Tax Credits: Calculating tax credits income

This section of the site explains about how to calculate income for tax credit claims. It's important to note that where a claimant has their tax credits terminated because they are moving to universal credit, there are new rules on how to calculate income in those cases. Please see our universal credit section for more information.

Unlike most social security benefits, for tax credits the gross income is used (i.e. before tax and national insurance contributions are deducted).

This will sometimes necessitate a calculation to add the tax back to income which is received, or deductions from income which are paid, net. This is shown in the example below.

Example

James and Jemima have the following sources of income for 2015/16.

 

£

James’s salary

16,000

Profits from Jemima’s business

18,000

Army disability pension*

2,300

Net bank savings interest (joint)

760

ISA dividend (joint)*

140

Rental income/profit (joint) **

 3,500

Total

40,700


James paid a net amount of £2,305 into a stakeholder pension, and he and Jemima jointly made gift aid donations of £702 net.

Their initial 2016/17 tax credits award will be based on their joint income for 2015/16 (as above) and is calculated as follows.

Step 1

Investment income (bank savings)

£

£760 x 100/80***

950

Property income

3,500

Sub-total

4,450

Less disregard

-  (300)

Total

4,150


Step 2

Employment income (James)

16,000


Step 3

Total of steps 1 and 2

20,150


Step 4

Add trading income (Jemima)

18,000

Total

38,150


Less deductions

Pension contributions (James) grossed up****:

£2,305
x 100/80

2,881

Gift aid donations grossed up****:

£702
x 100/80

878

Total deductions

 

- (3,759)

Total joint tax credits income

 

34,391


*Both Jemima’s army disability pension and the joint ISA dividend are disregarded for tax credits purposes.

**This is rental income from a property James and Jemima do not live in and is, therefore, not eligible for rent-a-room relief. See our property income section for changes to the rules for residential landlords from April 2017.

*** A gross income figure is used for tax credits, i.e. before tax and national insurance contributions are deducted. Income from savings is paid net, after deduction of basic rate tax at 20%. To arrive at the gross amount, apply the fraction 100/80 to the net payment.

****Similarly, pension contributions and gift aid payments are made net by the contributor or donor and the amount needs to be ‘grossed up’ at the basic rate of 20%.

Pension contributions and Gift Aid Payments

The gross amount of pension contributions to an approved pension scheme and of authorised Gift Aid payments should be deducted from the gross income figure.

For pension contributions, it is important to check how the contributions are paid, as referring simply to the ‘grossed-up’ amount can be misleading.

Where pension contributions are paid out of net income (i.e. out of income after tax and national insurance contributions are deducted), then the pension contributions should be grossed-up and deducted from the claimants taxable income figure.

Where pension contributions are paid out of gross income (i.e. before any tax or national insurance contributions are deducted), then no adjustment or ‘grossing-up’ is needed because relief has already been given for the pension contributions when calculating the person’s taxable income.

Example

The following shows how this works in practice. Tax credits require the person to declare the taxable income less 100% of any pension contributions.

Person 2 will have a P60 that will show £16,800 (which is £18000 minus £100 x 12 pension contributions) and so they need make no adjustments for their pension contributions.

Person 3 will have a P60 showing taxable pay of £18,000. They can deduct their pension contributions. In this case the £80 a month is grossed up to take account of the tax relief of 20% that is added to the pension fund via tax relief from HMRC. This means the person can deduct a £100 x 12 = 1,200 and declare £16,800 to HMRC.

The result is that both people with pension contributions end up having their tax credits based on the same figure. Without the adjustment made by Person 3, this would not happen.

 

Person 1 – No pension

Person 2 – Occupational pension

Person 3 – defined pension contribution scheme through employer

Pension deduction type

None

Deducted from gross pay before tax and NI are deducted

Deducted from net pay (after tax and NI are deducted)

 

Annual salary

£18,000

£18,000

£18,000

Gross pay per month

£1500

£1500

£1500

 

Less personal allowance

£(916.66)

£(916.66)

£(916.66)

Less pension contribution from gross pay

0

£(100.00)

0

Pay on which tax is due

£583.34

£483.34

£583.34

Tax due

£(116.66)

£(96.66)

£(116.66)

NI due

£(109.99)

£(109.99)

£(109.99)

Less pension contribution from net pay

0

0

£(80.00)

(The scheme claim 20% tax relief from HMRC - £20 making a total into the pension pot of £100)

Net income

£1,273.35

£1,193.35

£1,193.35

 

 

 

 

Income to declare to tax credits

£18,000

£16,800

£16,800

(2016-17 rates and allowances)

Specific income categories

The guidance notes provided by HMRC follow the claim form TC600 and show the claimant the information to include when making a claim.

Last reviewed/updated 10 April 2017