What Is Income TaxThe first income tax was introduced in Great Britain in 1799, to fund the war against the French forces under Napolean. Income Tax is a “temporary tax” and expires every year on the 5th April and Parliament has to reapply it by an annual Finance Act. The PAYE (Pay As You Earn) system was introduced in 1944 as it was thought to be a more efficient tax collection system.

What Do I Have To Pay Income Tax On

Income tax is applicable to taxable income which includes the following:

How Do I Pay Income tax

There are various ways that you may pay income tax, it may be deducted at source, such as with salaried income under Pay As You Earn (PAYE) or with bank interest. Tax payers that have earnings from sources such as rental income or self-employment will be required to file a self-assessment tax return (SATR) annually. The tax calculated from this will either be paid yearly or bi-annually.

  • Pay As You Earn (PAYE) – The majority of people use PAYE to pay Income Tax. Through PAYE the employer deducts Income Tax and National Insurance contributions directly from your salary, dependent on your specific tax code.
  • Self Assessment tax returns – Should your finances be more complicated (such as being self-employed or have a high income) you may need to pay National Insurance and Income Tax via Self Assessment each year.
  • Income Tax on savings and investment interest – Income Tax is typically taken from interest on savings and investments automatically.
  • Income that’s not automatically taxed – You must fill in a tax return if you don’t pay tax through your wages or pension or if your untaxed income exceeds £2,500.

How Is Income Tax calculated

It is calculated on the income received, or with the case of self-employed income the net profit. Most people have a personal allowance, some groups have a higher personal allowance e.g. over 65s. Any income earnt within your personal allowance will not have any income tax deductions. If any tax has been deducted, this can be claimed back. Once the personal allowance has been exhausted the following levels of income tax are applied:

Current rates and allowances

The current tax year is from 6 April 2014 to 5 April 2015

Personal Allowance

Most people’s Personal Allowance is £10,000, unless you were born before 6 April 1948 or your income’s over £100,000.

Income tax rates

Tax rate 2014 to 2015 – Taxable income above your Personal Allowance
Basic rate 20% £0 to £31,865 
Most people start paying basic rate tax on income over £10,000
Higher rate 40% £31,866 to £150,000 
Most people start paying higher rate tax on income over £41,865
Additional rate 45% Over £150,000

Previous tax years

2011 to 2012 2012 to 2013 2013 to 2014
Personal Allowance £7,475 £8,105 £9,440
Tax rate Taxable income above your Personal Allowance Taxable income above your Personal Allowance Taxable income above your Personal Allowance
Basic rate 20% £0 to £35,000 £0 to £34,370 £0 to £32,010
Higher rate 40% £35,001 to £150,000 £34,371 to £150,000 £32,011 to £150,000
Additional rate 45% n/a n/a Over £150,000
Additional rate 50% Over £150,000 Over £150,000 n/a

A 10% starting rate applies to savings income only. If, after deducting your Personal Allowance from your total income liable to Income Tax, your non-savings income is above this limit then the 10% starting rate for savings will not apply. Non-savings income includes income from employment, profits from self-employment, pensions, income from property and taxable benefits.

The rates available for dividends are the 10% ordinary rate, the 32.5% dividend upper rate and the dividend additional rate of 42.5%.

Please note that tax payers that earn over £100,000 have a gradually reduced personal allowance, and that the top rate of income tax of 50% was reduced to 45% in the 2013-14 tax year.

Income Tax Example

Niko has income tax (including national insurance) to pay from his self-employment as a consultant and two rental properties, the total tax for the year 2011/12 (6th April 2011 to 5th April 2012) is £26,000 and has already paid £21,000 on account in January and July 2012 for this tax year. He files his 2011/12 tax return in August 2012; he will have to pay the following:

The underpayment of £5,000 tax will need to be paid by 31st January 2013, he will then also be asked to be paid the same amount of tax on account for the year 2012/13, so will pay as follows:
By 31st January 2013:

  • £5,000 balance outstanding on 2011/12 tax year
  • £13,000 first payment on account

By 31st July 2013:

  • £13,000 second payment on account

If he thinks that 2012/13 is going to be a less profitable year for him than 2011/12 he can request to pay a lower payment on account.

Tax-free and taxable state benefits

Most UK residences qualify for a Personal Allowance of tax-free income. This is the amount of income you can have before you pay tax. The amount of tax you pay can also be reduced by tax reliefs if you qualify for them.

National Insurance

When planning for your income tax payments do not forget to consider National Insurance (NI) implications. NI is effectively an additional tax, however, it has different rates and is not applicable in all income.

For example NI is not applicable to rental income or bank interest. If you are under the PAYE system you will pay Class 1 employee national insurance and your employer will pay employer national insurance. If you are self-employed you are subject to Class 4 and Class 2 NI.

If you would like to review your current tax situation, contact us for a tax review.

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Further information can be found on the HMRC site including their Tax Checker Calculator.