Tax Credit
Definition
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Dividend Tax Credit (Historical Context): Formerly, a tax allowance associated with dividends paid by a company. A shareholder received a tax credit for the corporate tax already paid at source, typically at a rate of 10/90. For example, a dividend of £90 received by the shareholder had an associated tax credit of £10. For those paying the basic rate of income tax, there was no further tax payable. For higher-rate taxpayers, dividends were taxed at a rate of 32.5%, and for additional rate taxpayers, the tax was 37.5%. However, from April 2016, this system was replaced by a new dividend tax arrangement.
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General Allowance Against Tax Liability: Any other form of allowance or reduction granted to a taxpayer against a tax liability, helping to reduce the overall tax owed.
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Social Security Payment (UK): In the UK, tax credits also refer to social security payments such as the Working Tax Credit or Child Tax Credit, administered by HM Revenue and Customs (HMRC). Despite being termed ’tax credits,’ these payments do not affect the taxable amount but rather provide financial support directly to the eligible individuals or families.
Examples
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Example 1: Dividend Tax Credit: Under the former tax credit system, if an investor received a dividend payment of £90, they would also get a tax credit of £10. For basic rate taxpayers, this would cover their tax liability on the dividend. Higher rate taxpayers, however, would have to pay an additional tax on this income.
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Example 2: Working Tax Credit: A low-income family may be entitled to claim Working Tax Credit, which supplements their earnings. This does not reduce their tax payable but provides additional income to help manage living costs.
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Example 3: Renewable Energy Tax Credit: An individual installing solar panels on their home may be eligible for a tax credit to offset some of the installation costs, thus reducing their overall tax liability.
Frequently Asked Questions (FAQs)
What replaced the dividend tax credit system in the UK?
From April 2016, the dividend tax credit system was replaced by a new dividend tax structure where shareholders receive a tax-free dividend allowance and any dividends above this threshold are taxed at new rates.
Does a tax credit reduce my taxable income?
No, unlike tax deductions which reduce your taxable income, a tax credit directly reduces the amount of tax you owe.
Can tax credits be refunded?
Yes, some tax credits are refundable, meaning if they reduce your tax liability to below zero, you could receive a refund. Examples include the Earned Income Tax Credit in the US.
Who is eligible for the Working Tax Credit?
Eligibility for the Working Tax Credit in the UK depends on factors such as the number of hours worked per week, income level, and other specific circumstances like disability.
Can tax credits be carried forward?
Certain tax credits can be carried forward to subsequent tax years if they are not fully used in the year they are earned. This depends on the specific rules of the credit.
Related Terms
- Tax Deduction: A reduction in taxable income, which may result in a lower tax liability.
- Non-refundable Tax Credit: A tax credit that can reduce liability to zero but not beyond; any excess credit is forfeited.
- Refundable Tax Credit: A tax credit that can not only reduce liability to zero but also result in a refund of the excess credit.
- Dividend Allowance: The amount of dividend income that is tax-free before higher rates apply.
Further Reading
Online Resources
Suggested Books
- Tax Deductions and Credits by Donya Z. Curie
- JK Lasser’s 1001 Deductions and Tax Breaks 2023 by Barbara Weltman
Accounting Basics: “Tax Credit” Fundamentals Quiz
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