Income Tax is a tax you pay on the money you earn. The government collects this tax through HMRC. The money collected supports public services such as the NHS and education.
However, not all income is taxable.
What Counts as Taxable Income?
You pay Income Tax on a wide range of income sources. These include:
- Earnings from employment (such as wages and bonuses)
- Profits from self-employment or freelance work
- Pension income (including the State Pension and private pensions)
- Rental income from property you own
- Benefits from your job (such as company cars or private medical cover)
- Interest on savings above your allowance
- Income from trusts and certain State benefits
Additionally, income earned through online platforms or apps may also be taxable.
What Income is Tax-Free?
Not all income is subject to tax. In fact, the tax system includes several allowances and exemptions.
For instance, you do not pay tax on:
- The first £1,000 of self-employment income (Trading Allowance)
- The first £1,000 of rental income (Property Allowance)
- Dividend income up to £500 (Dividend Allowance)
- Income from Individual Savings Accounts (ISAs) and National Savings Certificates
- Lottery or Premium Bond winnings
As a result, these tax-free amounts can reduce your overall tax bill.
Income Tax Rates and Bands
The UK uses a progressive tax system. This means you pay different rates on different portions of your income.
| Rate | Amount |
|---|---|
| 0% (Personal Allowance) | Up to £12,570 |
| 20% (Basic Rate) | £12,571 to £50,270 |
| 40% (Higher Rate) | £50,271 to £125,140 |
| 45% (Additional Rate) | Over £125,140 |
Each rate only applies to the income within that band. Therefore, not all your income gets taxed at the highest rate. This system ensures fairness. In other words, people who earn more contribute a higher percentage of their income.
Personal Allowance Explained
Most people receive a Personal Allowance. This is the amount of income you earn before paying Income Tax.
| Standard Personal Allowance | £12,570 |
| Reduced Personal Allowance | Applies when income exceeds £100,000 |
| No Personal Allowance | Applies when income exceeds £125,140 |
You lose £1 of your Personal Allowance for every £2 you earn above £100,000. Therefore, you will no longer have a Personal Allowance by the time you earn £125,140 and will pay tax on all earnings.
Tax on State Benefits
Some State benefits counts as taxable income, while others remain tax-free.
| Taxable | Tax-Free |
|---|---|
| State Pension | Universal Credit |
| Jobseeker’s Allowance | Personal Independence Payment (PIP) |
| Carer’s Allowance | Housing Benefit |
| Contribution-based Employment and Support Allowance | Child Benefit (depending on your income level) |
In this case, you should always check the tax status of each benefit you receive.
How Do You Pay Income Tax?
There are two main ways to pay Income Tax. The method depends on how you earn your income.
Pay As You Earn (PAYE)
Most employees pay tax through PAYE. Employers deduct tax and National Insurance before paying your salary. Your tax code tells your employer how much tax to take.
This system makes paying tax simple and automatic. As a result, many people do not need to contact HMRC directly.
Self Assessment
If you are self-employed or earn untaxed income, you must complete a Self Assessment tax return each year. You also pay any tax owed directly to HMRC.
You must register for Self Assessment if:
- You earn over £1,000 from self-employment
- You earn over £2,500 in untaxed income (such as rental income)
Additionally, company directors and higher earners may also need to submit a tax return.
Reducing Your Income Tax Bill
You can reduce your tax bill by making use of allowances and reliefs. These reduce your taxable income.
| Marriage Allowance | Transfer £1,260 of unused Personal Allowance to your spouse |
| Savings Allowance | Earn up to £1,000 tax-free from savings interest |
| Dividend Allowance | Receive £500 tax-free from dividend income |
| Pension contributions | Contribute to a pension to reduce your taxable income |
| Gift Aid | Donate to charity to reduce your taxable income |
If you are registered blind, you may qualify for the Blind Person’s Allowance.
Working Out If You Need to Pay
You can work out if you need to pay Income Tax by following these steps:
- Add up all your taxable income (including benefits)
- Subtract your tax-free allowances
- Review what remains
If you have income left after allowances, you must pay tax. However, if nothing remains, you should not need to pay and may be due a refund.
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This article is for general informational purposes only and does not constitute legal or financial advice. While we aim to keep our content up to date and accurate, UK tax laws and regulations are subject to change. Please speak to an accountant or tax professional for advice tailored to your individual circumstances. Pi Accountancy accepts no responsibility for any issues arising from reliance on the information provided.