Tax Credits: The four steps

The Income Regulations prescribe a series of four steps to work out income for tax credits purposes. The claim form does not require this, but we have set out the steps below in order to give a complete picture of the legislative method.

NOTE: This section of the site explains what is income for tax credit claims. Where a claimant has their tax credits terminated because they are moving to universal credit, there are new rules on how to calculate income. Please see our transition to universal credit section for more information.

For joint claims, the joint income for the relevant tax year of both partners (or of all members of a polygamous unit) should be used, as in the example below. Only the income of the partners in the couple, or members of the polygamous unit, is aggregated; any income belonging to any children in the household is left out of account, except in certain circumstances where a claimant artificially transfers income to a child in an attempt to maximise their tax credits entitlement.

Step 1. Add together:

  1. pension income 
  2. investment income
  3. property income
  4. foreign income
  5. notional income 

If the total is £300 or less, it is ignored completely. Otherwise, £300 is deducted from the total. There is no notional capital rule as for social security benefits - only the actual income from savings is counted. The rationale of the £300 was to protect the position of former benefits claimants whose savings were small enough to come within the £3,000 capital limit applied by the DWP at the time WTC and CTC were introduced.

Step 2. Add together:

  1. employment income
  2. social security income
  3. student income
  4. miscellaneous income 

Step 3. Add together the amounts in Step 1 and Step 2.

Step 4. Add trading income to - or if there is a loss subtract the trading loss from - the total in Step 3.

Then deduct:

If a claimant has sustained a loss in a UK or overseas property business (‘property loss’) it can be set against total income for tax credits purposes.

Unlike mainstream tax, income for tax credits includes all worldwide income, whether or not it is remitted to the UK or is exempt under the terms of a double taxation treaty. ‘Unremittable’ income is an exception to this rule (explained below).

Where a claimant would be chargeable to income tax but for some special exemption or immunity from income tax, tax credits income must be calculated on the basis of the amount which would be so chargeable but for that exemption or immunity. In other words, income must be taken into account for tax credits even if it is exempt from tax, unless it is specifically disregarded under the Income Regulations.

Income paid in a foreign currency must be converted into sterling using an average of exchange rates in the 12 months up to 31 March in the tax year in which the income arises. HMRC publish the exchange rates at www.gov.uk/government/collections/exchange-rates-for-customs-and-vat

Last reviewed/updated 28 July 2016