What is income tax
Income tax is a tax on income including:
- earnings from employment, including benefits in kind such as a company car
- earnings from self-employment
- most pensions income, including state, occupational and personal pensions
- some social security benefits
- interest on most savings
- income from shares (dividends)
- rental income
- income from a trust.
Not all types of income are taxable. For more information about which kinds of income are taxable, see Taxable and non-taxable income.
You won't usually have to pay tax on all your income, even if it is all taxable, because you will be entitled to a certain amount of income tax free in each tax year. The tax year runs from 6 April one year to 5 April the following year.
There is no minimum age at which you become liable to pay income tax. What matters is the amount of your taxable income. If this is below a certain level, no tax is payable.
How income tax is calculated
To calculate roughly how much income tax is payable for a particular tax year, use the following steps. The income tax rules are complex so this will not necessarily give you the precise answer in every case:
Step 1 Add together all your taxable income, before tax, from all sources, including employed earnings and self-employed profits, taxable social security benefits, income from renting out accommodation, pensions and interest from bank and building society accounts, for the year. Leave out non-taxable income such as housing benefit, pension credit, maternity allowance, child benefit, child tax credit and working tax credit, personal independence payment, premium bond prizes and lottery winnings. For a full list of tax-free income see Taxable and non-taxable income. You must use gross amounts in Step 1, that is, the amount of taxable income before any tax was deducted. This will give you your total income for working out how much tax you have to pay.
Step 2 Check whether you can claim tax relief for any money you have spent out over the year. For example, on your contributions to a pension scheme (but not on pension contributions where tax relief is given at source – these are taken into account in Step 4) or for paying certain employment expenses. Take these off your total income here. If you are self-employed, business expenses are deducted before reaching your taxable profit.
Step 3 Check which tax free allowances you are entitled to. If you live in the UK on a day to day basis, you will be entitled to a basic Personal Allowance, unless your income is over £100,000. If you were born before 6 April 1948, you will be entitled to a higher age-related Personal Allowance, although this may be restricted depending on your income. If you are blind, you could get a Blind Person's Allowance. These allowances are deducted at this stage of the calculation, leaving an amount of income on which tax is payable. This amount is called your taxable income.
For more information about tax allowances, see Income tax allowances and amounts.
Step 4 To calculate the tax payable for 2015/16, you should:
- calculate tax at 20% of your taxable income up to the basic rate limit of £31,785. If you are on a low income, savings income will only be taxable at 10%, even if your bank or building society has taxed it at 20%, so a repayment could be due, then
- if you have taxable income over £31,785, calculate tax at 40% of your taxable income over £31,785 and up to £150,000, then
- if you have taxable income over £150,000, calculate tax at 45% of your taxable income over £150,000, then
- add the last three figures together. This is the amount of tax that is payable for 2014/2015, but
- if your household is receiving Child Benefit and one member of the household has income above £50,000, you may have to pay extra tax in addition to the amount above. For more information, see Child Benefit and tax if you have a high income.
Example: Your taxable income is £11,000 after deducting your personal allowance from your total income.
You have no taxable income above the basic rate limit of £31,785, so you pay tax at the basic rate of 20% on all your taxable income.
20% X £11,000 is £2,200.
For more information about tax rates and about how savings income is treated, see Income tax rates.
You can find out more about income tax rates on the GOV.UK website at: www.gov.uk
You should now be able to work out the amount of tax due for the year, unless you are entitled to Married Couple's Allowance (see Step 5). When you have calculated the total tax due, take off tax already paid – that is, PAYE tax deductions from employment earnings and occupational pensions, and tax deducted at source from savings income.
Step 5 If you are married or in a civil partnership and one of you was born before 6 April 1935, you can claim Married Couple's Allowance. If this applies to you, 10% of the Married Couple's Allowance is deducted from your tax bill at this stage.
For more information about claiming Married Couple's Allowance, see Income tax allowances and amounts.
Following these steps may not give the right result if:-
- you are self-employed and have made a loss for the year
- you were born before 6 April 1948, you make charitable payments under Gift Aid and your age-related personal allowances are reduced because of the level of your income
- you have overseas income that is taxed abroad.
Income that is not taxable
Some income is not taxable, which means that you don't have to pay tax on it. This income is ignored when working out how much tax you have to pay. Examples of income which is not taxable include premium bond prizes, housing benefit and child benefit.
For a list of income which is not taxable, see Taxable and non-taxable income.
Most people living in the UK are entitled to a basic Personal Allowance, but this is reduced for people with incomes over £100,000 a year. You may also be entitled to an age-related allowance, Blind Person's Allowance and/or Married Couple's Allowance. This means that some of your income, which would otherwise be taxable, will be tax free.
If you are an employee or a pensioner who is taxed under Pay As You Earn (PAYE), your personal allowances will be spread throughout the year, so that each week or month you will have a certain amount of tax-free income and then pay tax on the remainder.
If you are self-employed or have other taxable income not taxed under PAYE, your personal allowances will be taken into account when your tax bill is calculated after you have sent in your annual tax return or repayment claim.
For information about tax allowances and who can claim which allowances, see Income tax allowance and amounts.
In addition to personal tax allowances, income spent on certain things, for example, professional subscriptions or the cost of the tools of your trade, can be deducted when calculating tax. This is known as tax relief on outgoings. These reliefs reduce the amount of your taxable income so you pay less tax.
Tax reliefs for employees are spread throughout the year in the same way as personal tax allowances. Tax reliefs for self-employed people and people who have other taxable income are taken into account when their tax bill is calculated after they have sent in their annual tax return or repayment claim.
For more information about tax reliefs, see Tax reliefs.
Income tax rates
Income is taxed at different percentage rates depending on the amount of your taxable income after deducting allowances and reliefs. You may pay tax at more than one rate at a time.
For more information on income tax rates , including rates for past years, see Income tax rates.
Income on which tax has already been paid
When you're calculating the tax due, you need to work out whether or not you have received any income on which tax has already been paid. For example, interest on savings in a building society or bank account usually has tax taken off before it's paid to you. Income from employment or an occupational pension should also have had tax taken off before the payment was made to you.
When you're working out the total tax due for the year, you need to take into account that tax has already been paid on this income. The gross amount of this income (that is, the amount you received plus the tax deducted) is taken into account when calculating your total taxable income before personal allowances and tax reliefs are taken off.
National insurance contributions
As well as checking that the correct tax has been taken off your pay, you may also want to check that the correct national insurance contributions have been deducted, so leaving you with the correct take home pay. National insurance contributions are calculated on gross pay. For employees they are deducted at different rates depending on your pension arrangements and on your level of income.
If you are self-employed you pay National insurance contributions at different rates, depending on your profits.
You can find more information about national insurance and how much you pay on the GOV.UK website at www.gov.uk. If you need help with checking your national insurance, consult an adviser, for example, at a Citizens Advice Bureau. To search for details of your nearest CAB, including those that can give advice by e-mail, click on nearest CAB.
If you are a taxpayer, you must, by law, keep records of your income and any expenses you claim against tax. You will need these records if HMRC asks you to complete a tax return. You can find more information about what records to keep and how long you must keep them for on the GOV.UK website at www.gov.uk.
How HM Revenue and Customs collects income tax
Deduction of tax at source
Most taxpayers pay their tax through deductions that are made from their income before they receive it. This is called deduction at source.
Some of the most common examples of deduction at source are PAYE, see below, and bank and building society interest, see below.
Pay As You Earn (PAYE)
By law, anyone making payments to employees or members of occupational pension schemes is obliged to operate the PAYE system. This means they must deduct income tax, and class 1 national insurance contributions where appropriate, from the payments that they make, and must send these sums to HM Revenue and Customs (HMRC).
You are entitled to receive written confirmation of deductions that have been made by:
- payslips, showing gross pay, deductions made and net pay if you are an employee; and
- a P60 certificate at the end of each tax year, confirming the amount of gross earnings or pension, and any income tax and class 1 national insurance contributions deducted; and
- a P45 certificate whenever you change jobs, which shows the pay and tax in the job you are leaving, the tax code operating on your earnings at the time you left and, in some cases, the earnings and income tax deducted in the tax year to date.
For more information about PAYE and notifying the tax office about taxable income, see The Pay As You Earn (PAYE) system.
Bank and building society interest
Banks and building societies deduct income tax from the interest paid on most deposits made with them by individuals, and pay this over to HMRC. This is done before the interest is paid into your account.
The bank or building society must confirm the amount of interest earned in each tax year and the amount of income tax deducted. The bank or building society must give you the information free of charge if you ask for it. A number of banks and building societies send these details to all their investors each year, as a matter of course. Statements and pass books may also show this information.
If you do not need to pay any tax on this interest, for example, because your total taxable income from all sources falls below your personal tax allowances for the tax year, you can arrange to receive your interest gross, that is, without deduction of any tax. You should ask your branch of the bank or building society for form R85, which you must complete and return to the branch. Interest will then be paid without tax deduction, avoiding the need to claim a tax refund.
Collection of tax by Self Assessment
You have to pay tax direct to HMRC through the system of Self Assessment where the full amount you owe was not, or could not be, paid by deduction at source. For example, this will happen with:
- profits from self-employment
- rental income from property
- interest received gross, for example, on National Savings investments accounts
- income from overseas
- employment-related benefits in kind
- Child Benefit where a member of the household has taxable income of over £50,000. For more information, see Child Benefit and tax if you have a high income.
The Self Assessment process
If you have to pay tax through Self Assessment because, for example, you are self-employed, then you must fill in an annual tax return. HMRC will calculate your tax bill based on the figures in your tax return. You can also work out the amount of tax due yourself if you want to.
Paying tax under Self Assessment
If you send in a paper tax return by the filing date of 31 October following the end of the tax year you will be sent a tax calculation. HMRC will follow the calculation with a statement of account, which is like a tax bill, in time for the due date for payment of 31 January. If you file an online return, your tax bill is calculated automatically. The online filing date and the due date for payment is the same, 31 January following the end of the tax year.
For information about tax returns, see Tax returns.
For more information about Self Assessment, see Self Assessment.
If you need help with the Self Assessment process, you should contact HM Revenue and Customs, or consult an adviser, for example, at a Citizens Advice Bureau. To search for details of your nearest CAB, including those that can give advice by e-mail, click on nearest CAB.