What Is Income Tax And When Do You Start Paying It?

Let's take a deep dive into a hot topic that can boggle even the sharpest minds – income tax. From understanding when it's time to start paying your tax, to the complexities of filing your 'self-assessment tax return' from the UK or as a 'non-resident', there's a lot of ground to cover. We'll unravel these taxing concepts one by one so that you don’t get overwhelmed with the information.

What Is Income Tax?

So, income tax. It's that pesky little portion carved out from your hard-earned income, isn't it? But why do you have to pay for it, and what is it used for?

Any income, whether from employment, self-employment, rental income, and so on, is subject to income tax. The funds collected from this tax are primarily used to provide public services, and infrastructure, and meet the country's other financial obligations. Remember that new road or the public healthcare system? Yes, income tax contributes significantly to those.

When Do You Start Paying Tax?

Generally, you only start paying income tax when your income (the total earned from different sources) surpasses the pre-defined tax-free allowance which is £12,570 in the UK. We will touch on this later!

How much Income Tax do I need to pay?

The amount of tax that you pay is derived from your total taxable income. HMRC, in charge of levying and collecting taxes, have outlined the steps involved in determining an individual's tax liability.

Current Income Tax Slabs in the UK

Let's dive deeper into the various tax brackets and their corresponding rates in the UK.

The Basic Rate: 20%

The Basic Rate is the first tax bracket you'll come across. This applies to taxable income from £12,571 to £50,270. Here, you get charged a tax of 20% on your income.

The Higher Rate: 40%

The next rung is the Higher Rate for taxable income between £50,271 and £125,140. This bracket sees an increased tax of 40%.

The Additional Rate: 45%

For incomes above £125,140, you will get taxed at the Additional Rate of 45%. This is the highest tax bracket in the UK. Well, for every £2 you earn above £100,000, you lose £1 of your personal allowance. This means your personal allowance is zero if your income is £125,140 or above.

As you move from the lower to the higher brackets, the percentage you need to pay in taxes increases. This is known as progressive taxation which ensures that those who earn more contribute more in taxes, making it an equitable system.

How to Calculate Total Income

Your total income can be calculated by adding together the profits from the five different sources listed below.

1. Income from salary: Earnings from a salary or pension are included in this category if you are or formerly were a paid employee.
2. Income from business/profession: Earnings from a business or profession refer to money made by activities carried out in a private capacity, such as running a company or practising a trade.
3. Income from house property: This refers to the sum of money made through the collection of rent on a property that is owned but is not being used for commercial reasons.
4. Income from capital gains: Gains on investments are defined as income received from investments in capital assets such as stocks, real estate, gold, and other similar investments.
5. Income from other sources: Earnings derived from different sources: revenue from a variety of sources, including but not limited to lotteries, monetary gifts, and earnings from savings accounts.

What are Tax Deductions?

Whether you're a seasoned businessman or a recent graduate starting your first job, knowing common income tax deductions can significantly lower your total taxable income and, thus, your tax liability. So, what exactly are tax deductions, and how do they function?

Tax deductions or 'write-offs' lower your taxable income based on the expenses you report in your online tax return. In addition to the personal allowances, pension contributions, and charity donations, you may deduct costs associated with your job, such as uniforms, tools, and travel expenditures for which you are not reimbursed by your employer.

If, as a self-employed person, you incur a loss during a given tax year, you can carry that loss forward and deduct it from your future profits. The sum of the eligible expenses is deducted from your gross total income, resulting in your 'net taxable income'.

Here are a few common tax deductions to look out for:

• Medical Insurance Premiums
• National Insurance Contributions
• Pension contributions
• Business expenses
• Donations to charities

Remember, the more deductions you claim, the lower your net taxable income and fewer the taxes you pay. But always ensure that your claims are legitimate!

This implies that for a photographer, purchasing a camera is a justified business expense, but probably not for a real estate agent. No matter what you're deducting, keep track of all of your receipts for expenses. If the HMRC investigates you, having documentation of your spending will help you avoid difficulties.

It's worthwhile to try using an online tax software: Taxd to figure out your specific situation and ensure that the claims you're making are accurate.

"An intelligent and informed taxpayer is the best guarantee of democracy." - Calvin Coolidge

To calculate your total taxable income, follow these 3 simple steps:

1. Sum your total income
2. Deduct your exemptions
3. Subtract your deductions and allowances

At the end of these steps, you will be left with your total taxable income.

Who Should Pay Income Tax in the UK?

Not all money you earn is subject to income tax. The UK government has set some tax-free allowances and tax bands. If your annual income falls into these allowances, you may not need to fork out tax.

The Untouchables: Who Doesn't Need To Pay?

Like any rule, there are exceptions to income tax as well. Several state benefits are income tax-exempt, such as:

• Universal Credit
• Tax Credits
• Child Benefit (with specific income limits)
• Benefits from friendly societies

Non-Taxable Income

The UK government grants tax concessions for some types of income as well, which include:

• Income from tax-exempt accounts, like Individual Savings Accounts (ISAs) and National Savings Certificates.
• Some state benefits, like housing benefits and attendance allowance.

Who Holds The Responsibility?

Primarily, it's your responsibility to ensure your taxes are being accurately calculated and paid on time. But it largely varies based on how you’re earning.

If you’re employed, your employer would generally deduct tax through the Pay As You Earn (PAYE) system before giving you your salary.

If you’re self-employed, you'll have to report your income to HMRC and pay tax through the self-assessment process.

If you’re getting a pension (other than the state one), your provider often deducts the tax before making the payment.

If you need professional assistance in calculating and paying your taxes, contact us at Taxd.

National Insurance Contributions (NICs)

UK citizens must pay both income tax and National Insurance Contributions (NICs). NICs are an obligatory payment that helps to support the National Health Service (NHS) and other public services. There are two primary kinds of NICs:

• Class 1 NICs are paid by both workers and employers.
• Class 2 NICs are paid by self-employed persons.

The amount of NICs you pay is determined by your income and work status. For workers, your company deducts NICs from your pay. Self-employed people must calculate and pay their own NICs.

Latest Update: NIC rates and criteria are adjusted on a yearly basis. The lower earning limit for 2024/25 is £533 per month. You can only make National Insurance deductions on earnings above this amount.

Income Tax for Savings and Investments

While your major source of income, whether from work or self-employment, is taxed, so are your savings and assets. Here's the breakdown:

Interest: Interest collected on savings accounts, bonds, and other assets is often taxed. However, there are tax-free savings accounts (ISAs) that enable you to earn interest while avoiding income tax.

Dividends: Dividends from stocks and other assets are subject to income tax. However, there is a dividend allowance that permits you to earn a certain amount of dividend income each year without paying taxes.

Capital Gains: If you sell an item (such as stocks or property) for a profit, you may be required to pay capital gains tax. There are several exclusions and reliefs available, such as Principal Private Residence Relief for earnings from the sale of your primary residence.

Latest update: The dividend allowed for the tax year 2024/25 is £500. This means you may receive dividends of up to £500 tax-free.

Taxation of Pensions

Pensions are normally taxed as income when the monies are withdrawn. However, there are various tax-efficient methods to save for retirement:

• Pension contributions: You may make contributions to qualifying pension plans using pre-tax income, which reduces your taxable income.

• Tax-free lump payment: When you retire, you may often take a tax-free lump amount from your pension. This lump amount is subject to certain limitations.

Latest update: For the 2024/25 tax year, you may contribute up to £60,000 to your pension while still receiving tax savings.

How to Pay Less Tax by Saving and Investing

There are various strategies to lower your income tax obligation by saving and investing:

Individual Savings Accounts (ISAs) allow you to earn income or capital gains without paying taxes. There are two sorts of ISAs: cash ISAs and stocks and shares ISAs.

• Increase your pension contributions to minimise your taxable income.
• Investing in Venture Capital Trusts (VCTs) might result in income tax breaks as well as possible capital gains tax advantages.
• Invest in Enterprise Investment Schemes (EIS)-backed enterprises to obtain income and capital gains tax breaks.

Note: The maximum amount you may invest in VCTs in one tax year is £200,000.

What’s the Difference Between Income Tax and National Insurance?

While both income tax and national insurance contributions are taken from your wages, they serve different functions.

Income tax funds public services such as education, healthcare, and social security. National insurance funds the NHS and other public services.

The particular rates and levels for income tax and NICs vary on a regular basis, so it is important to remain up to speed.

Final Words

While taxes are a bitter reality of life, an understanding of tax deductions and how to calculate your taxable income can minimise their impact. With the rise of digital platforms, tax filing has become more streamlined, reducing the hassle and simplifying the experience.

Income tax need not be another "grown-up" challenge that you push under the rug. The UK's tax system may seem complicated at first, but with a little bit of patience, you can start making sense of where your money goes. For professional assistance in paying taxes in the UK, contact us at Taxd!

FAQs

1. What is income tax?

Income tax is a government levy charged on individuals’ and businesses' income. It's one of the main sources of government revenue and is used to fund public services.

2. When do you start paying tax?

You start paying income tax when your income exceeds the basic personal allowance in the UK, which is £12,570.

3. Who is required to pay income tax?

Anyone earning an income above a certain threshold is required to pay income tax. This includes employees, self-employed individuals, businesses, trusts, and estates.

4. How does tax work in the UK?

Income tax is levied at graduated rates so that higher income categories are subject to higher income tax rates. Tax is applied to the entire income (from all sources of earned income as well as investments), less a few specific deductions and allowances.

5. What happens if I don't pay income tax?

If you don't pay income tax, you could face penalties like fines, interest on the unpaid tax, or possible legal action. It's crucial to file and pay your taxes on time.