How is Income Tax Calculated?

Published: 11th March 2025

What is Income Tax?

Income Tax is a tax that UK taxpayers pay to HM Revenue & Customs (HMRC). It’s calculated on taxable income, which is the portion of your earnings subject to tax after deducting allowances and any applicable reliefs. The main allowance is a tax-free amount known as the Personal Allowance.

For most people, their taxable income comes from their salary or wages, but it also includes pension income, profits from self-employment, rental income for landlords, and interest or dividends from certain savings and investments.

What is Income Tax used for?

Income Tax is one of the UK government’s largest sources of revenue, accounting for approx. 27% of all tax collected. It primarily funds public services, including the NHS, education, emergency services and the welfare system. It also contributes to national infrastructure projects such as transport networks, housing, policing and local government services that keep the country running.

How is Income Tax calculated?

You calculate Income Tax based on your total taxable income, subtracting any allowances or reliefs you qualify for. The UK follows a progressive tax system, which means different portions of your income are taxed at different rates.

The more you earn, the higher the percentage of tax you pay on the upper portions of your income.

Step 1: Work out your total taxable income

Start by adding up all your sources of taxable income, then deduct your Personal Allowance – this is the amount you can earn before paying any tax. For the 2024/25 tax year, the Personal Allowance is £12,570 for most people.

If your total yearly income is below this amount, you won’t pay any Income Tax. If your income exceeds £100,000, your Personal Allowance is gradually reduced by £1 for every £2 earned above this threshold. Once your income reaches £125,140, your entire Personal Allowance is removed, and all your earnings become taxable.

Step 2: Determine your tax rate

After deducting your Personal Allowance, your remaining taxable income is taxed in bands. The UK’s progressive tax system means you only pay the higher rates on the portion of income within each band, rather than on your entire income.

For the 2024/25 tax year, the Income Tax bands in England, Wales and Northern Ireland are:

• Basic Rate (20%): Income between £12,571 and £50,270
• Higher Rate (40%): Income between £50,271 and £125,140
• Additional Rate (45%): Income over £125,140

Example Calculation: If your total taxable income is £60,000, you would pay:

No tax on the first £12,570 (covered by your Personal Allowance).
20% tax on the portion between £12,571 and £50,270.
40% tax on the portion between £50,271 and £60,000.

Step 3: Apply additional tax-free allowances

On top of the Personal Allowance, certain types of income have their own tax-free allowances, including:

• Personal Savings Allowance (PSA): Basic-rate taxpayers can earn up to £1,000 in interest from savings tax-free, while higher-rate taxpayers can earn up to £500. Additional-rate taxpayers don’t receive this allowance.
• Dividend Allowance: All taxpayers can earn £500 in dividend income tax-free, regardless of their tax band.

These allowances aren’t exemptions but rather 0% tax rate bands. This means that any income exceeding these limits is taxed at your usual Income Tax rate.

How to pay Income Tax

How you pay Income Tax depends on how you earn your income. Most people have tax deducted automatically by their employer, while others must report and pay directly to HMRC.

Paying through PAYE (Pay As You Earn)

If you’re employed, your Income Tax is deducted automatically through PAYE (Pay As You Earn). This is the system your employer or pension provider uses to take Income Tax and National Insurance contributions from your salary before paying you. Your tax code tells your employer how much to deduct.

At the end of the tax year, you’ll receive a P60, which summarises how much tax you’ve paid. If too much or too little tax has been deducted, HMRC will either issue a refund or request additional payment.

Paying through Self-Assessment

If you’re self-employed, receive rental income or earn other untaxed income, you must register for Self Assessment and submit a tax return to HMRC each year.

• The deadline to register is 5 October following the end of the tax year in which you started earning untaxed income.
• The deadline to file your tax return is 31 January after the end of the tax year if filing online (31 October if filing a paper return).
• The deadline to pay your tax bill is also 31 January for the previous tax year’s earnings.

If your tax liability exceeds £1,000, you may need to make payments on account, which are advance payments towards next year’s bill. These are due in two instalments: 31 January and 31 July.

If you’re unsure whether you need to fill in a Self-Assessment form, or need help accurately calculating your tax contributions, please contact a member of our team.

Making a payment to HMRC

If you need to pay HMRC directly, you can do so online, by bank transfer, Direct Debit or at your bank. The quickest and easiest way is through the HMRC website.

Failure to pay your tax bill on time may result in penalties and interest charges, so it’s important to meet the deadlines. If you’re struggling to pay, HMRC may allow you to set up a Time to Pay arrangement, which lets you spread the cost over monthly instalments.

If you are self-employed or managing multiple income sources, our accountancy services can help ensure your records are accurate and your returns are filed correctly.