The 1000% Tax Trap - And How To Avoid It
Imagine getting a pay rise of £1,000 per annum and then finding your tax liability increasing by £1,055, that’s over 100% tax. Now imagine your pay rise is just £100 but your extra tax liability is still £1,055. That’s a tax rate of over 1000%! Instead of £1,055, this extra liability might be £1,752, £2,449, or even more. This is not a myth, for many thousands of taxpayers this will be a reality from 6th April 2013.
The change that was proposed is that from 6th April 2013, child benefit will be clawed back from parents where one partner is a higher rate taxpayer. So using tax rates for 2011/12, a husband who is the breadwinner of a family unit comprising himself, his wife and two children, will have to repay all of the child benefit paid to his wife if his taxable income exceeds £42,475 by just £1.
At present the rates of child benefit paid are £20.30 per week for the eldest child and £13.40 per week for each additional child. In the fictional example above, over a whole tax year, £1,752.40 will have been paid to the mother of the children and if the father is a higher rate taxpayer his tax liability will be increased by the same amount.
So what tax planning is available to counter this seemingly unfair tax? Well, for many couples, there is no answer. If in our example the husband had a salary of £100,000 per annum there is no sensible planning that would enable him to reduce his taxable income below £42,476. But for those whose income is up to say £50,000 per annum there is plenty that can be done, but just remember we are talking total taxable income here, not just salary so account must be taken of investment income. So here are some ideas to think over in preparation for this change:
1. Be prepared to turn down that pay rise your boss offers you.
2. Benefit someone less fortunate than you by making a charitable donation under gift aid.
3. Ask your boss if you can have a weeks unpaid leave.
4. Benefit yourself by making a contribution to your pension scheme.
5. Gift your investments to a lower earning spouse or partner so that he / she receives the income that those investments generate.
By and large any planning carried out has to be during the tax year and with the best will in the world, you might get your fine tuning wrong and find out after the end of the tax year your income is say £100 over the top of the basic rate tax band, is there any scope for planning then? Well, yes there is. If you make a gift aid donation before the following 31st January and before filing your tax return you can elect to have that donation treated as though it was paid in the tax year just ended. So a net donation of £80 would be sufficient to reduce taxable income by £100 and avoid an expensive claw back of child benefit.
Suppose you earned £50,000, your wife earned £30,000 and you each contributed £4,000 gross to your individual pension plans. As a family, child benefit would be preserved if your wife suspended her contributions and you doubled yours.
You may find that the level of your income is such that tax planning requires unaffordable levels of pension contributions. If this is the case, why not skip a year’s contribution and double up in the following year? That way you may be able to preserve child benefit every other year. In fact, if you think you may be in that position in two years and are making contributions to a pension plan, why not suspend contributions now so that you can pay more after 6th April 2013?
Planning is fairly straightforward for those who are employed, but less so for those who are self-employed and those who are owner managers of a limited company. We have produced detailed guides covering these areas. If you would like a copy, please send an email to info@warr.co.uk with “Child Benefit Self-Employed” or “Child Benefit Limited” in the header.
Disclaimer
This document has been produced for general guidance only and does not constitute tax advice. Whilst every care has been taken in its preparation, Warr & Co will not accept liability for any loss incurred as a result of any use made of this document or its contents. We will be happy to offer specific advice to clients when requested. Should you have any queries or wish to discuss any of the points raised please contact Suresh Dhokia or Peter Edwards on 0161 477 6789.
Date of Article: 17th June 2011
