Tax Planning for Families: The Complexities of Using Children’s Allowances
When considering tax planning strategies, many parents might look to their children’s personal allowances as a potential way to reduce the family’s overall tax burden. After all, like adults, children have their own suite of personal allowances. Including the personal savings allowance and the dividend allowance. However, leveraging these allowances is not as straightforward as it may seem, particularly when HMRC’s anti-avoidance rules come into play. In this blog, we explore how these rules work and the key considerations for parents.
Utilizing Children’s Personal Allowances: The Challenges
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Earned Income
Children, like adults, have a personal allowance for income tax purposes, which for the tax year 2024/25 is £12,570. This means that any income they earn, such as from a Saturday job or a paper round, can be received tax-free up to this amount. However, parents who own a family business might be tempted to employ their children to make use of this allowance.
While it’s legal to employ your child in your business, HMRC imposes strict conditions. The child must perform actual work, and their pay must reflect the market rate for the work done. HMRC may disallow salaries deemed excessive or those that seem like an attempt to divert income from the parent to the child. For example, paying your child £12,570 for minimal work could easily attract HMRC scrutiny and potential penalties.
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Savings Income
A minor child may have savings from which they earn interest. Like adults, they benefit from the personal savings allowance and potentially the savings starting rate band. However, HMRC’s anti-avoidance rules prevent parents from shifting income to their children to take advantage of these allowances.
Specifically, if the interest earned on money given to a child by a parent exceeds £100 in a tax year, that interest is treated as the parent’s income for tax purposes. This rule effectively limits the benefits of transferring savings to a child. Parents must be particularly mindful of this rule in times of rising interest rates. Which could inadvertently push the interest earned over the £100 threshold.
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Dividend Income
Dividend income is another area where parents might consider using their children’s allowances. Especially given the reduction in the dividend allowance to £500 from April 2024. The idea of transferring shares to a child to make use of their dividend allowance and basic rate band is appealing. However, similar to savings income, anti-avoidance rules apply.
If a parent gifts shares to a minor child and the dividend income exceeds £100, the income is taxed as if it were the parent’s. This rule is designed to prevent income shifting within families to reduce tax liability. Therefore, the strategy of transferring dividend-paying shares to children often does not achieve the desired tax savings unless the shares were purchased by the child with funds not provided by the parent.
While the concept of utilizing children’s personal allowances to reduce the family’s tax bill is attractive. HMRC’s anti-avoidance rules make it challenging to implement this strategy effectively. Parents should proceed with caution and ensure that any income earned by their children genuinely reflects their work or investment, and is not merely a conduit for reducing the parent’s tax liability. For personalized advice on navigating these complex rules, consult with our team at Merranti Accounting.
