What Are Tax Credits?

Tax credits are a form of financial support provided by the UK government to help people on low or moderate incomes. From experience, they are often misunderstood because many people think they are part of the tax system in the same way as allowances or deductions, when in reality they are a benefit paid by HMRC to top up income.

Although tax credits are now closed to most new claimants, millions of people are still receiving them, and they continue to play an important role for those already on the system. Understanding what they are, how they work, and how they interact with tax and other benefits is essential, especially if your circumstances change.

What tax credits are designed to do

Tax credits exist to support people who are working, raising children, or living with a disability, where income alone may not be enough to meet basic living costs.

Rather than reducing the amount of tax you pay, tax credits are paid directly to you, usually weekly or four weekly. They are administered by HMRC, not the Department for Work and Pensions, which is one reason they can feel confusing.

In simple terms, tax credits are a payment from HMRC to help support household income.

The two main types of tax credits

There are two main types of tax credits that people may still be receiving.

Working Tax Credit This supports people who are in work but on a low income. It can apply to employees and self employed individuals, provided certain conditions are met, such as working a minimum number of hours.

Child Tax Credit This supports people who are responsible for children. It is based on household income and the number of children you support.

Some people receive one type, others receive both, depending on their circumstances.

Who can still claim tax credits

Tax credits are now closed to most new claims. Universal Credit has replaced them for new applicants.

However, you may still be receiving tax credits if:.

• You claimed them in the past and your claim is ongoing

• You have not moved to Universal Credit yet

• Your circumstances have not triggered a move to Universal Credit

From experience, many people remain on tax credits for years, but a change in circumstances can end the claim.

How tax credits are calculated

Tax credits are calculated based on household income and circumstances, not just individual income.

Key factors include:.

• Total household income

• Whether you are single or in a couple

• Number of children

• Hours worked

• Childcare costs

• Disabilities

HMRC uses income from a previous tax year as a starting point, then adjusts payments during the year as estimates change. This is one reason overpayments can occur.

Why overpayments are common

Overpayments are one of the biggest issues with tax credits.

From experience, overpayments usually happen because income or circumstances change during the year, but HMRC is still paying based on earlier information.

Common causes include:.

• Increase in income

• Change in working hours

• Moving in with a partner

• Children leaving education

When HMRC later recalculates entitlement, it may decide too much was paid and ask for money back.

Reporting changes to HMRC

If you receive tax credits, you are required to report changes in circumstances promptly.

This includes changes to:.

• Income

• Working hours

• Relationship status

• Childcare arrangements

Failing to report changes is the main reason people end up with large overpayment demands.

From experience, keeping HMRC informed early makes problems far easier to manage.

How tax credits are paid

Tax credits are usually paid directly into your bank account. Payments can be weekly or four weekly depending on your claim.

They are not taxable income. You do not pay Income Tax on tax credits, and they do not appear on a P60 or payslip.

However, they can affect entitlement to other benefits and support.

Tax credits and self employed people

Self employed people can receive tax credits, but income reporting is especially important.

HMRC looks at taxable profits, not turnover. This means expenses matter, and accurate accounts are essential.

From experience, self employed claimants often struggle when profits fluctuate, because tax credits are based on estimates that may later turn out to be wrong.

This is another common cause of overpayments.

Moving from tax credits to Universal Credit

Eventually, most people on tax credits will be moved to Universal Credit through a process called managed migration.

When this happens:.

• Your tax credits will stop

• You will need to make a Universal Credit claim

• There may be transitional protection in some cases

The rules are complex, and timing matters. Making a Universal Credit claim voluntarily can sometimes end tax credits immediately.

From experience, it is important not to rush this without understanding the impact.

How tax credits interact with tax returns

If you are self employed or complete a Self Assessment tax return, your tax credits claim and your tax return are linked.

HMRC uses figures from your tax return to finalise your tax credits entitlement. Errors or late returns can delay final calculations or trigger overpayments.

Keeping both in sync is critical.

Common misunderstandings about tax credits

There are a few misconceptions I see regularly.

One is that tax credits reduce your tax bill. They do not. They are a separate payment.

Another is that HMRC will automatically adjust payments correctly without updates. In reality, HMRC relies heavily on information you provide.

I also see people assume tax credits are permanent. They are not, and changes in circumstances can end entitlement quickly.

Getting help with tax credits

Tax credits can be stressful to deal with, especially when overpayment letters arrive.

Support is available through:.

• HMRC’s tax credits helpline

• Citizens Advice

• Accountants or tax advisers where self employment is involved

From experience, getting advice early is far better than reacting after an overpayment has built up.

Key points to takeaway

From my experience, tax credits are best understood as income support rather than a tax mechanism. They exist to help people whose earnings alone are not enough, but they rely heavily on accurate and up to date information.

If you are receiving tax credits, the most important things are to report changes promptly, keep good records, and understand that payments can change when your circumstances do.

While tax credits are gradually being phased out, they remain very relevant for many households. Understanding how they work puts you in a much stronger position to manage them confidently and avoid unpleasant surprises later on.