How philanthropy might reduce your tax bill in January

Have you made charitable donations since 6^th April 2023?

When you’re completing your tax return, you normally focus only on information which relates to the previous tax year i.e. 6^th April 2022 to 5^th April 2023.  There is however something you might have done since 6^th April 2023 (or might still do this January) which can be taken into account and could reduce your tax bill for the previous tax year.  The UK tax system enables you to carry back tax relief on certain charitable donations you make in the current tax year (2023/24), up to the date you file your tax return for the previous tax year, as long as you do this before 31^st January.  This means if you, or your accountant, are yet to press the button on filing your tax return, you might still be able to reduce your 2022/23 income tax bill if you have made a qualifying charitable donation, or are about to do so in January before your tax return is submitted.

Charitable donations can reduce your income tax bill in two ways

Let’s consider a case study to illustrate this, with an example of someone in their 50’s in England and Wales who earns a salary of £109,000 in tax year 2022/23.  This individual has significant ISA investments and is not currently making pension contributions. 

Since this individual is earning more than £100,000, they won’t get the full tax-free personal allowance of £12,570, which starts to taper off after £100,000 of income, and eventually disappears once you have income of £125,140 or above.  Their personal allowance is reduced by £4,500, with the result that £4,500 more of their income is taxed in the higher rate band at 40% rather than basic rate of 20%.

The 2022/23 income tax bill of this individual would be £32,832 (see footnotes for calculations).  

Alternatively, let’s now imagine this individual has not yet filed their 2022/23 tax return, and in January 2024 makes a donation of £8,000 to their favoured UK charity, before filing their tax return to meet the deadline at the end of the month.  This donation is done with a Gift Aid declaration. There are three financial benefits which flow from this philanthropic act. 

First, the charity can claim Gift Aid of £2,000 (25% of the donation) to boost the donation up to £10,000 (the gross donation). 

Second, because the donor is a higher rate taxpayer, tax relief is given by extending their basic rate band (the 20% tax band) by the gross amount of the donation (£10,000).  This means £10,000 less income is taxed at 40% and is taxed at 20% instead. 

Third, the donation also extends the individual’s £100,000 threshold by the gross amount of the donation (£10,000).  This means the adjusted net income for this individual in 2022/23 is now £99,000 instead of £109,000 and as a result, their full tax-free personal allowance of £12,570 is therefore reinstated.  The financial benefits of making a charitable donation are particularly noteworthy for individuals in this income bracket, who not only benefit from the Gift Aid tax relief for higher rate taxpayers, but who also receive the secondary impact of a restored personal allowance.

As a result of this £8,000 donation in January 2024, the 2022/23 income tax bill of this individual would now be £29,032, prompting a tax refund of £3,800.

Watch the small print – not all charitable donations qualify for tax relief

There are some important details and qualifying criteria relating to Gift Aid, and you should always take advice to understand your own tax position and whether tax reliefs are available to you.  Depending on what rate of tax you pay, and the status of the recipient of your donation, it is possible that no tax relief may apply.  Further, if you are claiming tax relief on donations made since 6^th April 2023 in the tax return you file in January 2024, your donations from this, and the previous tax year together must not be more than four times what you paid in tax in 2022/23.  There is complexity here which could trip you up, without the correct advice. 

Last January, HMRC revealed that 129 people had been online to submit their tax return between midnight and 1am on 1^st January.  If that’s not what you were doing to bring in the new year, and you’ve still to file your own tax return this month, don’t forget that your philanthropy today might still reduce your income tax bill for last year.

Footnotes

This article is not tax advice. Your individual circumstances will affect your income tax position and not all charitable donations qualify for Gift Aid.  Different income tax rates apply in Scotland. Please take professional advice. 

Calculations for case study:

Personal allowance (12,570 – 4,500) = £8,070 tax free

Next 37,700 @ 20% = £7,540 tax

Balance of £63,230 @ 40% = £25,292 tax

Total income tax bill of £32,832

After charitable donation with Gift Aid:

Personal allowance of £12,570 tax free

Next 47,700 @ 20% = £9,540 tax

Balance of £48,730 @ 40% = £19,492 tax

Total income tax bill of £29,032

Income tax reduced by £3,800