What is Tax Free Income?

Most income is taxable but the government does allow some income to be tax free through a variety of tax reliefs and tax free allowances.

Tax reliefs and tax free allowances offer individuals the opportunity to reduce their taxable income and potentially lower their overall tax liability.

Understanding how your income is taxed and if you can use tax free allowances and tax reliefs to reduce your tax bill is important.

If you’re not familiar with what qualifies as tax free income you may overlook some significant tax saving opportunities.

HMRC makes available a number of tax reliefs and tax free allowances for both employed and self employed individuals.

Our tax free income guide covers many of the most common and valuable tax reliefs, tax free allowances and the tax efficient ways you can use them.

Tax allowances for tax free income

Tax free allowances enable you to earn up to a specific amount of income before having to pay income tax.

Tax allowances have the potential to lower how much income tax you owe but not all allowances operate in the same way.

Some tax allowances decrease the taxable portion of your income while others offer a tax credit or reduction that can be deducted from your tax liability, effectively reducing the amount of income tax you have to pay HMRC.

Tax free personal allowance:

Most individuals are eligible to receive a specific amount of income that is exempt from income tax called the basic personal allowance.

Both employed and self employed individuals are entitled to the personal allowance which is expected to be worth £12,570 per tax year up to April 2028.

The personal allowance is applicable to all residents of the United Kingdom but it is gradually reduced for those with taxable earnings exceeding £100,000.

Marriage allowance:

The marriage allowance is accessible to individuals who are married or in a civil partnership.

It allows a partner who earns less than the personal allowance to transfer 10% of it to their partner, who must be a basic rate taxpayer.

As a result the higher earning partner receives a tax credit which reduces their taxable income.

Married couples allowance:

If either or both partners were born prior to 6 April 1935, they may be eligible to apply for the allowance known as the married couple’s allowance.

The married couple’s allowance (MCA) can be claimed if one or both spouses were born prior to 6 April 1935 and decreases the tax liability of one spouse by 10% of the entitlement amount.

Tax free savings interest allowance:

The majority of individuals can earn some interest on their savings without being subjected to tax.

The savings interest allowance covers interest from sources like banks, buildings societies, payment protection insurance (PPI) and life annuity insurance.

The personal savings allowance (PSA) is worth £1000 per tax year for basic rate taxpayers and £500 if you pay higher rate tax. Additional rate taxpayers get no personal savings allowance.

There’s also a starting rate for savings allowance which can be worth up to a maximum of £5,000. If your overall taxable income is equal to or exceeds £17,570 you won’t qualify for the starting rate for savings allowance.

Tax free trading allowance:

The trading allowance is specifically for income from self employment. Examples would be profits from being an Amazon reseller or eBay sales.

Individuals are entitled to earn up to £1,000 tax free from all self employed income sources combined.

Tax free property allowance:

The property income allowance (also known as the property allowance) is valued at £1,000 annually.

By using the property income allowance you could earn up to £1,000 in rental income without being subject to income tax.

If you co-own a property with others each co-owner is eligible to use the £1,000 property allowance towards their share of the total gross rental income.

Rent a room scheme:

The rent a room initiative is accessible to individuals who rent out a furnished space to a lodger in their primary residence.

Rent a room is open to homeowners and leaseholders, provided they have received consent from their property owner to lease an additional room.

If you qualify for the rent a room program you can earn up to £7,500 in annual rent tax free, or £3,750 if the room is let out jointly.

Tax free dividend allowance:

The dividend allowance is accessible to all shareholders irrespective of their income level and is valued at £500 (previously £1,000) per person from April 2024.

There’s no tax liability on dividend earnings that stay within the dividend allowance during that tax year.

Capital gains tax:

Capital gains tax applies to the profit a person makes when selling or disposing of an asset that has appreciated in value.

CGT isn’t levied on the total sum you receive but on the gain that you’ve made.

Individuals are given a tax free capital gains tax allowance of £6,000 per tax year.

Tax reliefs for tax free income

There are tax reliefs for both employed and self employed taxpayers that can be used to increase the tax free element of your income.

Tax relief can be claimed for a range of reasons against many different types of income sources.

In our list below we have focused on forms of tax relief that can be used to reduce taxable income:

Employment tax relief on expenses:

Taxpayers employed under PAYE can be eligible for tax relief on some of the costs incurred in doing their jobs.

HMRC calls them expenses of employment and needs you to claim them back on a form P87 or a self assessment tax return.

• Washing of work uniform or protective clothing.
• Mileage.
• Tools.
• Working from home.
• Union fees.
• Professional fees.

Self employed tax relief on expenses:

As a self employed individual you will have business related costs of which most can be used to reduce your taxable income.

Claiming tax relief on business expenses results in your taxable self employed income liability being lowered leading to less income tax being payable.

Tax free pension contributions:

When you contribute to your pension the government provides financial assistance known as pension tax relief.

You have the opportunity to receive tax relief on your private pension contributions, which can be as much as 100% of your yearly earnings.

The process of obtaining tax relief can either be automatic or require you to make a claim, depending on the specific pension scheme you are enrolled in and the rate of Income Tax that applies to you.

The amount of tax relief you receive is typically determined by your income tax rate.

Basic rate taxpayers are eligible for a 20% tax relief, while higher rate taxpayers can receive up to 40% and additional rate taxpayers up to 45% tax relief.

Charity donations:

Taxpayers with income falling under the higher or additional rates of tax can claim back the difference between your rate of tax and the basic rate on your charitable contributions.

Tax relief on charitable donations can be claimed through self assessment if you normally complete a tax return or through PAYE by an amendment to your tax code or a backdated claim made by HMRC webchat, phone or in writing.

Types of tax free income

Some income is tax free and doesn’t need you to apply for tax relief or use any tax allowances.

Tax free benefits:    

Most but not all benefits are free from being taxed.

• Tax credits.
• Universal credit.
• Pension credit.
• Housing benefit.
• Child benefit.
• Income related employment and support allowance (ESA).

Tax free premium bonds

National savings and investment (NS&I) premium bonds are a tax free investment product which gives you the chance to win up to £1 million on a monthly basis.

Any prizes won from premium bonds is free from tax and you don’t need to tell HMRC if you’re lucky enough to win.

Tax free individual savings accounts (ISA’s)

Individual savings accounts or ISA’s for short are similar to any other savings account but unlike most savings products the earned interest is tax free.

The government sets an ISA allowance each tax year (currently £20,000) which is the maximum amount an individual can save in an ISA in that year.

Savings interest generated from an ISA doesn’t contribute to your personal savings allowance because of it’s tax exempt status.

Maximising tax free income opportunities

Taking advantage of tax allowances and reliefs that make some or all of your income tax free is just sensible financial planning.

Learning what may apply to you and when to use it can save you a meaningful amount of money by reducing your tax liability potentially over many years.

Whether you are employed or self employed it’s important to remember that the government can change tax relief and allowances so keeping up to date with any adjustments is recommended.