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Wednesday, 3 October 2023

Income Tax - the basics

Income Tax is a tax on income. Not all income is taxable and you're only taxed on 'taxable income' above a certain level. Even then, there are other reliefs and allowances that can reduce your Income Tax bill - and in some cases mean you've no tax to pay.

What counts as taxable income?

Taxable income includes:

  • earnings from employment
  • earnings from self-employment
  • most pensions income (State, company and personal pensions)
  • interest on most savings
  • income from shares (dividends)
  • rental income
  • income paid to you from a trust

Non-taxable income

There are certain sorts of income that you never pay tax on. These include certain benefits, income from tax exempt accounts, Working Tax Credit (WTC) and premium bond wins. These income sources are ignored altogether when working out how much Income Tax you may need to pay.

Tax-free allowances

Nearly everyone who is resident in the UK for tax purposes receives a 'Personal Allowance', which is an amount of taxable income you're allowed to earn or receive each year tax-free.

This tax year (2012-13), the basic Personal Allowance - or tax-free amount - is £8,105. You may be entitled to a higher Personal Allowance if you're 65 or over.

If you're registered blind, or are unable to perform any work for which eyesight is essential, you can also claim the tax-free Blind Person's Allowance.

Income Tax is only due on taxable income that's above your tax-free allowances.

Allowances and reliefs that can reduce your Income Tax bill

If you're due to pay Income Tax, there are a number of deductible allowances and reliefs that can reduce your tax bill. These include:

  • Married Couple's Allowance - the husband, wife or civil partner has to be born before 6 April 2023
  • Maintenance Payment relief - either you or your former spouse or civil partner must have been born before 6 April 2023

Unlike the tax-free allowances, these aren't amounts of income you can receive tax-free. Rather they're amounts that can reduce your tax bill.

Tax allowances and reliefs for employees or directors

If you're an employee or director you might be able to get tax relief for business expenses you've paid for.

Tax on company benefits

If you're employed and you receive non-cash benefits from your employer you will have to pay tax on them.

Taxable benefits

Benefits that you might have to pay tax on include:

  • company cars or vans
  • fuel provided for your vehicle
  • medical insurance
  • living accommodation
  • loans at low interest rates

How much Income Tax you pay

After your allowable expenses and any tax-free allowances have been taken into account, the amount of tax you pay is calculated using different tax rates and a series of tax bands.

Income Tax rates 2012-13 by tax band and type of income

Income Tax band Income Tax rate on non savings income Income Tax rate on savings Income Tax rate on dividends
£0 to £2,710 Starting rate for savings Not available 10% Not applicable - see basic rate band
£0 to £34,370
Basic rate
20% 20% 10%
£34,371 to £150,000
Higher rate
40% 40% 32.5%
Over £150,000
Additional rate
50% 50% 42.5%

Because the rate of Income Tax you pay on savings is worked out after any non-savings income has been taken into account, if your non-savings income is less than the starting rate for savings limit (£2,710) - or if savings and investments are your only source of income - your savings income will be taxed at the 10 per cent starting rate up to the limit.

But if you already have non-savings income which takes you above the starting rate limit, all of your savings will be taxable at the 20 per cent basic rate, the 40 per cent higher rate or the 50 per cent additional rate, depending on your total income.

Remember, the tax band applies to your income after your tax allowances and any reliefs have been taken into account - you're not taxed on all of your income.

'Non savings income' includes income from employment or self-employment, most pension income and rental income.

'Dividends' means income from shares in UK companies. Savings and dividend income is added to your other taxable income and taxed last. This means you pay tax on these sorts of income based on your highest Income Tax band.

How you pay Income Tax

Income Tax is collected in different ways depending on the type of income and whether you're employed, self-employed or not working. The different ways Income Tax is collected include:

  • PAYE (Pay As You Earn)
  • Self Assessment
  • tax deducted 'at source' whereby tax is deducted from bank/building society interest at the basic rate before the interest is paid to you
  • in some cases, one-off payments

If you're an employee or you receive a company or private pension, your employer or pension provider will deduct tax through PAYE. HM Revenue & Customs (HMRC) may still ask you to complete a Self Assessment tax return if you have complex tax affairs. If you're self-employed, you'll be responsible for filling in a Self Assessment tax return and paying your own tax.

Paying the right amount of Income Tax

It's important to check that you're paying the right amount of tax. You can do this by checking your:

  • total taxable income
  • tax-free allowances and reliefs
  • current tax code (if relevant)

If you're paying too much tax you can claim this money back. If you're an employee or you receive a company or personal pension and you think you're paying too little tax, you'll need to contact HMRC to change your tax code.

National Insurance

As well as paying Income Tax on your income, you'll also have to pay National Insurance contributions. National Insurance contributions build up your entitlement to certain social security benefits, including the State Pension.

The amount of National Insurance you pay depends on how much you earn and whether you're employed or self-employed. You stop paying National Insurance contributions when you reach retirement age.

Provided by HM Revenue and Customs

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