Income tax is one of the simplest taxes to understand, but many of us may not have been aware of how it works before we really start to look into it. I would include myself in this, even after I first became an accountant!
Income tax is devolved in Scotland and the income tax bands and rates are different, but the general principles still apply. However, in this article I will be talking about income tax as it stands for the rest of the UK for the year that ends on the 5th of April 2026.
Let’s start with the personal allowance. This is an amount that everyone gets for which their income is tax free. The amount of the allowance does start to decrease when your total earnings exceed £100,000 but for most of us, it will be £12,570 for the current year. This means that the first £12,570 you earn each year will be free of tax.
You also won't start paying National Insurance until your income exceeds £12,570.
The personal allowance has previously increased year on year, however it has remained static for several years, which has meant that more people have been brought into higher tax brackets if their pay has increased due to inflation.
If you are employed, your employer won’t just start taxing you when your earnings for the year have totalled £12,500 but will instead tax you monthly or weekly on the assumption you will earn the same amount each period. This way your tax-free allowance is spread across 12 months and you don’t start getting large tax deductions towards the end of the year. One consequence of this is that if you leave your employment part way through the year you may have paid more tax than required and will be due a rebate.
After the £12,570 personal allowance, you are taxed at 20% of your earnings. This is what is called the basic rate band. This rate applies until you hit the threshold for the higher rate of tax which is currently £50,270. So any income between £12,570 and £50,270 incurs tax at 20%. This means that you will pay 20p out of every pound you earn between these amounts.
For National Insurance, the rate between these amounts is 8%, so you will pay 8p of National Insurance between these amounts.
At total annual earnings of £12,570, you will be paying no tax or National Insurance.
For every pound over that, you will be paying 28p in total deductions as discussed above. This means that if your earnings are £12,571, your total contributions will be 28p. If your earnings are £12,572, your total contributions will be 56p etc. All of your earnings prior to this point remain subject to no tax.
After £50,270 you will start to pay tax at the higher rate of tax which is currently 40%. However, this is only 40% on any income over £50,270. For example if you earned £50,271 you would only pay the 40% rate on the £1 which is over £50,000, therefore 40p. The earnings between £12,570 and £50,270 remain subject to the 20% rate.
At this point, your National Insurance contributions will actually drop from 8% to 2%. Therefore earnings after £50,270 are subject to total deductions of 42%. So you'll pay 42p for every pound you earn over this amount.
So for each additional pound you earn, you will be taking home 72p at the basic rate and 58p at the higher rate.
The higher rate applies until you earn £125,140 at which time you move onto the additional rate of tax for anything over this amount, which is currently taxed at 45%. As the same principles apply, I won’t go through an example of this.
As your tax code will take an amount each month based on your expected earnings over the year, it is possible that you might be over or undertaxed if circumstances change. HMRC will review everyone's overall tax liability for the year and will write to you if you have over or underpaid. If you have overpaid, then they will likely issue you a rebate. If you have underpaid, then you will be asked to make up the difference. Most often, this will be by adjusting your tax code in future years, meaning your personal allowance is reduced.
Reducing your tax burden
In order to reduce your tax bill, certain costs you incurred to earn the money can be deducted.
If you have a rental property, you can deduct costs that you incur on renting it out, or if you are self-employed you can deduct the costs that you incur to make your sales. These will all be deducted before your tax is calculated, thereby reducing your tax liability.
There are ways that you can extend your basic rate band if you make payments into a personal pension, if you donate to charity or if you claim the marriage allowance.
Other forms of income tax
You also need to pay tax on any interest or dividends you receive. These are also classed as income tax but will have certain additional tax free allowances and you can be taxed at different rates.
