There is good news for thousands of families earning more than £50,000 who feared that new rules meant they would have to pay back some or all of their child benefit money
Thousands of families who were warned they could lose some of their child benefit because of a clampdown, may be in the clear after all.
The current advertising campaign from HM Revenue & Customs emphasises that any parent earning more than £50,000 will have to pay back some, or all, of their child benefit through the tax system, following the introduction of rules earlier in the year.
But there are likely to be quite a number of parents earning more than this – perhaps £53,000 or £54,000 – who, unbeknown to them, can continue to claim child benefit without having it clawed back later.
That's because they don't realise that, for the purposes of this new regime, they can deduct the money they contribute to their pension from their headline salary. In many cases this will be several thousand pounds per year – which may be enough to take them below the vital £50,000 threshold.
Going forward, meanwhile, many parents will be able to avoid the new tax and still receive child benefit by paying more into their pension.
Around 1.1 million families are affected by what some claimed was "a new tax on children". Officially known as the "high income child benefit charge", it took effect on 7 January.
In a nutshell, this means these people can choose to carry on receiving child benefit, but will have to pay extra tax, and also fill in a tax return if they don't already. The extra tax will cancel out some, or all, of their child benefit which is currently worth £1,752 a year for a family with two children.
So far, more than 400,000 people have opted to give up their child benefit so they don't have to pay the extra tax. The rest have been continuing to receive the money, though some of them will have been unaware of the gathering storm clouds, or have chosen to ignore them. But HMRC is now "reminding" them that, if they haven't already, they must register for self-assessment by 5 October – or risk being hit with a penalty.
So how do the new rules work, who is affected, and what can they do to (entirely legally, of course) get out of paying the extra tax?
You receive child benefit if you're responsible for a child under 16, or under 20 if they stay in approved education or training. However, the government has introduced a system where the benefit is withdrawn gradually for those with an income above £50,000.
The tax charge is 1% of the amount of child benefit for each £100 of income between £50,000 and £60,000. For those earning more than £60,000 the charge is 100% of the amount of child benefit – so they will, in effect, get nothing. For a family with two children where one parent has an income of £54,000, their total child benefit is £1,752.40 a year (you get £20.30 a week for the eldest/only child, then £13.40 a week for each additional child). Their tax charge would be 40% of £1,752, which is £700. If that parent's income was £62,000, the tax charge would be for the full £1,752.
Things are complicated by the fact that the new rules came in on 7 January, just three months before the end of the 2012-13 tax year on 5 April. So for a family with two children, the maximum tax charge they face for 2012-13 is £438. For our family with two children, where one person earns £54,000, the extra tax is £175.
The really important thing is that what you might think of as an income of £50,000 a year isn't the same as the taxman's definition. The child benefit tax charge is based on your "adjusted net income". This is your total taxable income (ie, basic salary, plus any benefits such as a company car or private medical insurance, plus any savings, dividend or rental income), minus things such as pension contributions and charitable giving.
Some people who do the maths will find that while their basic salary is more than £50,000, once they lop off their pension contributions, their adjusted net income is actually less than that, and they are therefore not affected by the new rules.
HMRC has a guide to working out your adjusted net income but you would need to be an accountant to get your head around it. It's best to explain it with an example, so here is one HMRC produced, based on a simple scenario we gave them. Mr Smith earns £53,000, has no other income, and pays £226 a month into his company pension scheme, which he tops up with a further £110 a month of additional voluntary contributions (AVCs). In other words, he pays £4,032 a year in to his pension. He needs to deduct that figure from his salary, giving him an adjusted net income of £48,968. That is, of course, below the crucial £50,000, so therefore he isn't affected by the new rules, even though he assumed he was.
Going forward, there are some fairly simple ways for people to reduce their extra tax bill, or even escape it. The most obvious, if you can afford it, is to pay more into your pension.
It's not just accountants advising this – Citizens Advice endorses it on its website, which says: "You may be able to avoid having to pay the extra tax and still receive child benefit by reducing your taxable income. For example, you could do this by paying more into your pension. Pension contributions are taken out of your income before you pay tax. This could therefore reduce the amount of income on which you have to pay tax to below £50,000."
It adds: "You could also consider using salary sacrifice and opt to have some of your pay paid in the form of childcare vouchers. Childcare vouchers are also taken out of your income before you pay tax, so your taxable income will also reduce."
Another option is to buy extra holiday from your employer via salary sacrifice. For example, someone earning £52,000 might have £1,000 taken off their gross salary for one extra week's holiday.
Even better, you could increase your charitable giving. When calculating your adjusted net income, if you made a gift aid donation you take off the "grossed up" amount – ie, what you donated plus the basic rate of tax. So for every £1 of gift aid donations you made, take £1.25 from your net income.
Of the 1.1 million families affected by the new rules, most have either opted out of child benefit, were already getting a tax return, or have registered for self-assessment – leaving about 225,000 who need to act by 5 October.
When you register, you'll be sent a tax form for 2012-13. The deadline to complete your return is 31 October 2013 for a paper return or 31 January 2014 to file online. If you miss next weekend's deadline for registering, you could face a penalty of up to 100% of the tax due.
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