What is Income Tax? Your guide to UK Income Tax
Income tax is deducted from the salary you receive from your job, and other earnings like bank interest, or pension income. If you are self employed income tax is deducted from your taxable profits.
Income tax is deducted by the tax office (HMRC) through PAYE if you are employed and self assessment if you are self employed.
Income tax is used by the government to pay for services provided by the state such as education and healthcare.
Not all income is taxable at the same rates with tax reliefs and tax free allowances available to help reduce your overall tax bill.
Being aware of what factors affect how much income tax you need to pay is important to make sure you pay the right amount of tax and not too much.
Our guide to income tax helps you understand more about what tax you will pay on your income and how to potentially reduce your current and past tax liability.
What is the Rate of Income Tax?
The amount of income tax you pay depends on the total you earn from all income sources.
How much you pay is calculated by working out how much money you earn and then subtracting a percentage of that money in tax.
Most people who live in the UK are entitled to a tax free amount of earnings; this is known as a tax free personal allowance.
The basic personal is deducted from your earnings and then the rest is normally taxed.
In some special circumstances extra allowances are granted, for example age related additions for those over 65, or a blind person’s allowance for those who are registered blind.
What are the Income Tax Rates and Bands?
The rates of income tax and tax bands are usually set during the annual Budget for the following tax year.
Income tax rates and tax free allowances can change up or down so it’s a good idea to keep an eye on any movements.
The same income tax rates and tax free allowances are typically available to both employed and self employed individuals.
Income Tax Rates and Bands using the 2024/2025 tax year as an example:
| Income Tax Band | Taxable income | Tax rate |
|---|---|---|
| Personal Allowance | Up to £12,570 | 0% |
| Basic rate tax | £12,571 to £50,270 | 20% |
| Higher rate tax | £50,271 to £125,140 | 40% |
| Additional rate tax | over £125,140 | 45% |
Taxable income is what you have earned, minus your personal allowance.
The remainder is taxed at the appropriate rate depending on your earnings.
Income Tax Payable example:
Tax year – 2024/2025
You earn £33,000 and your personal allowance is £12,570
£33,000 – £12,570 = £22,400 taxable income
You will pay basic rate tax at 20% on £22,400 = £4,480 income tax due.
Income Tax Free Allowances
Income tax free allowances are applicable to a variety of income types and let you earn a specific amount without paying any income tax.
We cover the most common tax free allowances below:
- Personal allowance:
The tax free personal allowance let’s you earn income up to that level without having to pay tax. Any income over the tax free allowance will be subject to the rates of tax applicable to your earnings.
- Dividend allowance:
The dividend allowance is in addition to your personal allowance and let’s everyone earn £1000 from dividends from April 2023 and £500 from April 2024 tax free.
- Savings allowance:
The personal savings allowance is worth £1000 for basic rate taxpayers, £500 for higher rate taxpayers with additional rate earners receiving no savings allowance.
A starting rate for savings is in addition to the personal allowance is worth up to £5,000 and is available if your other income is below £17,570.
- Self employed trading allowance:
The trading allowance provides relief from income tax and National Insurance contributions for trading, casual, or miscellaneous income up to £1,000 per tax year. This allowance is flexible and can be utilized against any type of trading, casual, or miscellaneous income.
- Property income allowance:
The property income allowance let’s you receive tax-free allowances of up to £1,000 each tax year If you have both types of income, you can enjoy a £1,000 allowance for each.
If your annual gross property income is £1,000 or less from one or more property businesses you won’t have to inform HMRC or reveal this income on a tax return.
- Rent a room scheme
If you have some extra space in your home and want to earn some extra income then the rent a room scheme can be a good option for you.
The scheme allows you to rent out as much of your furnished home as you want tax free up to a threshold of £7,500 per tax year.
If you are sharing the income with someone else then the rent a room scheme threshold is halved.
- Blind persons allowance
The blind person’s allowance is an additional part of your yearly tax free personal allowance worth £2870.
Both you and your spouse or civil partner can receive this allowance if you are eligible for it. If you are unable to utilize your full allowance due to not earning enough or paying tax you can choose to transfer it to your spouse or civil partner.
- Lifetime pension allowance
Most tax payers are given the standard lifetime allowance which from April 2023 is set at £1,073,100.
Normally you can take up to 25% from a pension as a tax free lump sum limited to a maximum of 25% of your unused pension lifetime allowance.
How do I calculate Income Tax?
How to calculate how much income tax you owe depends on your own set of circumstances.
Calculating income tax requires all of your taxable income, tax reliefs and applicable allowances to be taken into consideration.
For PAYE employees with no other sources of income you can use our free income tax calculator which let’s you enter your income and tax figures for a chosen tax year to help you with your own checks.
You can pay too much or not enough income tax without even knowing it. There are many reasons that can cause over or underpayments of tax.
Finding out if you haven’t paid the right amount of income tax sooner rather than later is beneficial because it gives you the opportunity to do something about it.
Do I have to pay Income Tax on all my income?
The good news is you don’t have to pay income tax on all of your income.
Income tax is not payable on:
- Interest on certain types of savings, for example tax free ISA’s.
- First £7500 a year from a lodger in your only or family home.
- Tax Credits.
- Many state benefits, including housing benefit and some income support payments.
- Wins from Premium Bonds.
- Student grants and loans.
- Maintenance payments received from a spouse or partner.
Income tax is payable on:
- Earnings from work, either self employed or normally employed. The number of hours you work doesn’t matter, if you earn enough you will pay income tax. These earnings include many bonuses and benefits for example company cars and medical insurance.
- Investment income, that is income coming from interest payments, dividends and capital gains collected upon the sale of assets.
- Some state benefits, including job seekers allowance and carer’s allowance.
- Interest on savings in some bank, building society and national savings and investments accounts and bonds.
- Income from a personal, state or company pension scheme.
- Rent received from tenants in a second or subsequent property, and/or, if over £7500 a year, rent from a lodger in your own home.
Income Tax and PAYE
The most common way HMRC deducts income tax is through the PAYE (Pay As You Earn) system, which is how all employed people pay tax.
Your employer or other income source will deduct tax automatically from your income and deliver it to HMRC on your behalf.
The amount deducted depends on factors such as personal allowance, which is a certain amount of income that can be earned without being taxed, and applicable tax bands.
National Insurance contributions are also collected through PAYE alongside other deductions like student loan repayments if applicable.
Income Tax and Self Employment
If you’re self employed you need to complete a Self Assessment tax return which tells HMRC how much income tax you owe.
This process involves reporting all relevant earnings during the specified period (usually April 6th – April 5th each year), calculating your total taxable profits after allowable expenses, determining how much income tax and national insurance contributions you owe based on these figures.
To avoid penalties or late fees associated with missed deadlines or inaccurate submissions it’s essential to keep accurate records throughout the year.
Income Tax and your Tax Code
A tax code is given to anyone who has income under PAYE. If the tax code you are given is wrong you can overpay income tax.
You can check your tax code through your personal tax account, HMRC app, on a payslip or a notice of coding P2.
If you think your tax code is wrong you should contact HMRC so your tax code can be checked and amended if needed.
Any overpayment of income will be refunded by HMRC either by BACS transfer or by you paying less tax in the remaining months of the current tax year.
Changing jobs or leaving the UK:
Sometimes when you only work for part of a tax year you can overpay income tax. This can happen if you change jobs or leave the UK during a tax year.
How can I pay less Income Tax?
There are ways to pay less income tax for both employed and self employed individuals.
The trick is knowing what can be claimed for, when to claim it back and what tax free allowances can be used.
Paying less income tax for the employed:
As many as one in three may have overpaid income tax. If you have been employed under PAYE in the last four tax years, you could be eligible to claim income tax relief or an income tax rebate.
Lots of reasons exist that can mean you could be eligible to claim a rebate on the income tax you have paid.
For PAYE tax payers not claiming back tax relief on work related costs is a common way to miss out on a refund of income tax.
It’s worth finding out what expenses you can claim tax relief for as many people assume they are already paying the right amount of tax.
Timescales apply so don’t delay in making a tax refund claim as you can only claim for the previous four tax years.
Paying less income tax for the self employed:
When your self employed there’s often more options available to reduce your income tax liability.
You or your accountant should cover as many areas as possible to keep your taxable income as low as you can.
To prevent overpaying, you can claim for your allowable business expenses. HMRC permits the deduction of expenses necessary to operate your business, reducing the amount of tax you owe by subtracting them from your profit.
Generally, if a purchase is not a capital asset such as machinery or a computer you can deduct its full cost when determining your taxable profits.
How do I claim an Income Tax Refund?
If you are employed you can claim an income tax refund from HMRC but you must do it within a four year timescale otherwise you will normally be out of time and not be eligible to claim.
The reason why you are owed a refund of income tax effects how you make your claim to HMRC.
We cover below some of the more general reasons why you could be owed an income tax refund and how to claim it back:
Employment expenses:
An employment expense is classed by HMRC as a cost incurred to perform your job. Not all costs incurred in doing your job are allowable for tax relief.
There is a long list of qualifying expenses including uniforms, tools, mileage and professional subscriptions.
You need to make a claim for employment expenses on HMRC form P87 which can be submitted online or downloaded and posted.
HMRC will send you a P800 tax calculation after the P87 is processed to let you know the amount of income tax refund you may be entitled to.
Automatic Income Tax Refunds
For an income tax refund where you don’t need to make a claim the PAYE system should automatically work it out and send you any overpayment however this does not always happen.
It is best to check your P60 and any P45 forms and then contact HMRC so they can review your tax record and repay any income tax you are owed.
