The basics of Income Tax
This section will provide an overview of the basics of income tax.
This is the prime tax concern for most people as it is charged on income from employment, self-employment, savings and investments.
HMRC Online Income Tax Service
Given that the rules governing income tax are complex, it is worth noting at the outset that Her Majesty’s Revenue & Customs (HMRC) has launched an online service to enable you to check your tax code and personal allowance online.
This service also enables you to:
- tell HMRC about changes affecting your tax code,
- update employer or pension provider details,
- see an estimate of how much tax you will pay, and
- check and change the estimates of how much income you may receive from jobs, pensions or bank and building society savings interest.
You can access the service at https://www.gov.uk/check-income-tax-current-year
Your income that is liable for income tax
- Earnings from your employment
- Earnings from your self-employment
- Your pension income
- Interest on most of your savings
- Your dividend income
- Your rental income
- Your trust income
Your income that is not taxable
- Income from your Individual Savings Accounts (ISAs)
- Interest from your tax exempt savings accounts
- Your Premium Bond wins
- Your working tax credit
Your Personal Allowance
Assuming you are resident in the UK you will have a personal allowance. This is the amount of taxable income you are allowed to receive in a tax year (6 April one year to 5 April the next) without having to pay income tax.
The basic personal allowance for the tax year commencing 6 April 2022 is £12,570.
If you are fortunate to have a total annual income of over £100,000 then your personal allowance is gradually reduced by £1 for every £2 of annual income over £100,000. Therefore once your annual income is over £125,000 you will have no personal allowance.
If you or your spouse/civil partner were born after 5 April 1935 and have an income below the personal allowance, the marriage allowance offers a potential tax saving. That person can transfer 10% of their personal allowance, which is partly being wasted, to their partner providing he or she is not a higher rate or additional rate tax payer.
This could result in an annual saving of up to £252 for the recipient (20% of £1,260). For further details please go to Income Tax Planning.
Tax on your savings income
You have the following annual allowances to offset tax on your savings income:
- your Personal Allowance
- your starting rate for savings
- your Personal Savings Allowance
Starting rate for savings
You may also get up to £5,000 of interest and not have to pay tax on it. This is your starting rate for savings. The more you earn from other income (for example your earned income or pension), the less your starting rate for savings will be.
If your other income is £17,570 or more you will not be eligible for the starting rate for savings.
If your other income is less than £17,570 your starting rate for savings is a maximum of £5,000. Every £1 of other income that you receive above your personal allowance reduces your starting rate for savings by £1.
Example Assuming your earned income is £17,000 and you received £400 interest on your savings.
Your Personal Allowance is £12,570 (2022/23) and it is used up by the first £12,570 of your earned income. The remaining £4,430 of your earned income (£17,000 minus £12,570) reduces your starting rate for savings by £4,430.
Your starting rate for savings is therefore reduced to £570 (£5,000 minus £4,430). This means you will not have to pay tax on your £400 savings interest.
Personal Savings Allowance
Depending on your tax band you may also receive some interest tax free as shown below. To calculate your tax band you will need to add your savings income to your earned income and deduct your personal allowance.
|Income Tax band||Personal Savings Allowance|
Income tax rates
Once the personal allowance and any marriage allowance are deducted from your income the excess is your taxable income. This is then taxed depending on where it falls in the income tax bands.
The income tax bands and rates for 2022/23 in England are shown below. Different rates apply in Scotland, Wales and Northern Ireland.
|Basic rate on taxable income up to £37,700||20%|
|Higher rate on taxable income between £37,701 and £150,000||40%|
|Additional rate on taxable income above £150,000||45%|
Tax on dividend income
If you own shares in a company, or a unit trust or investment trust, you are likely to receive dividend income. You may also receive dividend income from a stocks and shares ISA or venture capital trust but the dividend income from these products is tax free and does not need to be shown on your self assessment form.
If your total income including your dividend income is less than your personal allowance then you will pay no tax on your dividend income.
You also receive an annual dividend allowance of £2,000 (2022/23). If your dividend income is in excess of this then you will have to pay tax on your excess dividend income depending on your income tax band as follows:
|Tax band||Tax rate on dividends over the allowance|
Your dividend income may be in two income tax bands.
Example You get £5,200 in dividends and have earned income of £39,500 in 2022/23. This gives you a total income of £44,700.
You have a Personal Allowance of £12,570. Take this off your total income to leave a taxable income of £32,130. This is in the basic rate tax band, so you would pay:
- 20% tax on £26,930 of earned income (i.e. £32,130 -£5,200)
- no tax on £2,000 of dividends, because of the dividend allowance
- 8.75% tax on the excess dividends of £3,200
Child benefit charge
If you are in receipt of child benefit and your taxable income (before deducting the personal allowance) is over £50,000 then you effectively have to pay some, or all, of the child benefit back through a child benefit tax charge.
Where both you and your spouse/civil partner have an income that exceeds £50,000, the charge applies only to the one with the highest income.
The child benefit charge is charged at the rate of 1% of the full child benefit you received for each £100 of income between £50,000 and £60,000. If you have earned above £60,000, therefore, the tax charge will wipe out all of the child benefit you have received.
If you are affected by the child benefit charge you can elect to stop receiving child benefit and not pay the new charge if you wish. Alternatively you can keep receiving child benefit and pay the tax charge through self-assessment.
You should be aware that your taxable income can effectively be reduced by making pension contributions or giving to charity via Gift Aid and doing so could in certain circumstances remove some, or all, of the child benefit charge.
Non-cash benefits from your employment
When your employer provides any of the following benefits to you there will be additional tax for you to pay:
- Company cars or vans
- Medical insurance
- Living accommodation
- Low interest loans
If you are self-employed there are many expenses that can be set off against your income when calculating your tax liability.
Using an accountant for this is really essential as they would normally be expected to save you more tax than you would be able to do on your own.
If you own a company or have a high income from self-employment you should obviously use a chartered accountant. However, if you run a smaller self-employed business you should find that a certified accountant will be more than adequate and would be expected to charge lower fees.
If you are employed, the rules for obtaining tax relief for any business-related expenditure are very restrictive.
Paying your income tax
- Employed – If you are employed you will usually have most, if not all, of your tax collected using the Pay as You Earn (PAYE) system. Your employer will deduct tax using a tax code determined by HMRC to calculate how much tax should be paid.
- Self-employed and company directors – If you are in business or otherwise have more complicated tax affairs (e.g. you receive rental income or income from a trust) you will need to file self-assessment tax returns and pay your tax through the self-assessment tax system.
National insurance is a separate tax (or contribution) which you pay in addition to income tax. The national insurance contributions you pay are designed to fund social security benefits such as disability income and the state pension.
The amount of national insurance you will pay is calculated by reference to your employment status and how much income you earn. For a more detailed look at national insurance please refer to my separate notes on this.
It is important to be aware that it is your responsibility to tell HMRC if you owe tax rather than their job to tell you. They will, of course, tell you if they think you have overlooked something.
Links to more information
- Income Tax planning
- HMRC notes on Income Tax
- If you need personal financial advice on Income Tax then I am happy to introduce you to Flying Colours Life who have access to independent financial advisers throughout the UK
This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.
Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.
If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.