What is Marginal Tax? Marginal Tax Rates

Marginal tax is something that can affect the tax liability of both individuals who are employed or self employed.

The marginal tax rate represents the percentage of tax applied to each additional pound of income you earn.

For instance, if someone earns £75,000 annually, their marginal tax rate might be 40%, meaning they pay 40p in income tax for every extra pound earned.

Your total income tax liability for a specific tax year is determined by two main factors:

• Income that is covered by your tax free personal allowance (PA).
• The portion of income that falls within each income tax band. There are a number of tax bands which have their own rate of tax.

Your marginal tax rate and the rate at which you pay tax is often the same but sometimes the marginal tax rate can be different.

Marginal tax rates play a crucial role in ensuring that individuals with lower earnings contribute a smaller fraction of their income in taxes compared to those with higher earnings.

Marginal tax is not the same as marginal relief for corporation tax which relates to tax paid by limited companies only.

Knowing when your marginal tax rate may differ from your actual rate of tax is important so you can work out how much tax you will owe and help you implement tax saving strategies.

Understanding marginal tax

To fully understand the concept of ‘marginal tax’, it is necessary to examine income tax and the rates applicable to taxable income.

Marginal tax forms part of a progressive tax system where it guarantees that individuals with lower income contribute a smaller percentage of their earnings towards taxes compared to those with higher income.

This is demonstrated where individuals earning less than the personal allowance are not subject to any taxes, while those earning above £150,000 are charged a marginal rate of 45%.

HMRC generates a personal allowance which gives individuals a tax free sum in the tax year it is issued.

The remaining income after the personal allowance is then taxed at varying rates within each tax bracket.

After the personal allowance threshold, the tax rate for each additional pound earned is known as the ‘marginal rate’ of tax.

What are the marginal tax rates?

Income tax rates reflect the proportion of your earnings that you are required to pay as tax.

The rates increase gradually, corresponding to the tax bracket into which your income fits and depending on your earnings you could incur income tax at varying rates.

The income tax rates are subject to change with the rates for the 25/26 tax year as follows:

• Personal tax-free allowance: Income up to £12,500, 0% tax rate.
• Basic rate tax: Income from £12,501 to £50,000, 20% tax rate.
• Higher rate tax: Income from £50,001 to £150,000, 40% tax rate.
• Additional rate tax: Income above £150,000, 45% tax rate.

Using the above tax rates as an example if your income was precisely £150,000, your tax rate for the next pound earned would be 45%.

If you earned £149,999, your marginal tax rate would be 40% as an additional pound would not push you into a higher tax bracket.

Marginal tax and the personal allowance

The standard personal allowance (PA) is currently set at £12,500 per individual, which is exempt from income tax.

Your personal allowance can be higher or lower depending on a variety of factors which can include company benefits and employment expenses.

Once an individual’s personal income reaches £100,000, their tax-free personal allowance is gradually removed, resulting in an additional 20% tax on earnings between £100,000 and £125,140.

Using the 25/2026 tax year as an example:

For each two pounds earned above £100,000, you lose one pound of your personal allowance up to £125,140 at which point your personal allowance is completely eliminated.

Removing the personal allowance in this way can result in your marginal tax rate between earnings of £100,000 and £125,140 being 60% instead of the 40% higher rate of tax.

Please bear in mind that these are just examples, as tax rates can vary from year to year.

Ways to reduce marginal tax

Understanding the difference between your marginal tax rate and your effective tax rate is crucial for calculating your tax liability and devising strategies to legitimately reduce your income tax liability.

There are various methods available that can potentially offer an income tax reduction by altering the structure of your taxable earnings.

A few common ways to reduce your marginal rate of tax include:

• Transferring assets, such as dividend income, to your partner.
• Use a salary sacrifice scheme if your employer makes one available.
• Placing investments into individual savings accounts (ISA’s) accounts.
• Compensating your significant other with a salary.
• Swapping monetary earnings for non-monetary perks.
• Contributing extra funds to your workplace pension scheme.

Making use of any available tax free allowances is a logical route to earning some tax free income which is in addition to the personal allowance.

Some tax free allowances are automatically deducted from your taxable earnings, while others offer a tax credit or deduction that can be subtracted from your tax liability.

Both employed and self-employed individuals can also benefit from tax reliefs that can be claimed for various reasons and apply to numerous income sources.

Our guide to tax free income covers many of the most common tax allowance and reliefs that can be utilised by individuals who want to maximise their income tax position.

Seeking guidance from a tax planning specialist can assist in exploring potential alternatives especially if you have multiple forms of income from different sources.