The bonus gift from the Labour-led Welsh Government is not exempt from tax because "it is made in connection with employment" and would require a change in the law to make it so.
It now seems likely the will have to "gross-up the payment" themselves costing millions more than the £32m they budgeted for to ensure care workers still receive every pound of the £500 they were promised.
It is likely the bonus payment will impact benefit entitlements as it will be classed as income and will have to be declared to the Department for Work and Pensions.
A Treasury spokesperson told ITV News: "Payments made in connection with employment are chargeable to income tax and NICS unless explicitly exempt.
"The Welsh government has the powers and funding to gross up the payment, if its intention is for social care workers to benefit by at least £500," they added.
The Welsh Government were aware the payment was taxable when they made the announcement at the start of May.
At the time the First Minister said: "We are urging the UK Government and the HMRC to make an exception in these truly exceptional circumstances."
Both sides have said they were working together, but with no solution, the UK Government has asked the Welsh Government how it would like to proceed.
A Treasury spokesperson said: "We value the contribution of social care workers, particularly during the current crisis."
"We also understand that the collective response to Covid-19 needs to be UK-wide, which is why alongside our UK-wide support schemes we've provided over £2.2bn of funding for the Welsh Government to support people, businesses and public services."
"We are working with the Welsh government to determine the exact scope of the proposed bonus. Payments made in connection with employment are however chargeable to income tax and NICS unless explicitly exempt."
"The Welsh Government has the powers and funding to gross up the payment, if its intention is for social care workers to benefit by at least £500."
A Welsh Government spokesperson said: "We are very disappointed that the UK Government wants to tax the one-off thank you payment we are going to make to carers."
"We had hoped they would step up to the plate as we have done by prioritising these payments amongst all the very significant extra demands Covid-19 has made on us. We will continue to pursue this with them."
A spokesperson for the Welsh Conservatives said: "Welsh Government should have checked to see if £500 care worker bonus was subject to tax."
Speaking after it was revealed that the £500 bonus for care workers in Wales is subject to tax and NI deductions, Janet Finch-Saunders, the Shadow Social Care Minister, said: "This is an expensive mistake by the Welsh Labour Government, and one likely to dishearten some of the most dedicated and tireless people working in Wales."
"Welsh Ministers clearly rushed the announcement out because they were having a bad news day for failing to test care home staff and residents."
"The Welsh Government – and its Health Minister – really should have checked the tax status of these payments before making such a quick announcement, because the decision to tax these payments was made by HMRC – not the UK Government."
"The Welsh Government still has hundreds of millions in unallocated funds provided to Wales as a result of the UK Government’s response to the pandemic, it should use these to cover the cost of any deductions from care workers’ pay packets as a result of this foul-up."
Plaid Cymru's Delyth Jewell MS said: "This will be a blow to those carers who had been anticipating this bonus and might not now get the full £500 that is due them."
"Both the Westminster and Welsh Government need to sort this out between them and put our carers first to ensure the carers get the £500 bonus payment they expected to receive in full with assurances that it will not impact any benefit entitlement of claimants."
"However, the truth is that this bonus was never going to be enough. This crisis has truly exposed the year on year impact of cruel cuts and the way in which social care is seen as a second class service."
"Plaid Cymru believes all care staff should have parity of pay and terms and conditions with NHS staff, and that we should move social care staff onto NHS terms and conditions – as well as recognising the work that unpaid carers do."
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