• Once you have worked out your tax credits income you can begin to calculate your entitlement, or at least check the accuracy of the award notices you receive.



• We will take you through the computation stage by stage. This can be a long and time consuming exercise, even where your affairs are fairly straightforward. We have provided a few examples which illustrate the principles being described - click on the links below to view the examples.



• First, a few definitions:



• Award period
  
  This normally is the same as the tax year, 6 April to the following 5 April. When a claim is made at the beginning of the year, or is backdated to the start of the tax year, that is when the award period also begins. It lasts until the end of the year unless HMRC terminate it earlier, which they have power to do if they are of the opinion that:
  
  
  • you have ceased to be entitled to tax credits, or
  • you were never entitled to tax credits in the first place.


• If you apply for tax credits part way through a tax year, your award may only run for the remaining part of the year.
  
  
• Change of circumstances
  
  A change of circumstances is not to be confused with a change in income. Your personal circumstances are what determine what elements of child and working tax credit you are entitled to. So:
  
  
  • what are your normal working hours;
  • whether you have any disability;
  • your age;
  • whether you are married, cohabiting, a lone parent, single, or in a civil partnership with someone or otherwise part of a same-sex couple;
  • whether you pay for approved or registered childcare;
  • how many children you are responsible for, their dates of birth, and whether they have any disability;
  
  all play a part in the amount of tax credit you can claim.



• Some changes of circumstances must be reported to the Tax Credit Office, as outlined in Notifying information.



• Other changes in circumstances - such as birth of a child, onset of a disability, etc - may also be reported, and you may choose to do so in order to secure a higher credit, or prevent an overpayment building up.



• Relevant period
  
  This expression indicates a period during the award period in which the rate of tax credit you are entitled to remains the same. A relevant period is flanked by a change of circumstances which changes the rate at which you are entitled to tax credits.



• Specifically, this means any change in the elements of WTC (other than childcare) and CTC to which you are entitled. In the case of childcare element of WTC, a relevant period comes to an end if there is a change of more than £10 in your average weekly childcare charges, or you cease paying childcare charges altogether.

Calculating entitlement and 'relevant periods'

• Let us look now at how the calculation is made up.



• The first thing to note is that tax credits are paid at a daily rate throughout the award period. This means that the annual amounts announced at Budget time and shown in the tables below have to be subdivided into daily amounts. This is done by dividing the annual rate by 365 days (366 days in a leap year) and rounding up to the nearest penny.



• Bear in mind however that this does not include the WTC childcare element because this is worked out on a weekly basis.



• The equivalent daily rates for the annual rates fixed for 2008/09 are shown in the table below and are based on a leap year of 366 days.


Element

WTC

Basic
2008/09 annual rate £1,800
2008/09 daily rate £4.94
Couple and lone parent
2008/09 annual rate £1,770
2008/09 daily rate £4.85
30 hour
2008/09 annual rate £735
2008/09 daily rate £2.02
Disabled worker
2008/09 annual rate £2,405
2008/09 daily rate £6.59
Severe disability
2008/09 annual rate £1,020
2008/09 daily rate £2.80
50+ return to work (16 to 29 hours a week)
2008/09 annual rate £1,235
2008/09 daily rate £3.39
50+ return to work (30 or more hours a week)
2008/09 annual rate £1,840
2008/09 daily rate £5.05

CTC

Family element 2008/09 annual rate £545
2008/09 daily rate £1.50
Family element where child under one year old
2008/09 annual rate £1,090
2008/09 daily rate £3.00
Child element
2008/09 annual rate £2,085
2008/09 daily rate £5.72
Disabled child
2008/09 annual rate £2,540
2008/09 daily rate £6.96
Severely disabled child
2008/09 annual rate £1,020
2008/09 daily rate £2.80


• You then look to see if you have any changes of circumstances during the award period which alter your entitlement (see above). With each such change, a relevant period stops and another starts. Relevant periods are measured by the number of days in each.



• The tax credit award is worked out separately for each relevant period, as shown in the example of Susan 1.

The 'income test'

• The totals give the maximum tax credits to which you are entitled. A claimant's tax credit income is then compared with the income thresholds shown in the table below.



• If your income does not exceed the first income threshold (which is usually £6,420 but £15,575 if you are entitled to CTC only), you are entitled to maximum tax credits. If you have income which is above the first income threshold, your maximum tax credit entitlement is reduced by 39% of that excess. This is known as the fast taper.



• If you are entitled to CTC only, the fast taper does not apply to you until your income goes above the alternative threshold of £15,575. The fast taper is not applied to the family element. If your income exceeds the second withdrawal threshold of £50,000 (or a higher figure determined as shown below), your entitlement to the family element is withdrawn by 6.67% of that excess. This is known as the slow taper .




• The slow taper

  A similar calculation to Susan is that of Melissa. This demonstrates how when the fast taper has eliminated all other elements of both WTC and CTC, including the childcare element of WTC and the child elements of CTC, the slow taper begins to whittle away the family element.

  This point in the income scale where this starts to happen is never less than the second income threshold of £50,000, and can be considerably greater than that depending on the numbers of children you are able to claim for, and whether you have maximum eligible childcare costs. The example Melissa shows how this is calculated.




• Income thresholds

  The rates and thresholds shown in the following table are those for 2008/09
  
  First income threshold £6,420
  First withdrawal rate (per cent) 39%
  Second income threshold £50,000
  Second withdrawal rate (per cent) 6.67%
  First threshold for those entitled to CTC only £15,575




• Maximum rate entitlement for people on income support etc

  The income test described above does not apply for as long as you are receiving income support, or income-based jobseeker's allowance, or state pension credit. In other words, you are automatically entitled to maximum tax credits during such periods. There is no tapering away of your entitlement, nor counting of relevant periods.

  At LITRG we have seen cases of claimants who have lost their jobs later in the year being denied tax credits because HMRC say they have earned too much earlier in the year. But the statute makes it clear that the income test is suspended for the period during which they are receiving any of the above benefits.

  There also appears to be a benefit in the way the income rules work for the period when their tax credits still have to be based on income. Let's say that you work and earn £6,000 to the date of your redundancy on 5 October 2008. When calculating your entitlement for the period 6 April 2008 to 5 October 2008 the income used is £6,000 x 183/365, assuming that you have no tax credits income for the rest of the tax year. This will often mean that you are entitled to a further payment of credits when you move on to income support.

  NB do not confuse income based jobseeker's allowance with contribution-based jobseeker's allowance. DWP award notices we have seen do not make the distinction clear, and a mistake can easily lead to an overpayment.




• Income disregard

  If your income goes up during the year, the increase is generally reflected in your income for tax credits, so that your tax credit entitlement will usually go down. But this is subject to an important rule. Any increase in income in one tax year as compared with the previous tax year does not affect tax credit entitlement if it does not exceed a certain amount; and if it does exceed that amount, only the excess is taken into account.

  The income disregard for 2008/09 is £25,000. It was also £25,000 for 2007/08 and 2006/07. For years from 2003/04 to 2005/06 it was £2,500. The dramatic increase was announced in the Chancellor of the Exchequer's pre-Budget Statement on 5 December 2005, the yardstick being the amount by which a family's income would increase if the second adult in the family took a job at the national average wage. The intention was to enable a family to take that step while being reassured that it would not affect their tax credit entitlement during that year.

'Protective Claims'

• Because your tax credit entitlement accrues at a daily rate throughout the year, income is worked out by being spread evenly, day by day, over the whole year.



• This can mean that tax credits already received may have to be recalculated.



• This can work to your advantage if you start the year on a high income and finish it on a low income, especially if you have made a claim at the start of the year and been given a Nil Award. This is because your award is recomputed for the whole year to give you the tax credit entitlement which is now your due. If you had not made a claim, but had delayed claiming until the fall in your income, you would only have been allowed three months' backdating.



• A claim made in these circumstances and followed by a Nil Award is loosely termed a 'protective' claim.




• Income increasing in-year

  In the tax years 2003/04 to 2005/06 this same phenomenon could work to your disadvantage if your income increased during the year by more than the previous £2,500 disregard. This was because your tax credit entitlement decreased not only for the rest of the year following the rise in your income, but also retrospectively for the part of the year for which you had already been paid.



• If, say, you earned £10,000 pa for the first six months of 2005-06, then in say September 2005 your income increased to £20,000 pa, by the end of the year you would have earned £15,000 in total. Your tax credits would be recomputed as though you had earned £15,000, less the disregard figure of £2,500, or tax credits income of £12,500. You would be treated as if you had earned that sum day by day evenly throughout the year, giving you £6,250 for the first six months and £6,250 for the second. An overpayment would have accrued for the first six months based on the £6,250 less £5,000 = £1,250 x 37% = £462.50, and this could not have been eliminated or reduced however promptly you notified HMRC of your increase in income.




• The increase in the disregard from £2,500 to £25,000 was designed to alleviate this problem. It ensures that from 2006/07, your tax credits entitlement will not be affected during the tax year in which your income increases by up to £25,000 as compared with income of the previous year. But note three things:

  1. Overpayments originating from before 2006/07

     First, the £25,000 disregard applies only to income rises in 2006/07 and subsequent years – overpayments being recovered now from final awards for 2005-06 and earlier years will still be calculated by reference to the £2,500 disregard applying in those years. See Zobeida.

  
  

  2. Reporting income rises to HMRC

     It might be thought that any income rises of £25,000 or less, because they have no effect on the award for the current tax year, need not be reported to HMRC until the time comes to complete the renewal forms in the following tax year. But in fact it is better to report such changes well before the end of the current year, otherwise the 'provisional' payments in the following year (ie the run-on payments in the first few months of the new tax year until the renewal forms are sent back) could well be too high and cause an overpayment to accrue. Have a look at Susan 2 which demonstrates how this works.

     Anticipating the likelihood of claimants not following this advice, the Government announced two further measures in the PBR 2005 which were designed to deal with the point.

     First, in early calendar year 2007, HMRC would contact 'key groups of claimants' to 'obtain more up-to-date income information on which to base the next year's payments while the finalisation process [was] completed.' This happened as planned.

     Secondly, from the tax year 2008/09, where claimants have not provided up-to-date information about their income and circumstances, the income figure used to calculate provisional payments will be uprated by average earnings.

  
  

  3. Income going down

     Imagine that at the start of 2008/09 you expect your income for that year to be lower than it was in 2007/08. There are two possible options open you: you could either do nothing and allow your 2008/09 to be based on previous year income, or you could report an estimated 2008/09 income to HMRC and your 2008/09 award would then be based on this lower figure. Each option has its merits.

     
     

     Option 1 – Do nothing

     Initial tax credits awards are based on previous year income. When you receive your 2008/09 initial award it will be based on your actual income for 2007/08. If you anticipate a much lower income for 2008/09 and choose not to report this (there is no obligation to do so until after the end of the tax year) then you will continue to receive tax credits based on your 2007/08 income. The problem with this is that the amount of tax credits you receive will not reflect your new lower income, however it will avoid potential overpayments if your income later rises (see Ferdinand & Miranda 2). It is likely in this scenario that you will have an underpayment at the end of the 2008/09 tax year which will be paid to you in a lump sum.

     
     

     Option 2 – Report an estimated 2008/09 income

     As stated above, initial tax credit awards are based on previous year income (in this case 2007/08). However, if you anticipate a much lower income for 2008/09 as compared to 2007/08 you can report this to HMRC as an estimate.

     HMRC will then revise your 2008/09 award to be based on your estimated 2008/09 income. The benefit of doing this is that you will receive an increase in tax credits at a time when your income has reduced.

     It is important to note that tax credits will be adjusted forward from the date that you provide HMRC with your estimated income. The underpayment that will have accrued from the start of the year until the date you report your estimated income will be held back for the time being, to guard against the possibility that your current estimate may be too low. If any underpayment remains after 2008/09 this will be paid to you in a lump sum. This is illustrated in Ferdinand & Miranda 1.

     
     

     Income falling then rising again

     However, complications set in if your estimated 2008/09 income, having fallen in relation to 2007/08 income, then starts to rise again.

     For example, you start the year on maternity leave then go back to work on full pay when your statutory leave period has expired. Or you lose your job then find another one.

     In this case, if you report the fall in your income and get paid extra tax credit, the Tax Credit Office will claw back that extra tax credit if you subsequently report that your income has gone up again. That is because the disregard of £25,000 is measured by reference to the amount of the previous year's income, and if your current year income falls below that level, then starts to rise again, the rise is not covered by the disregard until your income again catches up with 2007/08 levels. See the example on Ferdinand & Miranda 2.

     
     

     Holding back underpayments

     As discussed above, where claimants report a fall in income they will have the rest of their payments for the tax year adjusted accordingly, but will not immediately be paid the accrued underpayment from the earlier part of the year.

     The idea of this measure is to provide a buffer against any overpayment accumulated by the claimant during the year, especially if their estimate of income proves to have been too low.

     While helpful to those whose incomes fall during the year then rise again (see Ferdinand & Miranda 2), this will be of less assistance to those whose income falls and stays low. They will not get the underpayment that will have accrued up to that point until the end of the year.

     It is important to mention that the above describes the present situation. Prior to 2007/08 HMRC procedure was to pay any underpayments that accrued in a lump sum immediately. This meant that if claimants reported an estimated income, they would receive a lump sum payment immediately for the first part of the year. However if their income then rose later in the year this lump sum payment became an overpayment. In order to reduce the amounts of end-of-year overpayments, HMRC introduced the withholding of underpayments that accrued from the beginning of the year. (See Ferdinand & Miranda 3 if similar changes had happened in 2006/07).

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