use Gift Aid when donating to charity

When you drop £1 into a collecting bucket, one pound is all that a charity gets. However, each pound donated to charity via Gift Aid, Pay As You Earn giving or Deed of Covenant is worth £1.28, thanks to tax relief. Also, higher-rate taxpayers can claim a further 23p via their tax returns, so a donation of £1.28 costs them a mere 77p. If we all gave to charities in a tax-efficient manner, they would gain an extra £800 million a year, which would go a long way towards helping vulnerable members of society.

"Why does a slight tax increase cost you two hundred dollars and a substantial tax cut save you thirty cents?" (Peg Bracken)

Use your child's tax shelter

Parents, family and friends of children with Child Trust Funds (CTFs) can use these tax shelters to save or invest up to £1,200 a year while steering clear of the taxman. Our children would gain over £20 million a year if we all saved and invested in CTFs, rather than the taxable substitutes.

"There's nothing wrong with the younger generation that becoming taxpayers won't cure."

(Dan Bennett)

Use your personal tax allowances

If you don't earn enough to pay tax, then you should complete a form R85 in order to stop 20% savings tax being deducted at source; non-taxpayers lose nearly £320 million a year by not doing this. Also, if you are married or in a same-sex Civil Partnership, you can reduce your overall tax bill as a couple by transferring savings to a non-taxpaying partner. Again, this would save taxpayers almost £230 million a year.

"The only difference between a taxman and a taxidermist is that the taxidermist leaves the skin."

(Mark Twain)

Finally, I'll leave you with a quote about the moral right of individuals to avoid paying needless taxes:

"Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands."

(US Appeals Court Justice the Honourable Learned Hand)

So, don't feel bad about avoiding taxes, because you have the law on your side!

More: Use the Fool to compare cash ISAs, compare investments, compare pensions and compare Child Trust Funds!