Tax credits - building a view of true total reward

The tax credit system has developed in to one of the most complicated State delivered benefits in living memory. Just understanding how it works is a challenge but beyond lies some real opportunities to enhance the reward value of those on low and moderate incomes.

It is important to note that other benefits (e.g. disability benefits) are likely to have an impact on individual situations and we suggest that the Inland Revenue is the best place to obtain more information.

Tax credits

The Child Tax Credit (CTC) offers financial support with general family costs. Working Tax Credit (WTC) supports those on lower incomes and working parents may be eligible for additional help towards registered childcare costs. The amount of help parents receive will depend on a number of factors including their income, the size of their family and the amount the pay in childcare.

The receipt of employer provided benefits through a salary sacrifice scheme can affect entitlements to tax credits in two main ways.

Where employees' average earnings have effectively been reduced, they could receive a higher payment through the WTC and the CTC. However, the value received in employer provided childcare vouchers cannot be considered as childcare costs when calculations are made for employee entitlement to the childcare element of WTC. The childcare element of WTC may therefore be reduced. We have analysed this issue in detail and established that there are certain cut off points where it makes sense to avoid employer childcare vouchers and continue to reclaim the costs directly form the Revenue (please contact us for more information about this).

Defining what counts as earnings is critical to the figure that is used for the credit calculation. The current rules add salary and other taxable benefits in kind together, so someone sacrificing salary for a non-exempt benefit like medical insurance would see no increase in tax credits.

However, sacrifices to salary in exchange for exempt benefits are different. These are not counted as assessable income and an increase in the level of tax credit should be available (see note 1 below). We have shown an example of how this works below where an employee increases the value of their pay by £1,750 (see the example opposite).

Summary

Employees can optimise their reward by taking account of the tax regime in place and the benefits offered by their employer. It is not a simple process and good guidance is vital. However, the possibility of significantly increasing marginal income for low on lower and mid-range earnings is likely to deliver real value to employees for those employers willing to make the effort.

Example

Before a salary sacrifice:

After a salary sacrifice of £2,500:

This example shows that take home pay has only reduced by £750 whilst £2,500 of funding has been made available for benefits. Putting it another way, this employee has increased the value of their pay by £1,750 just by making best use of the tax and benefit system.

Assumptions: One Income Earner, two children. Qualify for basic element & second adult/lone parent element & 30hrs element of WTC only Qualify for family element and child element of CTC only

Note

The above example is for illustrative purposes only and the actual amount of tax and tax credit will depend on individual circumstances. It is also important to note that the non-salary benefits received may incur additional tax liabilities under benefit in kind rules unless they are specified as exempt benefits (e.g. pensions, approved life cover, HCI payments, etc.). In addition, the definition of earning for tax credit purposes will include the value of taxable benefits, along with a range of other types of income and this need to be carefully considered.