Contractors who are earning over £50,000 a year and, as a result, have received a letter from HMRC about withdrawal of their child benefit, have until 7 January 2013 to implement a tax strategy to avoid losing thousands of pounds.
A contractor with two children may lose up to £1,752 a year and could face a marginal rate of 54%, rising to 66.5% for three children, once means testing is introduced after the 7 January 2013 rule change. This is because the benefit will continue to be paid each month and then reclaimed via income deductions from the member of the household earning over £50,000.
The changes to the child benefit system will result in benefits being incrementally withdrawn once a contractor is earning over £50,000 of gross personal income a year. Eligibility for the benefit withdrawal is not measured by gross contracting fee income, but by a contractor’s gross income less charitable donations and pension contributions.
However, by adopting a range of simple tax management strategies, contractors may be able to both retain their child benefit and make greater tax savings, thus increasing their take-home pay. Strategies to avoid the income tax deductions include:
- Splitting income with a spouse or civil partner by sharing ownership of a limited company and paying that person a salary for their input into the company
- Reducing total salary and dividends to below the £50,000 gross personal income allowance, instead building up a cash balance in the company that may be used for company investments or to fund a sabbatical
- Funding life insurance and death-in-service policies and other long-term tax efficient financial products via a contractor limited company scheme.
- Using a company funded pension scheme to soak up earnings above the earnings limit
- Diverting cash into charitable donations that can also be used to keep a contractor’s gross personal earnings below £50,000.
The last three options are particularly suited to umbrella company contractors who don’t have the option of deferring income or sharing it with a spouse or civil partner.
Because the 31 January 2013 personal self-assessment tax return deadline is likely to consume many accountants’ time during December and early January, contractors are advised to consult their accountant and/or independent financial adviser as soon as possible to implement child benefit-related tax strategies.