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Tax planning: Relax and make allowances for yourself

Take all that you're entitled to from the Inland Revenue, says David Prosser
The Inland Revenue is not exactly renowned for its generosity. Even so, a system of tax allowances does enable people to shelter some, or even all, of their income from tax. There are also a number of ways to reduce the amounts that you might have to pay in capital gains tax (CGT) and inheritance tax (IHT).

Tax allowances

Everyone is entitled to a personal tax allowance. This is the part of your income the Inland Revenue does not consider when it is working out how much tax you pay.

Your personal allowance is the part of your income that is totally tax free. It is pounds 4,195 in 1998-99. Make sure you are claiming this allowance, particularly if you are covered by the self-assessment tax system. You cannot transfer your personal allowance to anyone else if you do not use it. However, husband and wives can transfer investments to each other, tax free. If one partner is not a taxpayer, he or she should hold any investments that generate income as the personal allowance means there may well be no tax to pay.

Retired people are entitled to an age-related tax allowance. This is basically a souped-up personal allowance. A single person aged 65 or over gets a personal allowance of pounds 5,220 this year or pounds 5,400 if they are over the age of 75.

Married couples who live together can claim an allowance giving tax relief at 15 per cent on pounds 1,900. This is a maximum tax saving of pounds 285. It is not much and there are rumours that it may disappear altogether in the Budget next month.

Unless you tell it otherwise, the tax office will give this allowance to the husband but it can be shared equally between partners, or the wife can take it all.

Married couples also get bigger allowances when they reach the ages of 65 and 75, as long as the claiming partner's income is less than pounds 15,600.

A widow can claim a small additional tax allowance in the tax year her husband dies and in the following tax year. This is worth up to pounds 285 in saved tax.

Capital gains tax

Capital gains tax is payable on profits you make when disposing of investments or some other assets, such as a second home. But there are several ways to reduce the amount of CGT you pay. First, everyone is allowed to make a certain amount of capital gains each year tax free. In 1998-99 this is pounds 6,800.

Also, note that all capital gains on investments held within a personal equity plan (PEP) or, after 5 April, an individual savings account (ISA), are totally tax free.

If you have used up your CGT, PEP and Tessa allowances and have additional capital gains, don't despair. You are allowed to deduct any capital losses you have made this year from your gains before declaring them to the tax office.

You may even deduct losses made in the previous five tax years if you did not use these to reduce your taxable gains at the time.

You can also reduce the size of your taxable gains by deducting the amount of the gain that was due to inflation between the time you bought it and April 1998.

After April 1998, you qualify for taper relief. This means that the longer you hold an investment the less tax you pay. Your local tax office (in the phone book under Inland Revenue) will explain how to apply.

Finally, investments in venture capital trusts and the enterprise investment schemes enable you to defer paying any capital gains tax, and the proceeds of such investments are CGT free. These are risky investments and you should not invest purely to save tax.

Inheritance tax

Inheritance tax is payable on your estate if it is worth more than the IHT allowance when you die. This is pounds 223,000 and is likely to increase year by year in line with inflation. This sounds a lot but the value of your home counts towards the value of your estate. If you have elderly parents you could be liable to pay tax at 40 per cent on the value of their estate over pounds 223,000.

The best way to limit future IHT liabilities is to give some assets away before you die, reducing the value of your estate. There are strict rules about how you do this but each of us can make as many gifts worth less than pounds 250 as we like in one tax year, although they must all be to different people. You can make other gifts worth up to pounds 3,000 each year.

You are also allowed to make "potentially exempt transfers". These are gifts not covered by the pounds 250 and pounds 3,000 limits. If you live for seven years after making these gifts, no tax is payable. There is speculation this rule may be abolished in the Budget.

Inheritance tax planning can get complicated and it is often worth getting professional advice. To preclude complications, you should certainly make sure that your will is always up to date.

David Prosser is personal finance editor of `Investors Chronicle'.