The child benefit tax charge: the advice essentials
The child benefit tax charge, introduced on 7 January, affects over one million families. A family with 2 children could see their annual spendable income drop by up to £1,752 pa in 2013/14; those with 3 children could lose £2,449 pa. At a time when prices are rising faster than incomes, it will be critical for many families to know how they’ll be affected, and what options they may have to improve their situation.
What are the implications of the tax charge?
Benefit payments will continue to be paid in full to the claimant, but will be clawed back by way of a tax charge on the household’s highest earner if their personal taxable income exceeds £50,000 per tax year. For you, this means:
- Once taxable income exceeds £60,000 in a tax year, the charge will be 100% of the benefit claimed i.e. the value of the benefit is wiped out.
- For incomes between £50,000 and £60,000, the tax charge is 1% for every £100 income exceeds the £50,000 threshold. These people will be better off overall as the tax charge will always be less than the benefit claimed.
- For the 2012/13 tax year, the tax charge will never exceed 25% of the yearly benefit claimed as the tax charge will only have been operational for one quarter of the current tax year. So, the tax will be limited to £438 where benefit is being claimed for 2 children; £612 for 3 children.
- Around 500,000 people will need to complete a tax return for the first time, and will need to register for self assessment by 5 October 2013. The first return will need to be in by 31 January 2014 for those submitting online. Failure to do so could result in fines and late payment penalties.
What action can you take?
Advice will very much depend on the personal circumstances and priorities of yourself. The possibilities include:
- Make an individual pension contribution to reduce income to below £50,000. This would wipe out the child benefit tax charge altogether. And higher rate tax relief would also be available on the contribution if it all falls in the higher rate band. It’s also worth checking that the client has accounted for existing contributions in their calculation of adjusted net income.
- If you cannot afford to make a contribution that reduces income to the £50,000 threshold, then any contribution reducing income to a level between £50,000 and £60,000 will still result in a surplus of child benefit over the tax charge. A tax return would still have to be completed though.
- A pension contribution by salary sacrifice is an alternative way of reducing taxable income. With the agreement of their employer, an employee can reduce their contractual income in return for an equivalent employer payment to their pension. In addition to the tax savings above, the employee will also save NI at 2% for payments over the upper earnings limit. And the contribution itself can be increased if the employer agrees to pass their 13.8% NI saving on to the pension. A contribution by salary sacrifice could mean that a tax return is not needed.
- Where both partners are making a pension contribution, consider paying the lowest earner’s contribution to the highest earner’s pension. The adjusted net income of the highest earner will be reduced at no extra cost to the family as a unit. Child benefit tax may be saved, and higher rate relief can be claimed on the extra contribution. For example, if the family are currently funding up to £3,600 gross for the non-working ‘stay at home’ parent, switch this to the working parent. Although this may make financial sense, it will not be a solution for all everyone. You may prefer to keep some independence.
- Payments to charity under gift aid reduce taxable income in a similar way to an individual pension contribution. Gift aid payments are paid net of basic rate tax, and so must be grossed-up before deducting from income.
- If the person being assessed to the tax charge is also the holder of income bearing investments, consider transferring these to their lower earning partner. As the gross value of savings income is included in taxable income, this simple solution could make a difference.
- Do nothing. Continue to claim the benefit and pay the tax. This is more likely to be a consideration for those families where the higher earner has adjusted net income between £50,000 and £60,000, when the benefit will still exceed the tax charge. They may not be able to afford to see their net spendable income fall further by making a pension contribution. With this option, you are still obligated to complete a tax return.
- Where the high earner has taxable income in excess of £60,000, some families may conclude that it’s not worth making a claim for child benefit in the first place. After all, they won’t be any better off financially. But there’s still an incentive for some. Assume that one parent stays at home to look after the children and doesn’t work. As they won’t be paying national insurance, they won’t be building up any entitlement to state pensions. But by claiming benefit for a child under the age of 12, they will receive NI credits which will protect their entitlement.
- A family can still claim child benefit, perhaps for the reasons above, but avoid the tax charge by asking HMRC to stop the payments. The high earner will then only be taxed on any payments received up to the date payments stop. A self assessment return will still have to be filed if any payment is received in a tax year. Payments can be restarted if a client’s circumstances change.
What is taxable income?
The income figure used to test against this new £50,000 threshold is the same one used to assess entitlement to the personal allowance and the age related element of personal allowance – ‘adjusted net income’ (ANI). The calculation is broadly:
The SUM of:
- Taxable income from employment, including any company benefits (and after adding back any tax relief given for payments to trade unions or police organisations); and
- Taxable profits from self employment; and
- Interest, dividends and rental income received (gross values) ; and
- Any pensions received (including state pensions) and taxable social security benefits.
- Pension contributions – gross value; and
- Trading losses; and
- Grossed-up amount of gift aid payments (grossed-up by basic rate tax).
Note, personal allowances should NOT be deducted in arriving at ANI.
What are the current rates of child benefit?
The current weekly rates of benefit are £20.30 for the first child, and £13.40 for each subsequent child. These rates will remain unchanged in 2013/14. 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 e.g. they remain in full time ‘non-advanced’ education. The Child Benefit Office will contact parents before a child reaches 16 to determine if benefit can still be claimed.
The child benefit tax charge has been heavily criticised from some quarters. It’s seen as unfair and complex. But it’s with us, so you will need advice to see through the complexity and secure the best result for yourselves.