QUESTION: Last year my wife had twins. She decided to give up work for a few years as we also have two other children at home and it made sense. I had just secured a new job and my earnings had increased significantly, so our combined income was unchanged even though I was now the only earner in the family. Neither of us therefore expected the after tax household income to fall. On top of that, we recently received a letter advising us that we are no longer entitled to child benefit which will be a further loss of £3,213 a year. I can’t understand why we are so much worse off even though our combined earnings haven’t changed. Why are we paying so much tax now? Why have we lost out on child benefit and is there anything we can do?
ANSWER: As the end of the tax year approaches, now is a good time to review your financial affairs and check if you are paying more tax than you need to and determine if you can take steps to minimise your family’s total tax exposure.
With this in mind, it is often worth reviewing the distribution of income between family members. Social security benefits, including tax credits and universal credit are awarded on the basis of the combined total parental income, but child benefit entitlement is based on the income of the higher earner in the family and disregards the second earner.
This means that many families with an unequal distribution of income can be disadvantaged. Couples who both earn just below £50,000 are each in a position to maximise available personal allowances and utilise lower tax rates. This is because £50,000 income is enough to utilise the personal allowance of £12,500 per person and also utilise the 20 per cent income tax band of £37,500 per person.
Couples earning just below £50,000 generally therefore pay less tax than a family with one parent earning, for example, £90,000 and a second parent who is not working.
Consider the Johnson family. Each parent earns £45,000 and they have three school age children. The threshold for restricting child benefit is £50,000. As the higher earner in the family earns £45,000, the Johnson family are fully entitled to child benefit. An added benefit of the household income being shared equally between both spouses is that all the family taxable income falls into the 20 per cent tax band. This is because each parent is entitled to earn £50,000 before moving into the higher 40 per cent tax band. The family can therefore utilise two 20 per cent tax bands.
In contrast, the Brown family have two young babies and the father is not earning any income due to his decision to stay at home to look after the children. Mrs Brown earns £90,000, and because her income exceeds £50,000 she starts to pay tax at 40 per cent once she exceeds this threshold.
Unlike the Johnson family, the £90,000 Brown family income is not all taxed at 20 per cent and doesn’t benefit from both parents combined tax free allowance of £25,000. Also, the Brown family lose all their child benefit entitlement because the higher earner, Mrs Brown, exceeds the child benefit threshold.
So, in spite of both the Johnson and Brown families have similar household income, the Brown family pay much more tax and lose all their entitlement to child benefit.
Families in this situation can sometimes save tax if they transfer income producing assets to the parent who is not earning taxable income or is the lower earner in the family.
For example, the higher earner could make a gift of investments which produce taxable income, to the lower earner. Similarly, savings and investments could be put into joint names to share the interest income.
If the higher earner is self employed consideration could also be given to employing the other spouse in the business, perhaps in a minor role, for a small salary.
It is important that any planning undertaken to take advantage of personal allowances or to utilise lower tax rates is carried out after specific tax advice has been sought as each family’s personal circumstances will differ. Also, HMRC can challenge transactions which they believe are disingenuous.
:: Janette Burns (j.burns@pkffpm.com) is associate tax director at PKF-FPM Accountants (www.pkffpm.com). Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.
