BENEFITS EXPERT: Solving the tax credit puzzle

Despite all the recent talk about Working Tax Credit cuts I keep hearing of people who, like me, have no idea how they will be affected.

Can you explain how Tax Credits are calculated so I might be able to work it out for myself?

To understand how Tax Credits are worked out there are three things that need to be explained. These are the ‘Maximum Amount’, the ‘Threshold’ and the ‘Taper’.

The Maximum Amount: Tax Credits are not worked out by the week, as other benefits are, but by the year.

So each person’s calculation starts with a sum of money that is the most they can receive in a tax year.

This maximum amount varies between individuals, usually according to the size of the family, although extra can be included for those with a disability.

The maximum amount for a single childless worker is usually £2,770 a year. For a full-time working single parent with four children, for example, it would be £16,445.

The Threshold: Of course not everyone will actually be paid their maximum amount. This only goes to those with incomes small enough to be beneath ‘the threshold’.

That threshold is £6,420 a year. Somebody working 16 hours a week for the National Minimum Wage, for example, would have an annual income of £5,574 a year if they have nothing else coming in.

As their income is below the threshold they will receive the maximum amount. The same would apply to a self-employed person whose net annual profits were under the threshold, or if they had no profits at all. The Taper: But most people on Working Tax Credit have an income above the threshold, and so receive less than their maximum amount.

The higher their income, the more their entitlement is reduced. Every £100 of annual income above the threshold causes £41 to be deducted from the maximum amount.

So an annual income of £16,420, which is £10,000 above the threshold, reduces Tax Credits to £4,100 below the maximum amount.

This process of withdrawing benefit as income rises is called ‘the taper’. Accordingly, the loss of £41 in benefit for every extra £100 of income is referred to as ‘a taper of 41%’.

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The Changes: In his Budget statement George Osborne announced that from next April the maximum amount would be frozen, but the threshold would be reduced to £3,850 and the taper increased to 48%.

Do the maths and you will see that, under these rules, an annual income of £16,420, as above, reduces Tax Credits to £6,033 below the maximum amount.

Compared to the current rules, that makes a difference of £37 a week.