Maxing a tax efficient difference with our gifts

Many of us will gift to charitable causes regularly throughout the year, using Gift Aid or Payroll Giving, but fewer of use appreciate how this works, we purely give from the goodness of our hearts to help others less fortunate.

Gift Aid

Gift Aid works similar to how personal pension tax relief would work. When you make a donation to a charity though Gift Aid, basic rate income tax relief is added to the payment by HMRC and the total amount, known as the gross payment, is paid across to the charity. If you are a higher rate i.e. 40%, or an additional rate i.e. 45%, income tax payer, you can enter the total gross payments you make in a tax year onto your self-assessment tax return and claim further tax relief, few people appreciate this additional tax claim.

Some 52% of those who donate money to charity said they used Gift Aid on their donation, according to the UK Giving 2017 report, by the Charities Aid Foundation. You need to ensure you complete a Gift Aid declaration form for each charity you wish to donate to.

This is how the numbers work;

Gifting £100 to a charity via Gift Aid would mean they would claim 25% of the contribution and a total of £125 would (eventually) end up in the charity bank account. The £100 has effectively been ‘grossed-up’ by the 20% income tax you have paid (100/20%) = £125.

If however you pay income tax at 40%, you can enter the £125 gross payment on your self-assessment and effectively claim a reduction in your end of year tax payment of a further 20% or in this example £125 x 20% = £25.

So for every £100 you give as a higher rate tax payer, you reduce your income tax bill by £25.

It goes further if you are an additional rate income tax payer (i.e. you have total income over £150,000pa), you clam 25% (45%-20%) of your gross contributions, or £31.25 for every £100 you pay to a charity.

This additional tax refund makes the effective net cost to you far less, as shown in the table below;

Tax payer Payment Total charity receives Net cost to you
 Basic or 20%  £100  £125  £100
 Higher or 40%  £100  £125  £75
 Additional or 45% £100   £125  £68.75

Do I have to pay tax to use Gift Aid?

It’s important to know you need to pay tax to use Gift Aid, and it’s the donor’s responsibility to notify the charity if they become a non-tax payer. You cannot claim more tax in Gift Aid than you pay.

How do you claim tax relief?

Complete the charitable giving section on your annual self-assessment tax return or ask HMRC to amend your tax code which is used to calculate how much tax-free income you’re entitled to. You can reach HMRC on 0300 200 3300.

How long can you claim back for?

If you forget to – or were unaware you could – claim tax relief you have four years to submit a claim for tax ‘overpayment relief’ to HMRC. That’s four years after the end of the tax year your claim relates to.

For example, currently it’s the 2018/2019 tax year and it ends 5 April 2019, so you could claim as far back as the 2014/2015 tax year which ended 5 April 2015.

Payroll Giving

An alternative to Gift Aid is Payroll giving, or I have also seen this referred to as Give As You Earn. If you donate to a charity through a payroll giving scheme at work, donations are taken out of your gross pay – that’s your pay before tax (and national insurance) is deducted. So there’s no tax relief to claim and it’s far easier.

Gifting to a charity in our will

If the art of living is giving, what about our final bequest?

Many of us don’t appreciate the benefits of leaving a charitable legacy through our will.

All gifts to a charity are exempt from inheritance tax, so if you left your whole estate, or at least the excess of your estate which is over the tax-free allowances – your estate would pay no inheritance tax.

Each estate has a tax-free ‘nil rate band’ of £325,000 per person and possibly a tax-free ‘residential nil rate band’ which is currently £125,000 per person (if your main residence is left to your direct descendants ) up to these amounts, you would pay no inheritance tax and for estates valued over this amount, you would likely pay inheritance tax at 40% on the excess. It’s important to note that both of these tax-free allowances can be inherited from your spouse, if they predecease you.

However, for most, this is a step too far and this may upset the surviving family! So, leaving 10% or more of your taxable estate to a charity would have the effect of reducing your inheritance tax rate from 40% to 36%.

Therefore in this example, a married couple, with a will and an estate of £1m, could deduct two lots of £325,000 and two lots of £125,000 (assuming they meet the criteria) to give a taxable portion of their estate of £100,000.

Ordinarily, this would be taxed at 40% or £40,000 inheritance tax, however leaving 10%, or £10,000 to a charity, reduces the inheritance tax rate from 40% to 36%, and would make the remaining £90,000 estate taxable at 36% or £32,400 inheritance tax.

Here are the numbers;

Estate value: £1,000,000
Nil rate band (times two): £650,000
Residential nil rate band (times two): £250,000
Net taxable estate: £100,000

No charity payment – 40%: £40,000

With a £10,000 (10%) charity payment – 36%: £32,400

Summary

Of course there is the finer detail to any financial planning, but the concept of leaving a legacy in your will to a charity is very tax efficient and helps others, from beyond the grave and will reduce the amount of inheritance tax your executors will need to pay.