What is Income Tax?
HMRC levies Income Tax on various forms of income earned by individuals, businesses, and other entities, though not all income qualifies as taxable. Taxpayers pay Income Tax directly to HMRC, instead of through indirect collection methods.
HMRC uses Income Tax to generate revenue that funds public services such as healthcare, education, infrastructure, and other essential services.
What is Taxable Income?
Taxable income includes:
- Earnings from Employment: This includes salaries, wages, bonuses, and tips.
- Self-Employment Profits: If you’re generating income through business activities or services sold online, these are taxable. However, HMRC should be notified if your earnings exceed certain thresholds.
- Certain State Benefits: Some benefits provided by the state are taxable.
- Pension Income: Most pensions, such as state, company, and personal pensions, are taxable.
- Rental Income: If you rent out property, this income is usually taxable unless it falls below certain limits, such as those set by the Rent a Room Scheme.
- Job Benefits: HMRC considers any benefits you receive from your job, such as a company car, as part of your taxable income.
- Income from trusts and interest over your savings allowance also fall into the taxable category.
What is Not Taxable?
You won’t have to pay tax on:
- The first £1,000 of self-employed income (your ‘trading allowance’).
- The first £1,000 of property rental income, unless you are part of the Rent a Room Scheme.
- Earnings from tax-exempt accounts, such as ISAs or National Savings Certificates.
- Dividends under your dividend allowance and some state benefits.
- Income from lotteries or bonds, like the National Lottery or premium bonds.
- Rent below the threshold of the Rent a Room Scheme if you have a lodger.
Tax Allowances and Reliefs
Most UK residents can claim a Personal Allowance, which lets them earn a certain amount of income before they must pay any tax. For the tax year 2023/24, HMRC has set the Personal Allowance at £12,570. The table below shows the tax rates you pay in each band if you have a standard Personal Allowance of £12,570.
| Band | Taxable income | Tax rate |
|---|---|---|
| Personal Allowance | Up to £12,570 | 0% |
| Basic rate | £12,571 to £50,270 | 20% |
| Higher rate | £50,271 to £125,140 | 40% |
| Additional rate | over £125,140 | 45% |
You may reduce your taxable income through various tax reliefs, provided you qualify for them. These can cover aspects like investments, savings, and certain approved expenses.
How Do You Pay Income Tax?
- Pay As Your Earn (PAYE): Most individuals pay their Income Tax through the PAYE system. Employers and pension providers use this system to deduct Income Tax and National Insurance Contributions (NICs) directly from wages or pensions.
- Self-Assessment Tax Returns: If you have more complex financial circumstances, such as being self-employed or having a high income, you might need to file a tax return each year. This is also necessary if you have untaxed income over certain thresholds.
Tax on State Benefits
Some State Benefits are taxable. For instance, the State Pension might lead to a tax obligation that HMRC will usually handle by adjusting your tax code. If the State Pension is your sole income, HMRC will inform you if you owe any tax.
Tax-Free State Benefits
Several State Benefits are non-taxable, including Child Benefit, Disability Living Allowance (DLA), and Universal Credit, among others. These benefits do not contribute to your taxable income.
Determining Your Tax Status
To determine if you need to pay income tax, add up all your taxable income, including taxable state benefits. Subtract your tax-free allowances from this total. If there’s anything left, you’re liable to pay tax. If not, you might not need to pay tax or could be due a refund.
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