The basics of income tax – an overview

Income tax affects most of us. Nevertheless, there are many uncertainties on the subject: what exactly is it? And how much can an individual be taxed? How do different tax rates work? These questions are important, and wising up on this topic can help you in the long run. This article will introduce the basic concepts of income tax in an easily understandable manner. Additionally, not all income is taxable, so it’s good to know where you may be eligible for an exemption or deduction, as a business, or as an individual.

What exactly is income tax?Income tax is, as the name suggests, tax on your income. If you work in the UK, you’ll most likely have to pay a form of income tax, and the amount depends on how much money you make. This is calculated annually. If your income is equal to or below £11,850 (as of 2018), you do not have to pay any tax on your income. As your income is calculated annually, it means that if you earn £11,850 in one month, but nothing in the other eleven months, you’ll remain in the 0% tax bracket (more on this below).

Definition

Income tax taxes each individual on the money they make each year. The different rates on income tax may change each year, and the rates are set in the Autumn to come into effect of the spring of the next calendar year, i.e. the start of the new tax year.

How much can I be taxed?

Income tax is calculated in terms of different tax bands. The different categories of income are the tax bands, which encompasses a range of incomes. The amount you have to pay is calculated as a percentage, called a marginal tax rate. The following table shows what the tax band and marginal tax rates are for 2018:

2018 Tax Bands

Band

Rate

Income after allowances 2018 to 2019

Basic rate in Scotland

20%

£2,001 to £12,150

Basic rate in rest of UK

20%

Up to £34,500

Intermediate rate in Scotland

21%

£12,151 to £31,580

Higher rate in Scotland

40%

(41% from 2018 to 2019)

£31,581 to £150,000

Higher rate in rest of UK

40%

£34,501 to £150,000

Top rate in Scotland

46%

Over £150,000

Rest of UK additional rate

45%

Over £150,000

(Source: Gov UK’s Tax rates and Bands)

It may seem drastic for a single person in Wales, for example, to have to pay 45%on an income of £150,100, or 40% on an income of £36,000, when they’re only just within that tax bracket – and the good news is that they don’t have to. This is where marginal tax rates come into play. Essentially, what this means is that different income brackets are taxed differently: the first £34,500 is taxed at 20%, regardless if a person earns £33,000 annually or £35,000. The remaining £499 in the case of someone earning £35,000 is then taxed at 40% – and this goes on throughout the tax bands.

What kinds of income are taxed?

You’ll need to make a tax declaration to the HMRC stating all the income you have received in that calendar year. An easy way to remember the types of income you can receive (broadly speaking), is to think of money, services, and property. These three things are all ways in which an individual can receive income. This means that wages, salaries, commissions, rental income, and self-employed income are all considered to be a form of income, and are all required to be declared to HMRC as part of your income.

You should also be aware that other forms of income that may not seem as obvious are also taxed. If you receive benefits for services you provide, these may also be considered to be taxable income. For example, if you have a company car which you use for your personal daily life, this may also count as part of your taxable income. These are commonly known as “fringe benefits” and it is worth checking with a tax advisor to see which of these count as part of your taxable income. Some company benefits such as childcare and canteen meals are tax free.

Note

You may have to pay tax on income you don’t even have yet. For example, if a relative sends you a cheque for your birthday, but you don’t cash it by the end of the tax year, the date of the cheque is what counts, not when you receive the income. So this would also count as taxable income for the year you received it.

Non-taxable income

Income tax doesn’t apply to all types of income, as the name would have you believe. Of course, the majority of a person’s income can be taxed through income tax, but there may be some exceptions to this. For example, welfare benefits, interest and income from savings and investments, as well as the first £30,000 of payments which are compensation for being made redundant, along with items like grants, maintenance payments and training courses.

The full list can be found on the gov.uk website under HMRC’s income tax page, which lists taxable and non-taxable income in detail. If you’re in doubt about what income of yours is taxable, and what isn’t, check with an accountant!

Tax exemptions

If you are a British resident, you’ll be eligible for the first £11,850 of your income to be tax free, as a personal allowance. However, if your income exceeds £150,000 this personal allowance decreases the more you earn. Furthermore, if your business is registered as a UK charity, there is tax relief for income you receive as a gift.

Note

You count as a UK resident if you stay in the UK for more than 183 days a year, if you have annual visits to the UK for 91 days in 4 consecutive years. A company is considered to be a UK resident if it is incorporated in the UK; or if it is managed within the UK.

Deductions

Deductions are a fixed amount of money which will not be taxed as part of income tax. They are costs that the government will not tax, so for example, if you are repaying your student loan, you won’t be taxed on the income you made to repay that loan. In other words, the amount paid into student loan repayments each year would be deducted from the gross income, meaning that you’d have to pay less income tax overall.

Please note the legal disclaimer relating to this article.