Income tax refers to the tax levied directly on your personal income. Not all income is taxable and there are various allowances and reliefs that can reduce a person's income tax bill, or see them exempt from paying any tax at all. These allowable expenses and tax-free allowances will be considered when your total payable income tax is calculated according to different tax rates and a series of tax bands.
This page will explore income tax in more depth, highlighting the sources of taxable income and the various allowances that are available. It will also identify the means in which income tax payments are made and how to claim an income tax refund.
What income is taxable?
Income tax is levied on the following sources of income:
Earnings from employment and self-employment
This includes income from full, part-time and temporary work, as well as any profits made from working for yourself - either as a partner or sole trader.
If you have been provided with non-cash benefits from your employer such as a company car, living accommodation, or medical insurance, you may have to pay tax on them. This will depend on how much you earn and the value of your benefits.
Retirement annuity, state, personal and company pensions are all taxable. If you have a pension scheme through work or a personal pension, the pension provider should take off any tax due using the PAYE tax code system. This method will also be used to deduct tax from your State Pension.
There are certain state benefits that are taxable. Through the PAYE system, income tax will be deducted from the following:
- Jobseeker's Allowance.
- Carer's Allowance.
- Incapacity Benefit - from week 29.
- Weekly Bereavement Allowance.
- Certain payments of Income Support.
- Graduated Retirement Benefit.
- Statutory Sick Pay.
- Statutory Maternity Pay.
- Statutory Paternity Pay.
- Widowed Parent's Allowance.
- Employment and Support Allowance - contribution based (depending on whether you have paid enough National Insurance contributions).
Interest on savings
Income tax will be deducted from bank and building society interest and any national savings and investment accounts or bonds.
Dividends from shares will be taxed.
Income tax will be taken from income made from a lodger in your own, or family home if more than £4,250 a year is paid. This also applies to a second property.
Other taxable income
Pensioner bonds and income from trust funds are also subject to income tax deductions.
Non-taxable income typically refers to:
- Attendance Allowance.
- Disability Living Allowance.
- Winter fuel payments and Christmas bonuses.
- Working Tax credit.
- Child Tax Credit.
- Child benefit.
- Housing benefit.
- Guardian's Allowance.
- Maternity Allowance.
- War Widows' Pension.
- Income Support - certain payments.
- Wins from premium bonds.
- Interest on Individual Savings Accounts (ISAs).
- Certain company benefits, including meals provided for employees in a staff canteen, hot drinks and water at work, a company mobile phone and childcare.
Income tax allowances and relief
There are various 'tax-free' and 'tax-deductible' income tax allowances and reliefs available which can help to reduce your income tax bill, and in some cases make you exempt from paying tax altogether. These include the Personal Allowance, Married Couples Allowance and some business expenses.
Each year, every person in the UK receives a Personal Allowance, which is an amount of taxable income they are allowed to earn or receive without having to pay income tax. The level of this tax-free allowance will depend on your date of birth and your total income (everything you receive from all taxable sources) in the tax year. Once you start earning above this tax-free allowance, income tax will be instantly levied.
Married Couples Allowance
If you are married or in a civil partnership, you or your partner may be entitled to the Married Couples Allowance - an income tax deduction which depends on the level of the claimant's income. Typically, your tax bill is reduced by 10% of the amount of Married Couples Allowance you claim, but you will not be entitled to any reduction if you are not a taxpayer, or if you are not living with your partner as a result of formal separation. For couples who are unable to live together for reasons such as work commitments, a forces posting or a custodial sentence, entitlement to the allowance will not be affected. It does not apply to individuals born before 6 April 1935.
Tax-free Blind Person's Allowance
Individuals living in England and Wales who are certified as blind, and are listed on a local authority register of blind persons, are entitled to the Blind Person's Allowance. If you live in Scotland or Ireland and are unable to perform any work that requires good eyesight, you will also be entitled to this income tax deduction, which is added to your Personal Allowance as an extra amount of income you can get each year without paying tax.
Maintenance payments relief
If you pay maintenance payments to an ex-partner or spouse, you may be entitled to maintenance payments relief which reduces the amount of tax you pay. This is only available for individuals who were born before 6 April 1935 and who are making maintenance payments to an ex-spouse or former civil partner under a Court Order following a divorce or separation.
Other allowances, reliefs and expenses
- Tax relief on pension contributions - Tax relief is provided on pension contributions in an effort to encourage people to save more. This reduces your income bill or increases your pension fund, and the deduction depends on whether you pay into an occupational, personal or public service pension scheme.
- Employers or directors - Employers or directors are entitled to tax relief for specific business expenses such as travel, work tools and specific clothing.
- Self-employed - Individuals who are self-employed are usually entitled to tax relief on all of their business expenses such as advertising, general office costs, travel and buying stock and materials.
How do you pay income tax?
Your income tax payments will be collected in a variety of ways depending on the type of income you receive and whether you're employed, self-employed or unemployed.
Income tax is collected via:
- PAYE (Pay as you earn) - Your employer deducts income tax from your wages every month using the tax code issued to them by the HM Revenue and Customs (HMRC). This can usually be found on your P45 or your payslip, which identifies what your tax-free allowances are. If you have a pension, your pension provider will deduct tax in the same way.
- Self-assessment - Self-employed individuals must register for and complete a self-assessment tax return to determine how much tax they must pay each month. Individuals with complex tax affairs will also be asked to complete this.
- Tax deducted 'at source' - Whereby tax is deducted at the basic rate from the interest you receive from bank and building society accounts. Usually, savings interest has tax taken off at 20% before you receive it, but if you're a higher rate (40%) or additional rate (45%) taxpayer, you'll owe the tax difference. Individuals on a low income however may be able to claim tax back.
- Extra income - Generally you should be able choose how you pay relevant tax for extra income - either through PAYE throughout the following tax year or through self-assessment in the form of an additional payment.
- National Insurance contributions - This is a form of income tax that builds up your entitlement to specific state benefits (i.e. the State Pension). You will pay National Insurance contributions from the age of 16 until you reach State Pension age, and the amount deducted will depend on how much you earn and whether you're employed or self-employed. Your National Insurance number is your own personal account number which makes sure your NI contributions and tax you pay are properly recorded.
Should you be paying income tax?
To work out whether you're a taxpayer there are three steps you need to follow:
- Add up all of your taxable income in a tax year (April - April).
- Work out all your tax-free allowances (Personal Allowance, Blind Person's Allowance etc.).
- Take your tax-free allowances away from your taxable income - if there is anything left you will qualify as a taxpayer.
Alternatively, you could also use the HMRC income tax checker. This will estimate how much income tax and National Insurance contributions you can expect to pay on your income.
Checking your income tax payments
The following checks are important for ensuring you are paying the right amount of income tax:
Check your tax code
A tax code is what your employer or pension provider uses to calculate the amount of tax to deduct from your pay or pension. It is made up of several numbers and a letter (e.g. 117L) and can be found on your payslip, your PAYE Coding Notice, your P60 or P45 forms. If your tax code is wrong, you could end up paying too much or too little tax, so you need to check it - particularly after changing jobs or if your circumstances changed.
Your P800 tax calculation
At the end of every tax year your employer or pension provider will send the HMRC details of the amount of income you have received, the tax you have paid and any company benefits you have received throughout the year. If you haven't paid the right amount of tax, the HMRC will send a P800 Tax Calculation, informing you of what you have overpaid or not paid. It's important you check your calculation and contact the HMRC straight away if you think it is wrong.
It is advisable to keep hold of information and paperwork about your tax income such as payslips, PAYE Coding Notices, bank statements, dividend vouchers, Statements of Account etc. to ensure you can keep on top of how much tax you are paying. These records will prove particularly useful if you have to complete a self-assessment tax return.
Income tax refund
In some cases, people can end up paying too much income tax - particularly if they change jobs or end up working more than one job at the same time. If you are worried that you have paid too much income tax, you are entitled to apply for an income tax refund. How you reclaim overpaid tax however will depend on your circumstances.
Common reasons why you might have overpaid tax through employment are:
- your employer was using the wrong tax code
- you're a student who only worked during the holidays
- you were only employed for part of the year
- your circumstances changed - i.e. you became self-employed or started working full time
- you were made redundant
- you stopped working and didn't get any taxable earnings or benefits for the rest of the tax year
- other sources of income changed/reduced which could mean your tax code is too high.
In order to reclaim overpayments of income tax, you need to get in touch with the HMRC, either by phone or letter so that they can check your claim and refund what you're owed. The means in which you receive an income tax refund will depend on the type of tax that has been overpaid (i.e. PAYE, self-assessment etc.). In most cases you will be refunded your overpayments - either for the current tax year or previous ones - but it is important to note that there is a specific time frame in which you can make a claim.
For full information on income tax, including the current tax rates, income tax allowances and income tax refunds, please see the HMRC website.
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