Two income levels catch many business owners out: the £60k child benefit trap and the £100k tax trap. From £60,000, you start to lose child benefit under the High Income Child Benefit Charge, and by £80,000 it has gone. Above £100,000, you gradually lose your personal allowance and, if you have young children, your funded childcare hours and Tax-Free Childcare. Graham warns that crossing £100,000 with children at nursery can mean earning around £25,000 more just to be no worse off.
Watch Graham talk this through: see the video on LinkedIn
Why earning more can leave you worse off
The tax system has a number of cliff edges where a small rise in income triggers a much larger loss of benefits or allowances. As Graham says, it is complicated enough that you can be penalised without knowing it.
Both traps are based on adjusted net income. That is your total taxable income, including salary, profits, dividends, rental profits and savings interest, less certain reliefs such as pension contributions and Gift Aid. It is not just your salary.
Who gets caught
The people most often caught out are those whose income moves from year to year or comes from more than one source:
- Company directors taking a small salary and larger dividends
- Sole traders and partners whose profits jump in a good year
- Employees who receive a one-off bonus or pay rise
- Landlords whose rental profits push them over a threshold
- Anyone who sells investments and receives large dividends or interest in the same year
Because both traps are measured over the tax year, timing matters. Contractors setting their rate for the first time can use our contractor rate vs salary guide to see where their income is likely to land. A bonus paid on 4 April falls in a different tax year from one paid on 6 April. For directors, the timing of dividends can be planned in the same way.
The £60,000 child benefit trap
If you or your partner claim child benefit and either of you has adjusted net income over £60,000, the higher earner starts to pay it back through the High Income Child Benefit Charge. You repay 1% of the child benefit for every £200 of income over £60,000, so at £80,000 it cancels out the child benefit completely.
For a family with two children, child benefit is currently £27.05 a week for the eldest and £17.90 for the second, about £2,337 a year. At £70,000, the higher earner repays half of that, around £1,169. Across the £20,000 band, the charge adds almost 12p to the tax on every extra pound, taking income tax on each extra £1 from 40% to nearly 52%, before National Insurance.
Directors who pay themselves a small salary and larger dividends are often surprised to find they are caught, because the dividends count in full. It is still usually worth claiming child benefit even if you pay the charge, because a claim protects National Insurance credits for a parent who is not working. The charge can now be paid through PAYE as well as through self-assessment.
The £100,000 trap
Above £100,000, your personal allowance is reduced by £1 for every £2 of income over the limit, and it has gone down to £125,140. In that band, the effective rate of income tax is 60%.
The maths works like this. Earn another £10,000 between £100,000 and £110,000, and you pay £4,000 of higher rate tax on it. You also lose £5,000 of personal allowance, which means another £5,000 of income is taxed at 40%, adding £2,000. That is £6,000 of tax on £10,000, or 60%.
Once income reaches £125,140, the personal allowance has been used up, so there is nothing left to lose. From that point each extra pound is taxed at the 45% additional rate only, which is why the rate drops back from 60% to 45%.
These rates apply to salary, profits and other non-dividend income. Dividends are taxed at 10.75%, 35.75% and 39.35% in 2026 to 2027, so a director taking dividends in the £100,000 to £125,140 band pays a little less than 60%, but still far more than the headline rate. Dividends also count in full towards both thresholds.
If you have young children, going over £100,000 also ends your entitlement to funded childcare hours and Tax-Free Childcare. That applies if either parent’s adjusted net income is over £100,000. In England, working parents can get up to 30 hours a week of funded childcare for 38 weeks a year for children from 9 months until they start school. Tax-Free Childcare adds £2 for every £8 you pay, up to £2,000 a year per child.
This is a cliff edge rather than a taper. £1 over the limit can lose the whole entitlement. Put together, Graham’s estimate is that a parent with children at nursery may need to earn an extra £25,000 or so just to be back where they were. Past £100,000, you can end up losing money for every extra pound you earn.
What you can do about it
- Pension contributions reduce your adjusted net income and can bring you back under a threshold.
- Employer pension contributions, including through salary sacrifice, keep that income out of your adjusted net income altogether. From April 2027, only the first £2,000 a year you sacrifice into a pension will be free of National Insurance. The income tax treatment is not changing, so salary sacrifice will still reduce your adjusted net income.
- Gift Aid donations also reduce adjusted net income.
- If you are a company director, plan the mix and timing of salary and dividends. Our 3 factors in a tax-efficient directors’ remuneration strategy explain how.
- Look at the whole household, not just one person’s income.
- Review your position before the tax year ends on 5 April, not after.
As an example, someone with adjusted net income of £110,000 who pays £8,000 into a personal pension has £10,000 added to the pension once basic rate relief is included. Their adjusted net income falls to £100,000, which restores the full personal allowance and, if they have young children, their childcare support. The extra higher rate relief is claimed back through self-assessment.
If you file a self-assessment return, the earlier it is done, the more time you have to act. Our post on what to expect from your accountant explains the key dates, and if you have sold or swapped crypto in the year, see what you need to report.
The rules for funded childcare differ in Scotland, Wales and Northern Ireland, and Scottish income tax bands are different, so the figures here are for England. For more on how recent changes affect business owners, read Budget 2025: what the tax changes mean for you.
Glossary
Adjusted net income: Your total taxable income, including salary, profits, dividends, rent and savings interest, less pension contributions and Gift Aid donations.
Personal allowance: The amount of income you can earn each year before paying income tax. It is £12,570 for most people.
High Income Child Benefit Charge: A tax charge that claws back child benefit when the higher earner’s adjusted net income is over £60,000.
Tax on each extra £1: Also called the marginal rate. How much of the next pound you earn goes in tax.
Higher rate and additional rate: Income tax of 40% on taxable income from £50,271 to £125,140, and 45% above £125,140.
Dividends: Payments a company makes to its shareholders out of profit. They are taxed at their own rates.
Salary sacrifice: Giving up part of your salary in return for your employer paying the same amount into your pension.
Relief at source: The way most personal pensions work: you pay in £80, and the provider adds £20 of basic rate tax relief.
Gift Aid: A scheme that lets charities claim back basic rate tax on your donations. Donations also reduce your adjusted net income.
Tax-Free Childcare: A government top-up of £2 for every £8 you pay towards childcare, up to £2,000 a year per child.
Funded childcare hours: Up to 30 hours a week of free childcare in England for working parents of children from 9 months until they start school.
Related reading
- Contractor Rate vs Salary: Why £50,000 Isn’t £50,000
- How Long Should Your Accountant Take to Get Back to You?
- Own Crypto? HMRC Knows. Here’s What You Need to Report
- 3 Factors in a Tax-Efficient Directors’ Remuneration Strategy
- Budget 2025: What the Tax Changes Mean for You
Close to one of these thresholds?
A short review before the end of the tax year can save a lot more than it costs. Book a free chat with the team.