What Are Tax Credits? A Simple Guide for UK Businesses

Tax Queen

Tax Expert @ Pie

4 min read

Tax credits are government payments that reduce your tax liability directly on a pound-for-pound basis, providing a full discount on taxes owed rather than simply lowering taxable income. Managed by HMRC, the traditional welfare system consisted primarily of Working Tax Credit (for low-income workers meeting specific weekly hour thresholds) and Child Tax Credit (to assist with raising children under 16, or under 20 in approved education). New claims for these legacy tax credits are permanently closed as part of the transition to Universal Credit, which consolidates six legacy benefits into a single monthly payment administered by the DWP. Existing tax credit recipients are required to complete annual reviews, report changes in circumstances within one month, and transition to Universal Credit when issued a Migration Notice to protect their payment entitlement. Beyond welfare tax credits, individuals can optimize their tax position through allowances such as the Marriage Allowance (saving up to £252 annually), pension tax relief, Tax-Free Childcare (saving up to £2,000 per child per year), or by tracking real-time tax liabilities using digital compliance tools like the Pie Tax App.

All You Need to Know

Tax credits are a brilliant way to cut your tax bill or even get money back from the government. Unlike other tax benefits, they directly reduce what you owe pound-for-pound, making them exceptionally valuable.

Think of it this way - if you owe £1,000 in tax and qualify for a £500 tax credit, you’ll only need to pay £500. It’s essentially a discount on your tax bill that can significantly improve your financial situation. Tax credits can also provide extra money to help with financial stability.

Most people don’t realise just how valuable tax credits can be. They’re specifically designed to help families, lower-income workers, and people with disabilities navigate financial challenges more effectively.

What Exactly Are Tax Credits?

Tax credits are payments from the government that cut your tax bill directly. They’re worth much more than tax deductions because they reduce the actual tax you pay, not just your taxable income.

The UK currently has two main types: Working Tax Credit and Child Tax Credit. However, most are being replaced by Universal Credit for new claimants, representing a significant shift in the benefits system. When eligibility for Child Tax Credit ends, individuals could consider claiming other benefits such as Universal Credit.

How much you get depends on your income, family situation, and whether you meet specific eligibility rules. Some credits even pay you money if your tax bill is less than the credit amount, providing additional financial support. Pension Credit offers crucial assistance for eligible claimants to help maintain their financial stability after existing tax credits are phased out.

Who Can Get Working Tax Credit?

Working Tax Credit helps people on lower incomes who work a minimum number of hours each week. You need to be 16 or over and working regularly to qualify for this valuable support.

Single parents need to work at least 16 hours weekly, while couples with children usually need to work at least 24 hours between them, with one person working at least 16 hours. Your income plays a big part in how much you receive. Income-related employment and support allowance (ESA) can also impact eligibility for Working Tax Credit.

Self-employed individuals can still qualify if their work is commercial, regular, and aimed at making a profit. Additionally, people with disabilities who work may get extra elements added to their Working Tax Credit.

How Does Child Tax Credit Help Families?

Child Tax Credit supports families with children under 16, or under 20 if they’re in approved education or training. You don’t need to work to claim it, making it accessible to a wide range of families. Individuals can claim Child Tax Credit if they have an eligible child, and it interacts with other benefits like Working Tax Credit.

Unlike Working Tax Credit, this benefit focuses solely on helping with the costs of raising children. The amount depends on your income and how many children you have, with additional support available for families with disabled children.

For most new claims, Child Tax Credit is being replaced by Universal Credit. However, some existing claimants can still renew their claims, so it’s worth checking your eligibility.

How Tax Credits Work

Tax credits are payments from the government designed to support individuals and families with low incomes. Administered by HM Revenue & Customs (HMRC), these payments are usually deposited directly into your bank account, providing a straightforward way to receive financial assistance.

Eligibility: To qualify for tax credits, you must meet specific criteria, including income limits, work hours, and family sise. These requirements ensure that the support goes to those who need it most.
Application: While you can no longer make a new claim for tax credits, if you are already claiming one type of tax credit, you can still add on the other if you become newly eligible. This flexibility allows you to adjust your claim as your circumstances change.
Renewal: If you are already claiming tax credits, you need to renew your award annually. This process involves confirming your details and income for the previous year. Additionally, you must inform HMRC of any changes in your circumstances within one month to ensure you receive the correct amount.

By staying on top of your tax credit claims and renewals, you can continue to receive the financial support you are entitled to.

Tax Credits vs Universal Credit: What's Changing?

Universal Credit is gradually replacing six older benefits, including both types of tax credits. Most new claimants now have to apply for Universal Credit instead of the traditional tax credits system.

If you’re already getting tax credits, you’ll eventually be moved to Universal Credit. The government is contacting people when it’s their turn to switch, so keep an eye on your correspondence. Employment and Support Allowance (ESA) can affect the calculations of maximum amounts for tax credits, and there are complexities surrounding reporting income and the associated disregards for income changes in relation to these allowances.

The payment schedule differs too, with tax credits potentially paid weekly or every four weeks, while Universal Credit comes monthly. Some people find they get more under Universal Credit, while others might get less, depending on specific circumstances.

How Do You Apply for Tax Credits?

Most new claims are now directed to Universal Credit instead of tax credits. However, exceptions exist for certain situations, so it's worth checking your specific eligibility.

If you're eligible to make a new claim for tax credits, you'll need to provide detailed information about your income, work hours, children, and any disabilities. You must renew your tax credits claim every year when HMRC sends you renewal forms.

Report any changes in your circumstances within one month to avoid being paid the wrong amount. HMRC has a dedicated tax credits helpline if you need assistance with your claim or have specific questions.

Other Tax Credits That Might Help You

Marriage Allowance lets you transfer part of your Personal Allowance to your spouse or civil partner. This could save up to £252 in tax annually, a significant benefit for many couples.

If you’re saving for retirement, pension tax relief works like a tax credit by adding money to your pension pot based on your income tax rate. This can substantially boost your retirement savings over time.

Self-employed individuals might qualify for special tax advantages through the Construction Industry Scheme. Parents can also get help with childcare costs through specific tax-free childcare schemes, saving up to £2,000 per child each year. Salary increases from a new job can impact tax credit calculations, introducing complexities based on current and previous income comparisons.

Important Dates and Deadlines

When dealing with tax credits, keeping track of important dates and deadlines is crucial to ensure you receive the correct amount and avoid any issues.

Annual Review: Each year, you will receive a letter called your Annual Review when your tax credits award ends. This letter contains important information about your claim, and you need to check that all details are correct. This process is known as ‘finalising’ your tax credits.
Deadline to Notify HMRC: If there are any changes in your circumstances, such as a change in income or family sise, you must report these changes to HMRC within one month. Prompt reporting ensures that your tax credits are adjusted accurately.
Deadline to Contact HMRC: If you believe there is a mistake in your tax credits award or if your personal details are incorrect, you must contact HMRC by the deadline specified in your Annual Review letter. Addressing errors quickly can prevent future complications.

By keeping these dates and deadlines in mind, you can ensure that your tax credits are managed correctly and that you receive the maximum amount of support you are entitled to.

Making the Most of Your Tax Situation

Tax credits can dramatically reduce what you pay to HMRC or even result in payments to you if you qualify. It's worth checking your eligibility regularly, especially as your circumstances change throughout the year.

Even though many tax credits are moving to Universal Credit, understanding what's available ensures you don't miss out on potential benefits. Getting professional advice can help you navigate the tax system and maximise your entitlements.

Pie is the UK's first personal tax app designed to help working individuals reduce their tax burdens. As the only self assessment solution with integrated bookkeeping, real-time tax figures, and expert advice, it makes managing your taxes much simpler.

Why not see how Pie.tax could help you understand your tax position better and ensure you're claiming everything you're entitled to? I recently helped a client save over £1,200 by identifying tax credits they didn't know they qualified for – it's often worth the time to check.