Money Matters - Summer 2011

Picking up the tab...

The first raft of measures restricting tax credit eligibility for higher income households have just come into effect, with further changes due next April. Changes that came into effect on 6 April include:

Couple in restaurant

The rate at which your tax credits are reduced where income exceeds £6,420 has increased from 39% to 41%.

The £545 family element of child tax credit is withdrawn where income exceeds £40,000 rather than £50,000, and the withdrawal rate is 41% instead of 6.67%.

The weekly maximums for childcare are unchanged, but the claimable proportion is reduced from 80% to 70%.

The amount of income disregard has been reduced from £25,000 to £10,000. Claims are initially based on income for the previous tax year, and the disregard is the amount by which current year income can rise before a claim is revised.

Take a couple with two children, both employed full-time, income of £45,000 and weekly childcare costs of £300. For 2010/11 they would have received tax credits of £7,179, but this year they will get about £1,800 less. Their marginal tax rate is probably 73% – income tax at 20%, national insurance contributions (NICs) of 12% and a 41% claw back of tax credits. In such a position, you might feel that a pay rise gives little benefit, since you will only keep 27p for each extra £1. If available, additional holiday entitlement or shorter working hours might be preferred.

Income is after deducting pension contributions and gift aid donations, so the government will pick up 61% of the tab (there is no NICs saving) if these are paid. If you are self-employed you could, for example, treat yourself to a business laptop, and save an additional 9% NICs – effectively funding just 30% of the cost yourself.

Sometimes the government might cover the full cost. The income reduction can also preserve tax credits for the following year, adding another 41% of tax saving – a total of 102% or 111%. And if you are a higher rate taxpayer the savings can be even greater.

Be warned though that this is a complex area, and unforeseen changes to your circumstances can easily ruin any tax planning. Contact us for further advice.