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Tax Credit

The term tax credit describes two different concepts:

-A recognition of partial payment already made towards taxes due.
-A state benefit paid to workers through the tax system, which has the effect of increasing (rather than reducing) net income.

Tax credits in recognition of tax already deducted

Within the Australian, Canadian, United Kingdom, and United States tax systems, a tax credit is a recognition of partial payment already made towards taxes due. A similar concept exists (fr:Avoir fiscal) in the French tax system, for example in the Credit Impot Recherche. This situation arises, for example, when standard rate tax has been deducted at source ("withholding tax"), but the tax-payer is subject to further taxation at a higher rate. It also applies in dividend imputation systems.

In some countries (e.g. the United Kingdom), "tax credit" refers to tax treated as deducted at source, which has not actually been deducted or paid. There is also a payable "R&D tax credit" available as part of the Research and Development tax relief scheme in the United Kingdom which refers to the cash element of a surrendered loss on eligible R&D work. This credit is worth up to 24.5% of eligible R&D spend.

Tax credits as a form of state benefit

Tax credits may be characterized as either refundable or non-refundable, or equivalently non-wastable or wastable. Refundable or non-wastable tax credits can reduce the tax owed below zero, and result in a net payment to the taxpayer beyond their own payments into the tax system, appearing to be a moderate form of negative income tax. Examples of refundable tax credits include the earned income tax credit and the additional child tax credit in the U.S., and working tax credits or child tax credits in the UK.

A non-refundable or wastable tax credit cannot reduce the tax owed below zero, and hence cannot cause a taxpayer to receive a refund in excess of their payments into the tax system. An example of a non-refundable tax credit is the Saver's Tax Credit [1] in the U.S. or the former children's tax credit in the UK. Another example would be declared gifts made to registered charities in the UK under the current Giftaid scheme, which attract tax relief (claimed by the charity) at the standard rate but which cannot reduce the donor's liability beyond the amount of tax actually paid by them in a given year. All tax credits in Ireland are non-refundable.

Conservatives or libertarians, who generally favor tax cuts, often criticize refundable tax credits, saying that they are actually subsidies disguised as tax cuts. In other words, they are spending in the form of direct transfers from the treasury to individuals, except that they are administered by the tax authorities rather than the agencies usually responsible for welfare.

Tax credits and minimum wage

Tax credits are a means tested benefit paid direct to employees to encourage them into work. In the United Kingdom, ‘child tax credit’ and ‘working tax credit’ are paid directly into the claimant's bank account, post office account, or by giro. A minimum level of child tax credits is payable to all individuals or couples with children, up to a certain income limit. The actual amount of child tax credits that a person may receive depends on factors such as the level of their income, the number of children they have, the age of the children they are claiming for and the education status of any children over 16. Working tax credit is paid to single low earners with or without children who are aged 25 or over and are working over 30 hours per week and also to couples without children, at least one of whom is over 25, provided they are working for 30 hours a week combined and at least one of them is working for 16 hours a week. If the claimant has children however, they may claim working tax credit from age 16 upward - provided that they are working at least 16 hours per week.

This indirect wage regulation forms an important part of income for low earners and their families. It reduces the stigma of collecting benefits for workers.

Tax credits and tax deductions

A tax credit is generally more valuable than a tax deduction or tax allowance of the same magnitude because a tax credit reduces tax directly, while a deduction or allowance only reduces taxable income and so the reduction in tax is only a fraction (the marginal tax rate) of the deduction or allowance.

In the United States corporate tax payers may lower the total amount of tax they owe to the federal government, via programs such as the New Markets Tax Credit Program.

Problems

In the UK the problem of tax credit overpayment has continued on a massive scale since inception leaving millions of claimants in debt.[citation needed] The cause of overpayment is many and complex at times. Guides have been produced to provide advice to those recipients of tax credits who have been overpaid through no fault of their own. Free advice is provided to charities and those who benefit from the assistance that charities such as the Citizens Advice Bureaus provide.