Child Benefit Trap
The high income child benefit tax charge (HICBC) impacts those who have adjusted net income over £50,000 and are (or their partner is) receiving child benefit. Reducing adjusted net income can reduce the impact or negate it entirely.
Finance Act 2012 made changes to child benefit with the introduction of the High Income Child Benefit charge.
The high income child benefit tax charge applies where there is one partner with adjusted net income of over £50,000 in a household where child benefit is claimed.
Child benefit is still a universal benefit, but the tax charge removes or partially removes the benefit.
Reducing adjusted net income can mean that the high income child benefit tax charge does not apply.
Child Benefit remains a universal benefit.
However, if someone:
has adjusted net income of more than £50,000, and
lives with a partner, in a household where Child Benefit is claimed or claims themselves, and
is the partner with the highest adjusted net income, then they will incur a tax charge which removes or partially removes the benefit of receiving Child Benefit.
Adjusted net income is the measure currently used to work out entitlement to personal allowances. Adjusted net income is, broadly, taxable income (it should be noted that this includes all rental income, FULL amount of bond gains and any other taxable income). Certain deductions are allowed, such as the gross value of personal (relief at source) pension contributions, gift aid and trading losses.
For those with adjusted net income between £50,000 and £60,000 then the charge will be 1% of the total benefit for every £100 of income over £50,000. The charge applies to the partner with the highest adjusted net income regardless of who actually receives Child Benefit.
If a taxpayer or their partner has adjusted net income of £50,000 or more after the 7 January 2013 and receives Child Benefit then they will be affected.
The amount of the charge will be collected through self-assessment or PAYE. The recipient of Child Benefit may decide not to receive payments which would mean that they or their partner will not be liable to the tax charge. However, claims should be completed for new children born so that entitlement to National Insurance credits are not lost.
The definition of partner includes those married, in civil partnerships or couples living together as if married or civil partners.
It’s important to note that the impact of this charge may increase, as based on UK rates of taxation you now also move into higher rate taxation when the HICBC starts. So clients may be moving from an effective 20% rate of taxation to a level of taxation much higher than 40%.
Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. NSND income includes employment income, profits from self-employment (including sole trades and partnerships), rental profits, and pension income (including the state pension). Similarly, from 6 April 2019 Welsh Taxpayers pay the Welsh Rate of Income Tax (CRIT (C for Cymru)) on NSND income. Other tax and deductions such as Corporation Tax, dividends, savings income and National Insurance Contributions etc. will remain based on UK rules. This could mean the amount of income tax relief which can be claimed on pension contributions by Scottish and UK tax payers may not be the same.
Identify adjusted net income.
Subtract £50,000 from adjusted net income.
The difference is the income giving rise to the tax charge.
Either: a. Reshape the tax causing income, or b. make a personal pension (relief at source) contribution in the tax year in which the child benefit tax charge will apply.
Case study 1: earnings
Mr and Mrs A have 3 children under the age of 16. Mrs A claims the child benefit and receives £21.05 per week for the eldest child and £13.95 each for the second and third child. Mrs A does not work.
Mr A earns £48,000 and has also received a bonus of £5,000. Total adjusted net income = £53,000
Total child benefit claimed = £1,094.60 for the eldest child and £725.40 for each of the other two children = £2,545.40
Tax charge for child benefit =£53,000 - £50,000 = £3000/100 = 30 30 x 1% = 30% of £2,545.40 = £763.62M
Mrs A will still receive the child benefit of £2,545.40. However, Mr A will suffer the tax charge of £763 (the charge rounded down to the nearest whole pound).
Therefore the effective rate of taxation between £50,000 and £53,000 is 65.43% (£3,000 taxed at 40% is £1,200, add on the £763 HICBC means that the tax is effectively £1,963 which is 65.43% of £3,000).
How can this charge be mitigated?
If Mr A makes a net relief at source pension contribution of £2,400 then this would be grossed up to £3,000. This £3,000 is deducted from the taxable income leaving an adjusted net income of £50,000. This would mean that there is no tax charge to pay. He would then be able to claim another £600 back as higher rate relief applies. Therefore, the pension contribution would actually cost £1,800.
The total tax saving is £1,200 plus £763 = £1,963.
So, the effective rate of tax relief is 65.43%.
Case study 2: Earnings and dividend
Mr and Mrs C have 2 children under the age of 16. Mrs C claims the child benefit and receives £21.05 per week for the eldest child and £13.95 per week for the second. Mrs C earns £50,000 from her job and has recently inherited a share portfolio of £100,000 which usually generates dividend income of £5,000 per year. Mr C also earns £50,000 per year from his job. Mrs C’s total adjusted net income = £55,000 (£50,000 + £5,000) Total child benefit claimed = £1,094.60 for the eldest child and £725.40 for the other child = £1,820. Tax charge for child benefit =£55,000 - £50,000 = £5,000/100 = 50% 50 x 1% - 50% of £1,820 = £910
Mrs C will still receive the child benefit of £1,820. However, she will suffer a tax charge of £910.
Therefore the effective rate of taxation between £50,000 and £55,000 is 37.7% (£2,000 taxed at dividend zero rate, and £3,000 taxed at 32.5% (Dividend Higher Rate of Taxation) is £975, add on the £910 HICBC means that the tax is effectively £1,885 which is 37.7% of £5,000).
This may seem beneficial in comparison to the first 2 case studies, but without the HICBC the income tax would have been an effective 19.5%, (£2,000 taxed at dividend zero rate, and £3,000 taxed at 32.5% (Dividend Higher Rate of Taxation) is £975, which is 19.50% of £5,000.
How can this charge be mitigated?
Mrs C could; "Bed and ISA" and 'Bed and Bond'.
Income from an ISA does is not included for adjusted net income purposes.
A bond is non-income producing. It is only chargeable gains that will impact adjusted net income. Therefore if she keeps regular withdrawals across segments within the 5% tax deferred allowance the withdrawals won’t impact her adjusted net income.
This means if she replaced her shares with an ISA and/or bond she could reduce her adjusted net income to £50,000.
She would then receive her child benefit without the tax charge of £910.
Personal Pension Contribution
If Mrs C makes a net pension contribution of £4,000 then this would be grossed up to £5,000.
This £5,000 is deducted from the taxable income leaving an adjusted net income of £50,000. This would mean that there is no tax charge to pay.
She will then be able to reclaim higher rate tax relief and retain the £910 child benefit.
The reduction in child benefit tax charge means effective rate of tax relief by making this pension contribution would be boosted.