HOW IT WORKS
In 2012/13 and later tax years, a proportion of the child benefit received by an individual may be taxable if the individual has “adjusted net income” exceeding £50,000 and either:
a. he was entitled to child benefit for any week in the tax year, and no other person who was his partner in that week had adjusted net income greater than his; or
b. another person who was entitled to child benefit for any week in the tax year was his partner in that week, and has adjusted net income less than his.
“Adjusted net income” means total gross income (including tax credits on dividends) after adding back relief for payments to trade unions or police organisations, less:
- trading losses;
- pension scheme contributions (grossed up, if paid net of tax); and
- Gift Aid donations (grossed up).
Partners for this purpose means:
- persons who are married, or living together as if they were married; or
- persons who are civil partners, or living together as if they were civil partners.
In 2012/13 any entitlement to child benefit which arises before 7 January 2013 is ignored.
If the child is not living with the claimant, and the claimant himself is not taxable on the benefit, the person with whom the child lives becomes liable if he has adjusted net income over £50,000.
The taxable percentage of the benefit is given by:
(Adjusted net income) – 50,000 / 100
Both the percentage and the taxable amount are rounded down to the nearest whole number.
If more than one person could be taxable on the same benefits, only the one with the highest adjusted net income is liable. The tax charged can be collected through self-assessment or PAYE.
Mr and Mrs Z receive child benefit for their two children of £35 per week in 2013/14, a total of £1,820. Their adjusted net income for 2013/14 is as follows:
As the higher-paid spouse, Mrs Z will be taxable on benefits of £1,456, calculated as follows:
|Adjusted net income||
|Percentage fraction (8,000/100)||
|Taxable benefit (80 % x 1,820)||
HOW TO RETAIN IT (source: Investor Chronicle – Moira O’Neill)
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.
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.