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 is subject to in-year finalisation, different rules apply on how to calculate income in those cases. Please see our existing tax credit claimants 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 2023/24.
|
|
£ |
|
James’s salary |
16,000 |
|
Profits from Jemima’s business |
18,000 |
|
Army disability pension* |
2,300 |
|
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 his work pension scheme from his net pay (a relief at source scheme) , and he and Jemima jointly made gift aid donations of £702 net.
Their initial 2024/25 tax credits award will be based on their joint income for 2023/24 (as above) and is calculated as follows.
Step 1
|
Investment income (bank savings) |
£ |
|
£760 |
760 |
|
Property income |
3,500 |
|
Sub-total |
4,260 |
|
Less disregard |
- (300) |
|
Total |
3.960 |
Step 2
|
Employment income (James) |
16,000 |
Step 3
|
Total of steps 1 and 2 |
19,960 |
Step 4
|
Add trading income (Jemima) |
18,000 |
|
Total |
37,960 |
Less deductions
|
Pension contributions (James) grossed up***: |
£2,305 |
2,881 |
|
Gift aid donations grossed up***: |
£702 |
878 |
|
Total deductions |
|
- (3,759) |
|
Total joint tax credits income |
|
34,201 |
*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.
***Pension contributions and gift aid payments can be made net by the contributor or donor and in that case 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. This is called a relief at source scheme.
Where pension contributions are paid out of gross income (i.e. out of income 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. This is called a net pay arrangement.
Example
The following shows how this works in practice. The table is based on 2023/24 rates. 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 using net pay arrangement |
Person 3 – defined pension contribution scheme through employer (relief at source scheme) |
|
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 |
£(1047.50) |
£(1047.50) |
£(1047.50) |
|
Less pension contribution from gross pay |
0 |
£(100.00) |
0 |
|
Pay on which tax is due |
£452.50 |
£352.50 |
£452.50 |
|
Tax due |
£(90.50) |
£(70.50) |
£(90.50) |
|
NI due |
£(52.04) |
£(52.04) |
£(52.04) |
|
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 |
£1,357.46 |
£1,277.46 |
£1,277.46 |
|
|
|
|
|
|
Income to declare to tax credits |
£18,000 |
£16,800 |
£16,800 |
(2023/24 rates and allowances)
For Scottish rate taxpayers, where contributions to the employer's pension scheme are paid under net pay arrangements, claimants automatically receive tax relief at the Scottish rates, if appropriate. For 2023/24 and 2024/25, pension providers who operate relief at source arrangements will give tax relief at the rate of 20% on pension contributions made by Scottish taxpayers. For non-taxpayers, or people who only pay income tax at the Scottish starter rate of 19%, HMRC will not seek to recover the extra tax relief given through this concession. More information about different level of adjustments for tax relief on pension contributions and gift aid contributions for Scottish rate taxpayers at lower rate is available on the LITRG website.
Last reviewed/updated 2 May 2023