Tax advisers are busy advising clients on ways to avoid the new child benefit high income tax charge. One document I received from Nick Braun, managing director of Taxcafe UK runs to 90 pages on how to retain child benefit. I’ve picked out the pertinent points from his advice and that of other tax experts.
Child benefit is a valuable tax-free gift from the government to parents. But your family's child benefit payments will be clawed back if either you or your spouse/partner have income over £50,000. If your income exceeds £60,000 all of your child benefit will be taken away.
At £20.30 a week for a first child and £13.40 per additional child, a family with three children caught by the new rules faces the prospect of being £2,450 worse off a year (£47.10 per week), broadly equivalent to nearly a £4,000 pay cut for a 40 per cent tax payer.
As the benefits continue for up to 20 years, parents could receive around £21,000 for a first child and around £14,000 tax free for each additional child.
The £50,000 threshold can be changed by the government but will not automatically increase with inflation. What this means is that if you earn less than £50,000 at present you may end up paying the child benefit charge in the future even if your income only increases because of inflation.
There could be a u-turn if the government finds the child benefit too difficult to implement. So do not take any action to avoid the child benefit charge that you will later regret if the new tax is changed or abolished.
SHOULD HIGH EARNERS OPT OUT OF CHILD BENEFIT?
Families with a member earning £60,000 or more have the choice of opting out of receiving child benefit or facing a tax charge via self-assessment to pay back the full amount received.
The tax man would probably prefer you to stop receiving child benefit to cut down on the number of tax returns. There are two small advantages: it will help with budgeting as you won’t have to find a lump sum to pay it back; plus, it will also allow you to avoid filling in a tax return, if you don't already complete one. However, if you opt out then you are in effect turning down an interest free loan from the government.
There is a misconception that if you stop receiving child benefit your state pension will suffer. If you are entitled to receive child benefit and do not work or do not earn enough, you qualify for national insurance credits that protect your state pension entitlement. You qualify to receive the credits as long as you have children under age 12.
However, if you stop your child benefit payments you will still receive national insurance credits as long as you are entitled to claim child benefit. This means that when you have a child, a child benefit claim form should always be completed, even if you decide to not receive the payments.
If your income is between £50,000 and £60,000 you should keep receiving child benefit. The tax charge will always be less than the child benefit received.
If your income fluctuates due to factors beyond your control and may be less than £60,000 in some tax years, you may wish to keep the child benefit payments going. A good example would be a self-employed individual whose profits fluctuate from year to year.
If you can control the amount of income you receive and keep it below £60,000 in some tax years, you may also wish to keep the child benefits going. A good example would be a company owner who can control the amount of dividend income he can receive.
BEST TACTICS TO RETAIN CHILD BENEFIT
Avoiding the child benefit charge is not an all-or-nothing outcome. You may wish to take action even if this means you only partly reduce the charge, or avoid it in some years but not others.
For the 2012/13 tax year the child benefit charge only applies to child benefit received between 7 January 2013 and 5 April 2013, ie one quarter of the tax year. This means the tax charge this year is effectively one quarter what it will be next year. So you may wish to concentrate on keeping your income below £50,000 for the 2013/14 tax year.
1. SHIFT INCOME
Avoiding the child benefit charge is all about reducing the higher earner in a couple’s adjusted net income to under £60,000 and, preferably, under £50,000.
You could do this by shifting income to the lower earning partner. Income that can be shifted, in certain instances, from one partner to another includes: private company dividends, self-employment profits, stock market dividends, rental income and interest income.
One of the simplest ways for almost all taxpayers to avoid the child benefit charge is by making pension contributions. Pension contributions reduce your adjusted net income by the amount of the contribution, which can then reduce the child benefit charge. Many people don’t like the restrictive pension rules that apply to your money once invested. However, others think the high tax relief makes it worthwhile.
How pensions contributions can work to your advantage:
Peter has income of £60,000 in 2013/14. His wife earns £30,000 and receives child benefit for two children of £1,752. Peter makes a £10,000 gross pension contributions. This results in his adjusted net income falling from £60,000 to £50,000. This means he will completely avoid the child benefit charge of £1,752.
In addition, he enjoys total tax relief of £5,752 (58 per cent) on his £10,000 pension contribution. This is made up of £2,000 basic-rate relief, £2,000 higher-rate relief and the £1,752 child benefit charge.
If Peter didn’t make the pension contributions, he faces paying £4,000 income tax on the top £10,000 slice of his income, and the maximum child benefit charge: £1,752. Peter’s total tax on the income will be £5,752, leaving him with just £4,248 take home income.
Peter has to decide whether he wants £10,000 saved in a pension versus £4,248 of after-tax income to spend.
3. SALARY SACRIFICE
Employees can reduce their income via salary sacrifice. Salaried employees can benefit from salary sacrifice pensions which provide both income tax relief and national insurance relief. It is also possible to sacrifice some of your salary in exchange for childcare vouchers. These will save you income tax and national insurance, and, by reducing your income, may help you reduce the child benefit charge. However, with childcare vouchers likely to be the next line of attack for a government bent on cuts, this may not be so easy in future.
Employees may also be able to avoid the child benefit charge by deferring cash bonuses. As a last resort, you could consider reducing working hours to spend more time with your children.
4. COMPANY OWNERS
Company owners can control the amount of income they withdraw from their companies. They can either keep with personal income below £50,000 each year, even though the company’s profits may vary considerably from year to year. Alternatively they could take big dividends during some tax years and small dividends during other years. This allows them to avoid the child benefit charge in some tax years.
Self-employed workers have more flexibility than regular employees, but not as much flexibility as company owners to avoid the child benefit charge. Some self-employed people may find themselves in the £50,000-£60,000 tax bracket in some years but not in others. They could save pension contributions for these years or make bigger than normal contributions. They could also time expenses to reduce the pre-tax profits of the business.
Employing your children if they are 13 or older is also an option, as income up to the personal allowance (£8,105 for tax year 2012/13) can be received tax free by the child, but becomes a tax-deductible expense for the business.
Alternatively you could convert your business into a company to control your income better.
Read more articles on paying less tax.