For parents receiving child benefit, particularly those that have investment properties, or have earnings from a company, you really need to read this to avoid a large potentially avoidable sneaky tax charge – the High Income Child Benefit Tax. This is known as the £50k child benefit trap.
The government brought in a tax measure several years ago to ensure that families who are “high earners” do not ultimately receive it.
The mechanism they settled on to ensure that the “better off” don’t receive this somewhat meagre hand out is fairly complex. Many parents are aware of this but in case you are not here is a brief summary
The High Income Child Benefit Charge
HMRC decided that, rather than simply not give you the child benefit in the first place, it would be far better to give you the benefit, and then basically claw it back if you earn more than they deem to be enough.
So you get the child benefit throughout the year, in the normal way.
Then at the end of the year, when
- you complete your tax return and tell HMRC that you have received child benefit (one rather suspects that they already know this!); and
- if you’ve earned above the threshold, pay some or all of it back to HMRC through your self assessment tax payments
This tax charge is called the “High Earner Child Benefit Charge”.
Now, it’s important to be aware that this tax is assessed on both “parents”. I say “parents” as its really based on adult child carers in the household. And the thinking behind it is pretty weird…
How does the High Income Child Benefit Charge work in practice?
The tax charge applies only to the higher earner and it works like this.
- Up to £50k income there is no tax charge.
- Above £50k HMRC claws back 1% of everything you have received for child benefit in the year for each additional £100 you earn.
So if you earned £55,000 you would owe half (50%) of what you had received in child benefit in the year. If you had earned £56,000 you would owe back 60% of what you owed in the year.
This continues up to an income of £60k, where at that point you would have repaid all the child benefit.
Do bare in mind that if one of you earns £60k and the other earns nothing, all the child benefit gets repaid. On the other hand, if you both earn £50k (so a household income of £100k – far better off than the single earner bringing in £60k), no child benefit is clawed back. Not, it would seem, a very well targeted tax given the hoops that need to be jumped through.
But this isn’t really the trap I was talking about – not the main trap – this is just the plain vanilla trap to be aware of.
What counts as earnings?
The real trap comes into play once you start looking at what is treated as “earnings”. This is not just your salary, it’s all you taxable earnings, which includes dividends, benefits in kind, interest, and most devastatingly rental income.
Historically, with property income you would calculate your profits net of mortgage interest, however recent changes (for residential buy to let landlords at least) has changed that.
I won’t go into the detail of how the changes work but a brief overview is that when calculating what your property income is, for residential buy to let properties, you now completely exclude the mortgage interest.
So as an example – where you previously earned rental income of £20k, with costs of £4k and mortgage interest of, say, £13k, you property income for tax purposes would be £3k, and you would be taxed on that £3k (£20k less £4k less £13k).
Why does this matter? The £50k child benefit trap
Using the example above, this £3k would previously have been treated as “income” when calculating how much you had earned for child benefit purposes. This meant that so long as you earned £47k or less for all your other income sources, you would not be paying the higher income child benefit charge
Now, things have changed. Using the above example, your property income would be treated as being £16k (£20k rental income less 4k costs – no account taken of your mortgage interest), and it is here where the trap lies.
With your property taxable income going up from £3k to £16k, now you can only earn (using the above example) £34k before the high income child benefit charge kicks in. If you maintained you income at £47k your taxable income would actually be £63k, meaning you would owe ALL the child benefit you received in the year back which could be a substantial amount.
Avoiding the £50k child benefit trap?
There are relatively limited measures you can take to avoid this additional tax charge but here is my list of a few favourites
- If you are earning above £50k and below £60k
- Pay into a pension scheme personally. Doing this reduces you taxable income and therefore reduces your high income child benefit charge. Its tax effective in that you save yourself 40% income tax, plus save yourself the child benefit tax. You get to keep the money, although you can’t use it until you draw your pension.
- Give personally to charity – this works the same as for pensions, only you end up with a warm fuzzy feeling, rather than money in your pension pot.
- For people earning income from their company through dividends
- Consider taking less in dividends. If your lifestyle does not require it, adjust your dividends so that you do not “earn” over £50k
- If you are married and your spouse earns less than £50k, consider making your partner a shareholder. This is complex from a tax perspective and needs to be done right so you should take expert advice (…happy to help…) on
- the transferring of shares to avoid triggering capital gains tax
- considering whether different classes of shares are required to pay different dividends
- For everyone
- Consider whether it is worth transferring you property into a limited company so that you can control what earnings are taxed on you personally, and when.
Conclusion
Ultimately you need to sit down with your accountant early in the tax year and decide on a strategy to deal with this, if its something that is going to be an issue for you. You have some options, but its not the same as it was a few years ago before the new rules on residential mortgage interest were brought in.
For more information on the high income child benefit charge see here: https://www.gov.uk/child-benefit-tax-charge
For more information on the residential mortgage interest restriction see here: https://www.gov.uk/guidance/changes-to-tax-relief-for-residential-landlords-how-its-worked-out-including-case-studies
