How to avoid the child benefit tax charge
IFA Jason Butler shares some simple tips for families who want to reduce their tax bills while keeping child benefit payments.
For some years now the child benefit tax charge for higher earners has been impacting those who qualify for child benefits. The implications of this charge aren't always immediately obvious, so read on to find out how it may affect you. Furthermore, there are ways in which you can reduce your level of exposure to this tax while continuing to receive child benefits.
Who can claim child benefit?
Child benefit can be claimed for all children under the age of 16. Once a child reaches this age, it may still be possible to claim benefit until their 20th birthday, if they remain in full time ‘non-advanced’ education. The current benefit (in the 2018-19 tax year) is £20.70 per week for the first child and £13.70 for each additional child.
So in a single year, a couple with one child would receive £1076.40 and a couple with two children would receive £1788.80, and so forth.
The tax charge for higher earning parents
A tax charge will be levied on the household’s highest earner if their personal taxable income exceeds £50,000 per tax year, if a parent has not requested that HMRC stop paying child benefit. Once taxable income exceeds £60,000 in a tax year, the charge will be 100 per cent of the benefit claimed, thus negating the benefit received.
What’s your ANI?
The income figure used to test against the £50,000 child benefit tax charge threshold is the same one used to assess entitlement to the personal allowance and the age-related element of the personal allowance and is known as ‘adjusted net income’ or ANI for short. ANI is calculated as follows:
– Total taxable income from employment, including any company benefits (add back any tax relief given for payments to trade unions or police organisations)
– Taxable profits from self-employment
– Interest, dividends and rental income received (gross values)
– Any pensions received (including state pensions) and taxable social security benefit.
Deduct all the following:
– Pension contributions
– Gross value
– Trading losses
– Grossed-up amount of gift aid payments (grossed up by basic rate tax)
The personal allowance should NOT be deducted in arriving at ANI.
If the net amount is below £50,000 then no child benefit tax charge is payable.
When to pay the tax
Is it worth making a claim for child benefit in the first place? Not always. Where the high-income parent has sustainable taxable income in excess of £60,000 per year, they can’t or don’t want to do any planning to reduce this income, and the other parent is accruing entitlement to a state pension through their own National Insurance (NI) contributions, it may not be worthwhile to claim.
But if one parent stays at home to look after the children, doesn’t work and doesn’t pay NI, they should continue claiming child benefit for a child under the age of 12, as this will protect their entitlement to a state pension by giving them NI credits for each year they claim child benefit.
To stop the charge
To avoid the tax charge the parent should ask HMRC to stop the payments. The higher income parent will then only be taxed on any payments received up to the date that they stop. A self-assessment return will still have to be filed by the higher earner if any payment is received in a tax year. Payments can be restarted if circumstances change.
Depending on your circumstances, preferences and resources, there are several potential ways that you might reduce or completely avoid the tax charge. It may be that a combination of these planning ideas, which all involve reducing your ANI, might work for you.
Make a pension contribution
Provided that you have sufficient relevant earnings (income from employment or self-employment) and an unused pension annual allowance in the current tax year, you could make a personal contribution to a registered pension.
Your ANI would be reduced by the grossed up pension contribution. Thus if your ANI before the contribution was £60,000, making a net pension contribution of £8,000 would, gross up to a £10,000 deduction in your ANI to £50,000. In addition to wiping out the child benefit tax charge, you would also qualify for higher rate income tax relief of 40 per cent on the contribution.
If one parent is a high earner under the child benefit tax rules but contributions are being paid to a pension for the other parent who does not meet the high earner definition, then it may be advisable to redirect these to the higher earner’s pension.
With your employer’s agreement, you could reduce your contractual income (known as salary sacrifice) in return for an equivalent employer payment to your pension. In addition to the tax savings above, you will also save NI contributions at 2 per cent for the amount sacrificed over the first £797 of income per week. If your employer agrees, they can also pass on their 13.8 per cent NI saving via an additional pension contribution. In this situation, a tax return may not be required.
Two caveats about pension planning:
- Be mindful of your lifetime allowance - currently £1 million.
- Be careful to avoid higher rate income tax on the eventual income or lump sum benefits arising from the pension plan. Depending on the amounts involved, there may be no point in avoiding the child benefit tax charge if it is only to find that you pay 40 per cent, rather than 20 per cent, income tax on the eventual pension benefits.
Cash gifts to charity under gift aid reduce taxable income in a similar way to an individual pension contribution. Like pension contributions, gift aid payments are paid net of basic rate tax, and so must be grossed-up before deducting from income. The value of a gift of investment holdings or real property at arms length and at full market rate, will be fully deductible from ANI for the purposes of determining whether or not your ANI exceeds £50,000.
Clearly, because you don’t benefit from the charitable gift, this strategy only makes sense if you were intending to make the gift anyway. Another way to look at it is that this approach would enable you to gift the child benefit to charity also, rather than it being clawed back in tax.
If the person being assessed to the tax charge is also the holder of income-paying investments, consider transferring these to their lower income spouse (or civil partner). As the gross value of savings income is included in taxable income, this simple solution could make a difference.
For those who own and control trading businesses via a limited company you could potentially do a number of things. You could add the other parent as an employee and pay them a salary for taking on some of your duties and a corresponding reduction in your salary. As long as neither of you has ANI of more than £50,000, then the child benefit tax charge will not apply.
Provided that you can still fund your day-to-day living costs, you could reduce your salary, dividends and benefits to below the £50,000 threshold and retain the funds within your company until you cease to qualify for child benefit.
If you are affected by the child benefit tax charge and wish to minimise the impact, then you should give careful consideration to adapting your retirement funding, charitable giving and/or business profit extraction strategies accordingly. At the very least make sure that you comply with your compliance obligations and make the correct election regarding claiming and receiving the benefit.
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