Reduce your tax bill now, before the Chancellor attacks your wealth.
Chancellor Alistair Darling has announced that the final Budget of this Parliament will be presented on Tuesday, 24 March.
Bad news for the well-heeled
This is no ordinary Budget of course. With the pressure on to cut the public sector deficit and an election less than 3 months away, higher earners and the wealthy are very likely to get caught in the crossfire.
Hence, anyone interested in minimising their tax bill has only a few days to act. Indeed, investors must react now in order to grab tax breaks that might get removed. Taking the right steps today could generate substantial tax savings for decades to come.
Four tax threats for investors
Indeed, it's easy to identify four areas where taxes could go up without risking too many votes:
1. Pension tax relief
Darling has already acted to cut the tax relief available to high earners. From 6 April 2011, individuals with a yearly income of £130,000+ face restrictions on the amount of higher-rate (40%) tax relief they can claim for pension contributions. Those earning £180,000+ will be entitled only to basic-rate (20%) tax relief.
The above move will affect a mere 300,000 people; just 1 in 100 workers. However, it will raise around £3.6 billion a year, which is a drop in the ocean when compared to the £178 billion shortfall expected in the 2009/10 tax year.
It seems highly likely that pension tax relief will be scaled back even further -- probably for those on upper five-figure salaries.
The solution
Do what you can to pump up your pension contributions before the Chancellor addresses the House of Commons on 24 March. My advice would be to look into making extra one-off or monthly contributions into a low-cost, flexible SIPP -- see 21 Years Of DIY Pensions.
2. Income tax
From 6 April 2010, the highest rate of income tax is to rise to 50% from 40%. This affects anyone with earnings of £150,000+. Likewise, the wealthy elite face a substantial increase in the tax rate applied to share dividends: from 6 April, this tax rises to 42.5% from 32.5%.
At the same time, those earning £100,000+ a year will be gradually stripped of their tax allowances, raising their effective rate of tax. For every £2 of earnings above £100,000, the personal tax allowance will reduce by £1 until it reaches zero. This will affect 700,000 people and raise £1.5 billion a year.
The solutions
The obvious answer to these tax hikes is to maximise your use of legal tax shelters. Every saver and investor should make full use of their yearly ISA allowances. To claim your 2009/10 ISA allowance, you need to open and fund an account by 5 April. Otherwise, this allowance is gone forever.
At present, you can put in up to £10,200 if you're 50+ and up to £7,200 otherwise. All adults get a £10,200 allowance in 2010/11 onwards.
In addition, high earners and sophisticated investors should look into Venture Capital Trusts (VCTs). When you invest in new VCT shares, you get 30% income-tax relief up to the level at which your tax bill is wiped out completely. In addition, VCT dividends are tax free, and there is no CGT to pay on gains from VCT shares. For more info, read High Earners Venture Back To VCTs.
3. Capital Gains Tax (CGT)
With big hikes planned to income-tax rates, the CGT rate of 18% (plus a £10,100 yearly tax-free allowance) looks remarkably generous. Only a small number of investors -- usually under 50,000 a year -- pay CGT.
With the growing popularity of investments producing capital gains rather than income, CGT is clearly in the Chancellor's sights. He could dramatically increase the rate of CGT by, say, returning it to its previous level of 40%, without harming the general public at all. However, this would hit successful investors and entrepreneurs for six.
The solutions
The obvious answer is to bank some profits now, in order to take full advantage of the current CGT rate and yearly allowance. Also, CGT isn't payable on gains made inside pensions and ISAs, so these should be your first port of call.
VCTs offer CGT breaks, and the Enterprise Investment Scheme (EIS) offers a range of tax reliefs for investors. Indeed, the EIS allows you to claim income-tax relief at 20% on up to £500,000 (a maximum claim of £100,000); defer previous capital gains for three years on up to £500,000 invested; pay no CGT on gains; claim loss relief against income tax; plus exemption from Inheritance Tax.
Then again, EIS companies are fiercely risky, so do read the warnings in The Risky Business Of Enterprise Investment Schemes.
4. Inheritance Tax (IHT)
Taxing the rich also extends to death duties for the well-off. The current nil-rate band for IHT of £325,000 will be frozen into the 2010/11 tax year. Estates valued above this band face a flat 40% rate of IHT.
Obviously, the present Chancellor and his successor could raise the rate of IHT to, say, 50% on the largest estates, plus freeze or lower the nil-rate band. Another option would be to restrict the level of IHT-exempt gifts which can be made each year.
The solution
One way to avoid IHT is to invest in AIM shares for at least two years, as I explained in Four Faults With AIM Shares. That's a risky option though and a better way is to make full use of available loopholes, as explained in Sharing Assets With Your Family.
In summary
There's an old saying that goes "don't let the tax tail wag the investment dog". So, when making any tax-based decision, make sure you have solid investment reasons for taking such action as well.
Once tax increases have been implemented, or allowances reduced, they are very difficult to roll back. A failure to act now could have a long-term impact on your personal wealth. So, don't delay; dodge tax today!
More from Cliff D'Arcy:
> Time is running out if you want to use your tax-free ISA allowance for 2009/10. And remember, if you're 50 or over, your limit has now been increased to £10,200. Protect your investments from the taxman with a Motley Fool Self Select ISA.
