This week around one million households will receive letters from HM Revenue & Customs about possibly losing Child Benefit.
From 6 April 2013 Child Benefit will be means-tested, so higher-rate (40%) and additional-rate (50%) taxpayers will no longer receive this valuable benefit. Here are the current rates of Child Benefit, which have been frozen until April 2014:
My wife and I have two young children. As a result, my spouse receives 13 four-weekly Child Benefit payments of £134.80, which amounts to a tax-free total of £1,752.40 a year.
As a higher-rate taxpayer, my wife pays a marginal tax rate of 42% (40% income tax plus 2% National Insurance contributions). Her Child Benefit is worth £3,021.38 a year before tax and, therefore, she stands to lose more than three grand a year from next April.
Three ways to beat the system
Then again, my wife's personal tax adviser (that's me) has already figured out a simple, easy way for her to hang on to all of her Child Benefit. Here are three ways that top taxpayers can legally beat the system and retain this tax-free support for their families in future:
1. Pump up your pension
The simplest way to avoid losing your Child Benefit is to avoid becoming a higher-rate tax payer in the first place.
The personal tax allowance for 2011/12 is £7,475, followed by a tax rate of 20% on the next £35,000 of earned income. Thus, the 40% tax rate kicks in for most taxpayers on earned income above £42,475 a year.
Anyone who can get their income just £1 below whatever the higher-rate threshold will be in 2013/14 will keep all of their Child Benefit, which could be worth thousands of pounds a year, free of tax.
For workers earning £40,000+ a year, the easier way to sneak below the 40% tax threshold is to pay more into their pensions. For example, paying an extra £2,000 a year into a pension could cut your take-home pay by just £1,200, thanks to 40% tax relief on this contribution.
What's more, if this additional pension contribution safeguards your Child Benefit, then it could mean thousands of pounds a year in extra income. One other way of achieving this would be to sacrifice part of your salary, in return for higher yearly pension contributions from your employer.
Of course, if you do go down this route, then make doubly sure that your pension contributions are high enough to drag you below the higher-rate threshold in 2013/14 and thereafter.
2. Collect childcare vouchers
A second way for higher-rate taxpayers to slip below the 40% tax band is to collect childcare vouchers from employers. By surrendering some of your pay for these tax-free vouchers, you can reduce your taxable income by up to £243 a month, or £2,916 a year.
Alas, since last April, this allowance has been cut to £28 a week for 40% taxpayers and £22 a week for 50% taxpayers (those earning over £150,000 a year). The good news is that existing members of childcare schemes still get the previous tax-free allowance in place before April 2011. Hence, this change affects only new joiners since 6 April 2011.
Grabbing your full allowance of childcare vouchers could drop your pay below the crucial 40% threshold.
3. Become a company
My third -- and most radical -- solution to this Child Benefit problem is to start your own private limited company. This can be a highly tax-efficient way to earn a good income while paying minimal amounts of tax.
For example, you could decide to pay yourself a minimal wage (below the thresholds for income tax and National Insurance), all of which would be tax-free. Then, instead of paying yourself any more in salary, you declare and pocket dividends from your company shareholding.
As long as your total income doesn't exceed the 40% tax threshold, then no extra tax is due on these dividends. However, your company will have to pay corporation tax at the 'small profits' rate of 20% on these dividends.
What's more, any dividends above this level attract higher-rate tax at 32.5%, less a notional tax credit of 10%. In effect, this translates to an effective tax rate of 22.5% of the declared dividend or a quarter (25%) of the net dividend in your hand.
Then again, incorporating as a company isn't an option for most employees, as an anti-avoidance rule known as IR35 requires that you prove you are not simply "an employee at arm's length."
In addition, there is a great deal of paperwork required to be a company director, so you may need to pay an accountant to administer your payroll and tax affairs. Even so, this is a very attractive tax route for high-earning consultants, the self-employed and freelancers like me!