Tax credits – is it a good idea to come out of the system?

by Tax Faculty Team on 27.03.2012 03:13

If HMRC has written to you, you may need to reply by 31 March 2012


Tax credits – working tax credit (WTC) and child tax credit (CTC) – are less generous these days, and HMRC is writing to claimants on higher incomes to tell them they are not likely to be paid any credits and will be taken out of the system from 2012/13 unless they ask to stay in.


However, the letters from HMRC are misleading, and claimants, or advisers who have clients claiming tax credits, need to think about the implications of coming out of the system. Claimants must tell HMRC by 31 March 2012 if they want to stay in.


The HMRC letter (reference TC1015) was sent to over a million tax credit claimants earlier this year. It is misleading because it quotes ‘one size fits all’ income levels at which (according to HMRC) claimants will no longer get any credits. But the income level at which credits cease will depend on each claimant’s circumstances, and some could remain entitled at levels higher than those quoted by HMRC.


For example, for WTC the letter refers to income ceilings of £13,000 and £18,000 for single people and couples respectively. People with disabilities are likely to lose out if they rely on these figures as they may have much higher cut-off points.


For CTC the letter states that the income limit is £26,000 for single and joint households. However, this is wrong for the majority of CTC claimants. For those who have more than one child, or pay childcare costs, or qualify for the disability elements, the cut-off will be higher than £26,000; in some cases it could be as high as £50,000.


If the claimant does not contact HMRC their claim will not be continued into 2012/13 and they will no longer receive tax credits unless they make a new claim. They will at least be free of the administrative burden of being in the system (eg dealing with the annual renewal and the requirement to notify changes of circumstances within one month).


However, even if the claimant’s income is clearly too high to be paid any tax credits, it is important to understand the possible disadvantages of coming out the system:


1.     The claimant will no longer have the benefit of a ‘protective claim’ if their income subsequently falls to a level where they will get some credits.


A claimant with a high income whose circumstances meet the criteria for tax credits is perfectly entitled to claim and remain in the system with a ‘nil award’. The claim protects their entitlement if their income falls because, for example, they lose their job, make a loss in their business or need time off to have a baby. HMRC would prefer that such people come out of the system in order to cut administrative costs.


If the claimant stays in the system and their income falls, they will be entitled to credits based on their lower income for the whole tax year. If they are outside the system and have to make a new claim, it can only be backdated by one month.


2.     If a claimant receiving the disability element of WTC allows their claim to lapse, the continuity might be broken so that they will not necessarily be able to claim the disability element again, even if they make a new claim in 2012/13. This is because of the way the rules on the disability element work.


3.     If the claimant has a tax credits overpayment from an earlier year, this will be recovered by setting it against an ongoing award – as long as there is one. But as soon as the claimant comes out of the system, the balance of the overpayment will become payable (though with the option of spreading it over 12 months rather than paying it all at once). We have come across cases where claimants coming out of the system were surprised to find themselves facing quite large overpayment demands, which had arisen from problems in the early days of tax credits and been carried forward (while gradually being paid back) ever since.


Each claimant’s situation needs to be considered on its facts. However, we think that many claimants who don’t mind a small amount of paperwork may be best advised to contact HMRC and opt to stay in the system.


Our recent news item gives details of all the changes to tax credits from April 2012.