Reduce the impact of the high income child benefit tax charge

How to reduce the impact of the high income child benefit tax charge

I provide business consulting services through my own limited company and I am the only director and shareholder.

To date I have restricted myself to salary and dividends to maximise my basic tax band even though I could have taken out a lot more dividends due to my company profits.

For the next two years I intend to take out an additional £40,000 of dividends across the two years on top of my basic band strategy – would I be better off splitting these additional dividends over two years or just doing it in one year?

I receive child benefit for three children so am aware this will be impacted if my earnings go above £50,000.

Answer, 2018

The short answer is the way you take the additional £40,000 of dividends will have an impact on your tax position over the two years as there will be significant additional tax payable.

However, the most crucial impact will be the difference in the level of child benefit that would need to be repaid under each of the outlined strategies.

Given you are already fully utilising your basic rate band using your current tax optimised salary & dividend extraction strategy then under both sets of circumstances that you outline the tax on the extra dividends will be at the higher dividend tax rate of 32.5% (assuming there is no change to dividend taxation rates in 2019/20).

As such the total tax that would need to be paid on the extra £40,000 of dividends would be £13,000.

This will either all be payable in one year should you take all of this at once or split at a rate of £6,500 per tax year where £20,000 is taken one year with the remainder of the dividends taken in year two.

It is the child benefit repayment that is going to be the crucial factor in determining the extraction approach in these circumstances.

Impact of high income child benefit charge

For three children the total child benefit received per year totals £2,501.20 – this is broken down as £20.70 per week for the first child with £13.70 paid per week for each additional child.

Since 2013 child benefit has been withdrawn on a pro-rata basis on total income between £50,000 and £60,000, whereby at an income level of £60,000 the full amount of the child benefit is repayable via the tax return system.

For the 2018/19 tax year the higher rate tax band begins where total income exceeds £46,350, with a small increase expected for the 2019/20 tax year.

As such under the scenario of taking £20,000 extra dividends one year with a further £20,000 the following tax year the total income for both years would exceed £60,000. Therefore, the full amount of child benefit received would be repayable in both years at a total cost of £5,002.40 (being £2,501.20 x2).

Where the full £40,000 is taken by way of dividends in year one with no additional dividends above the basic rate band in the second year (or vice-versa), then child benefit would only be repayable for the year that the additional dividends were withdrawn as your total income would be in excess of £80,000 in that particular year with total income remaining below £50,000 in the year without the additional dividends. As such it would only be a total of £2,501.20 that would be repayable.

Higher dividends in one year only to reduce impact of high income child benefit charge

As you can see from the above it is certainly beneficial as far as the child benefit is concerned to take the full amount in one year as opposed to splitting the extra dividends over two tax years – the tax saving in this example is £2,501.20.

This assumes you have sufficient distributable profit in the company to support the dividends.