Why more people face a big January tax bill

Let’s not beat around the bush, January is an awful month. You’ve just spent a packet on Christmas, your favourite clothes are inexplicably tight, and your efforts to work off a little holiday weight in the gym are hampered by everyone else trying to do the same thing.

It’s against this backdrop of seasonal wretchedness that HMRC stations its deadline for filling in a tax return, should anyone feel too chipper about the slight increase in daylight hours towards the end of the month.

The final deadline for submission to the tax authorities is 31 January, and the bad news is the forthcoming tax return in 2025 will be significantly more painful for many savers and investors. That’s because they face a higher tax bill on their bank interest, share dividends and capital gains.

Higher rates on your savings

The tax return people will be completing by the end of January 2025 refers to the tax year running from 6 April 2023 to 5 April 2024. It was during this year that the base rate reached its recent peak of 5.25%, and as a result, savers enjoyed access to higher rates of interest than they had seen since the financial crisis.

The average instant access rate offered by UK banks and building societies across the tax year was 2.5%, according to the Bank of England, though the most competitive rates were around double that amount. A positive development for savers, no doubt. But as a result of the dramatic shift in rates, many have had to think about the tax due on their interest payments for the first time in ages.

Nowadays, banks pay interest without any tax deductions, because of the personal savings allowance, an amount of interest taxpayers can receive each year tax-free. This is £1,000 for basic rate taxpayers, £500 for higher rate taxpayers and nothing for additional rate taxpayers.

When interest rates were close to zero, this meant most cash savers didn’t have to worry about a January tax bill. A higher rate taxpayer receiving an interest rate of 0.5% on their cash needed £100,000 sat in the bank to breach their personal savings allowance, during the days of ultra-low interest rates.

If that rate rose to 5%, suddenly anything over £10,000 in a standard savings account starts to create a tax liability. For plenty of savers, the January 2025 tax return will be the first time they have reckoned with the tax implications of higher interest rates.

Potential for more tax on dividends

Shareholders face a similar issue with their dividends. That’s because everyone receives a dividend allowance, which is the annual value of dividends which can be received tax-free.

When this was introduced in 2016/17, it stood at £5,000. From 2018, this was cut to £2,000, and for the tax year 2023/24, which is what taxpayers will be filing this coming January, it was cut to £1,000. That means the potential for even more tax for those who hold dividend-paying portfolios outside of a tax shelter. The tax return due in January 2026 will be even tougher, because for the current tax year the dividend allowance has been halved again, to just £500.

Gains on share sales are also in the spotlight this coming January because the capital gains tax (CGT) allowance has been drastically cut back too. This is the amount of gains you can cash in each year without paying tax.

Only a few years ago this stood at £12,300, but last tax year it was cut to £6,000, so those filing their tax return in the coming weeks will need to reckon with this too.

Impact of capital gains tax changes

Again, there is more pain in the post, as the current tax year has seen the CGT allowance cut to just £3,000, so next January promises to be even more punitive for anyone with gains to report to the taxman. This will be amplified by the fact the Chancellor has increased the rates of capital gains tax on shares from 30 October 2024, to 18% for basic rate taxpayers and 24% for higher rate taxpayers (from 10% and 20% respectively).

If you’re facing a large January tax bill as a result of these changes, there’s very little you can do about it, given the tax refers to the previous tax year, not this one.

One exception is making a charitable donation, which can be carried back one tax year, provided it is recorded in the forthcoming January tax return. If you’re a higher or additional rate taxpayer this could trigger a tax rebate which would be set against any tax you owe.

Even though your January 2025 tax bill might be a lost cause, it’s worth giving some thought to this time next year. Next January promises to be even worse for savers and investors filling in their tax returns, thanks to lower capital gains tax and dividend allowances, not to mention frozen income tax bands pushing more people into higher tax brackets.

It’s still possible to make pension contributions and ISA subscriptions in this tax year (provided you have allowance remaining), which could well help to reduce your tax bill next January, especially if you’re a higher rate or additional rate taxpayer.

The deadline for contributions is the end of the tax year on 5 April 2025. The January 2026 tax return might well feel like a problem for another day, but action now could really take the edge off what might otherwise prove to be a punishing tax bill this time next year.