Around 340 carers will have their allowances backdated after an investigation by the Local Government Ombudsman (LGO) discovered Liverpool City Council had been underpaying them.
The investigation was launched after a woman, who had been looking after her toddler nephew following a domestic violence incident, complained that the council was not paying her the correct benefits.
After looking into the woman's case the LGO discovered a wider problem in the Liverpool area, affecting 340 carers city-wide.
It found that the council was failing to pay foster carers who look after children aged up to four-years-old at the National Minimum Fostering Allowance set by government each year.
It also failed to pay the Special Guardianship Allowance (a separate benefit for carers who have parental responsibility for the children in their care) at the same rate as its foster carers.
Nigel Ellis, executive director for Investigations at the LGO, said: "Many councils struggle to recruit carers to look after children who find themselves - for whatever reason - unable to be looked after by their parents.
He added: "I'm pleased to say that Liverpool City Council has quickly accepted it is at fault and has agreed to backdate the benefits to both the complainant and the 340 other carers affected.
"I hope this swift response will go some way to alleviate the trouble the underpayment may have caused."
The LGO recommended that the original complainant receive backdated allowances of £10,912.
The council has agreed to backdate payment of its Special Guardianship Allowance at the same rate as its Fostering Allowance rate from April 2010, affecting around 146 people.
It will also pay all foster carers, looking after children under four, the Fostering Allowance in line with or above National Minimum Fostering Rates from April 2013 and will backdate the underpayment to April 2011, affecting an additional 194 carers.
In addition Liverpool City Council has agreed to carry out a review of its practice of deducting Child Benefit from those on Income Support in receipt of Special Guardianship Allowance.
Councillor Jane Corbett, cabinet member for children's services, said; "I would like to apologise to the special guardian in this case who was not paid at the correct rate. This is something we have remedied very quickly.
"We are clear that special guardians should be paid the correct rate and we are now carrying out an urgent review to make sure that both special guardians and foster carers are being paid appropriately. We have to ensure that the guardians and the children they care for are supported in the best and fairest way we can manage.
"Despite the cost implications, balanced against the financial challenges the authority is facing, we recognise that the Ombudsman's ruling is absolutely fair."