Understanding income tax is essential for anyone earning or managing money in the UK, whether as an individual, sole trader, or business owner. The UK’s income tax system is broad and complex, with various rules, rates, and reliefs depending on how income is earned and who is receiving it.
This comprehensive guide provides a clear and up-to-date overview of how income tax works in the UK, in line with current tax law and accountancy standards. We cover everything from how income tax is calculated, what rates apply, and who is required to pay, through to tax planning tips and recent legislative changes.
Section A: What is Income Tax?
Income tax is a tax levied by the UK government on the earnings of individuals and some business structures. It applies to income derived from employment, self-employment, pensions, property, savings, dividends, and other sources.
The purpose of income tax is to fund public services such as the NHS, education, social care, and infrastructure. It is collected either through PAYE (Pay As You Earn) or Self Assessment, depending on the type of income.
Rates and thresholds are reviewed annually by the government and may vary across the UK. Scotland and Wales apply separate bands and rates on certain forms of income under devolved powers.
Section B: Who Pays Income Tax in the UK?
You may be liable for income tax in the UK if you fall under any of the following categories:
- You are employed and earn over the personal allowance.
- You are self-employed or in a business partnership.
- You earn rental income from UK property.
- You receive pension income, dividends, or interest over allowance limits.
- You are a company director drawing salary or dividends.
While limited companies pay corporation tax, individuals involved in companies must pay income tax on the amounts they receive personally.
If you are a non-resident, you may still need to pay tax on UK-sourced income. This is governed by the Statutory Residence Test and relevant double taxation treaties.
Section C: When Do You Pay Income Tax?
In the UK, you are liable to pay income tax when your taxable income exceeds the personal allowance set by HMRC for the relevant tax year. The type of income you receive determines how and when the tax is paid — whether it’s deducted automatically via PAYE, or paid directly through Self Assessment.
Below, we outline the main types of income that can attract income tax and how tax is applied in each case.
1. Employment Income
If you are employed, your employer will usually deduct income tax from your salary through the Pay As You Earn (PAYE) system. This means tax is taken at source before you receive your wages.
You pay income tax on:
- Your wages or salary (after deducting your personal allowance)
- Bonuses, commissions, and tips
- Company benefits such as private medical insurance or a company car (these are known as “benefits in kind”)
Your tax code determines how much tax is deducted and reflects your entitlement to allowances and any deductions due to other income sources or unpaid tax.
2. Self-Employment
If you are self-employed, either as a sole trader or a partner in a business partnership, you are responsible for calculating and paying your own income tax through Self Assessment.
You pay income tax on your net business profits (gross income minus allowable business expenses). The tax year runs from 6 April to 5 April the following year, and you must:
- Register with HMRC
- Submit an annual Self Assessment tax return
- Pay any tax due by 31 January following the end of the tax year
Self-employed individuals may also be liable for Class 2 and Class 4 National Insurance contributions.
3. Property and Rental Income
If you receive income from letting out property, you may need to pay income tax on your rental profits.
You are taxed on:
- Rental income from residential, commercial or furnished holiday lettings
- Income from renting out a room in your own home (unless fully covered by the Rent-a-Room Scheme)
You can deduct allowable expenses such as:
- Letting agent fees
- Mortgage interest (restricted to 20% basic rate credit)
- Repairs and maintenance
- Council tax, insurance, and utility bills (if paid by the landlord)
Rental income is usually declared through Self Assessment, unless it’s minor and covered under specific exemptions.
4. Dividends and Savings Interest
Dividends: If you receive dividends from UK or overseas companies, you may be liable for dividend tax once your dividend income exceeds the dividend allowance (£500 for 2025/26).
Dividend tax rates depend on your income tax band:
- Basic rate: 8.75%
- Higher rate: 33.75%
- Additional rate: 39.35%
Dividends received within an ISA (Individual Savings Account) are tax-free.
Savings Interest: Interest from savings accounts is also subject to income tax, although most taxpayers benefit from the Personal Savings Allowance (PSA):
- £1,000 for basic rate taxpayers
- £500 for higher rate taxpayers
- £0 for additional rate taxpayers
Interest income is now usually paid gross (without tax deducted at source), and any tax owed must be declared via Self Assessment unless HMRC adjusts your tax code.
Section D: Income Tax Rates & Bands (2025/26)
Every UK taxpayer has a personal allowance — £12,570 for 2025/26 — below which no income tax is due. Once this threshold is exceeded, income is taxed progressively via marginal tax bands. These bands determine how much tax is charged at each level of income, meaning only the portion of income within each band is taxed at that band’s rate.
1. England, Wales & Northern Ireland
For taxpayers in England, Wales or Northern Ireland, the tax bands for 2025/26 are:
- Personal Allowance: £0 to £12,570 → 0%
- Basic Rate: £12,571 to £50,270 → 20%
- Higher Rate: £50,271 to £125,140 → 40%
- Additional Rate: Over £125,140 → 45%
Note: The personal allowance is tapered once income exceeds £100,000 — reducing by £1 for every £2 earned over the threshold — resulting in an effective 60% tax rate on that portion of income.
2. Scotland (Six Bands)
Scottish taxpayers follow a more granular structure, as Scotland uses six bands for 2025/26:
- Starter Rate: £12,571 to £15,397 → 19%
- Scottish Basic Rate: £15,398 to £27,491 → 20%
- Intermediate Rate: £27,492 to £43,662 → 21%
- Higher Rate: £43,663 to £75,000 → 42%
- Advanced Rate: £75,001 to £125,140 → 45%
- Top Rate: Over £125,140 → 48%
Note: The Scottish Government confirmed no changes to rates in 2025/26, though lower thresholds were slightly uprated for inflation.
3. Wales
Wales uses the same income tax rates and bands as England and Northern Ireland for 2025/26. However, these rates are technically split under the Welsh Rates of Income Tax (WRIT):
- 10p in the pound is paid to the Welsh Government
- The balance of the rate is paid to the UK Government
The total rates remain unchanged from those in England and Northern Ireland.
4. Summary Table of Tax Bands by Region
| Region | Band | Income (£) | Rate |
|---|---|---|---|
| England, Wales, NI | Personal Allowance | 0–£12,570 | 0% |
| Basic Rate | £12,571–£50,270 | 20% | |
| Higher Rate | £50,271–£125,140 | 40% | |
| Additional Rate | £125,140+ | 45% | |
| Scotland | Starter Rate | £12,571–£15,397 | 19% |
| Scottish Basic Rate | £15,398–£27,491 | 20% | |
| Intermediate Rate | £27,492–£43,662 | 21% | |
| Higher Rate | £43,663–£75,000 | 42% | |
| Advanced Rate | £75,001–£125,140 | 45% | |
| Top Rate | Above £125,140 | 48% |
Understanding which income tax rates apply is critical to accurate tax planning and determining the best way to structure your income across tax years, regions, and available allowances.
Section E: Personal Allowance and Tax-Free Income
UK taxpayers benefit from a number of tax-free thresholds and allowances, which reduce the amount of income subject to tax. Understanding and maximising these allowances is central to effective income tax planning.
1. Standard Personal Allowance
The standard Personal Allowance for 2025/26 is £12,570. This is the amount of income an individual can earn before any income tax is payable. It applies to most people under the age of 75 who have income below £100,000.
2. Reductions for High Earners
For individuals earning over £100,000, the Personal Allowance is reduced by £1 for every £2 earned over this threshold. This means that once income exceeds £125,140, the Personal Allowance is entirely withdrawn — creating an effective marginal tax rate of 60% within that taper zone.
3. Blind Person’s Allowance
If you are registered blind or severely sight impaired, you may claim the Blind Person’s Allowance. For 2025/26, this provides an additional £3,070 in tax-free income. This allowance is added to your standard Personal Allowance and can be transferred to your spouse or civil partner if unused.
4. Marriage Allowance
Marriage Allowance allows one spouse or civil partner (who earns below the Personal Allowance) to transfer up to £1,260 of their unused allowance to the other partner, provided the recipient is a basic rate taxpayer. This can reduce the couple’s overall tax liability by up to £252 a year.
This differs from the Married Couple’s Allowance, which only applies where one partner was born before 6 April 1935.
Section F: How to Pay Income Tax
How you pay income tax in the UK depends on your employment status and the type of income you receive. Most employees have tax deducted at source through the PAYE system, while self-employed individuals and those with untaxed income must declare and pay via Self Assessment.
1. PAYE (Pay As You Earn)
PAYE is the system used by HMRC to collect income tax and National Insurance contributions from employees’ wages or pensions before they are paid. Employers are responsible for calculating and deducting tax based on each employee’s tax code and submitting it to HMRC.
Your tax code reflects your Personal Allowance and any adjustments for other taxable income or deductions. If you’re on the wrong tax code, you may overpay or underpay tax, so it’s important to check and correct your tax code if needed.
2. Self Assessment
If you receive income not taxed at source — such as from self-employment, rental property, investments, or certain pensions — you may need to file a Self Assessment tax return each year.
You must register for Self Assessment if:
- Your self-employment income exceeds £1,000 (trading allowance)
- You receive more than £10,000 from dividends or savings interest
- You receive income from property above the £1,000 property allowance
- You are a partner in a business partnership
- You earn more than £100,000 annually (regardless of source)
Tax returns are usually due by 31 January following the end of the tax year (which runs 6 April to 5 April). Payment of any tax due must also be made by this deadline.
3. Deadlines and Penalties
Missing filing and payment deadlines can result in automatic penalties:
- Late filing: £100 penalty for returns up to 3 months late, with additional daily penalties thereafter
- Late payment: Interest charged from the due date plus 5% penalty after 30 days, and further penalties at 6 and 12 months
It’s important to keep digital or physical records of all taxable income and deductible expenses for at least five years after the 31 January filing deadline. These may be required if HMRC reviews your return or conducts a compliance check.
Section G: Income Tax for UK Businesses
UK businesses are taxed differently depending on their legal structure. Sole traders and partnerships pay income tax on profits through Self Assessment. Limited companies pay Corporation Tax, but directors and shareholders are liable for income tax on money they withdraw via salaries or dividends. Understanding the tax treatment of business income is key to ensuring compliance and making use of legitimate deductions and reliefs.
1. Sole Traders and Partnerships
Sole traders and partners pay income tax on their share of net business profits, not turnover. Profits must be reported annually through Self Assessment. In addition to income tax, Class 2 and Class 4 National Insurance Contributions (NICs) apply:
- Class 2 NICs: Flat rate (£3.45 per week for 2025/26)
- Class 4 NICs: 9% on profits between £12,570 and £50,270, and 2% on profits above that
Business owners can reduce their tax liability by claiming allowable expenses such as rent, utilities, and travel costs. Maintaining good records is critical.
2. Limited Companies
Limited companies pay Corporation Tax on profits (currently 25% for most companies). Directors and shareholders must also consider income tax on earnings they take from the company:
- Salaries: Paid via PAYE, subject to income tax and Class 1 NICs
- Dividends: Taxed at 8.75% (basic), 33.75% (higher), or 39.35% (additional rate) after the £500 allowance
Many directors take a small salary to benefit from NICs credits and extract additional profits through dividends. Dividends must be paid from distributable reserves and recorded in board minutes.
3. Business Expenses and Tax Relief
Allowable expenses reduce taxable profits and must be wholly and exclusively for business purposes. Common examples include:
- Office rent, equipment, and supplies
- Staff salaries and subcontractor fees
- Travel and subsistence
- Professional fees (e.g. accountants)
Capital allowances are available for major purchases such as vehicles and machinery. The Annual Investment Allowance (AIA) lets businesses deduct up to £1 million of qualifying expenditure in full.
Where personal assets are used for business (e.g. home or car), you may claim a proportion of the expenses or use HMRC’s simplified rates. Accurate record-keeping is essential to support any claims.
Section H: Income Tax and Pensions
Pensions offer both a means to save for retirement and a valuable source of tax relief. UK taxpayers can claim tax relief on contributions made to registered pension schemes, while withdrawals are taxed depending on the type and amount taken.
1. Tax Relief on Pension Contributions
Contributions to pensions are eligible for tax relief up to certain limits. For most people, tax relief is available at their marginal rate of income tax — 20%, 40%, or 45%. There are two ways tax relief can be applied:
- Relief at source: Pension provider claims basic rate relief on your behalf, and higher-rate taxpayers claim additional relief via Self Assessment.
- Net pay arrangements: Contributions are deducted from your salary before tax, providing immediate relief.
2. Annual and Lifetime Limits
The Annual Allowance limits the total contributions that can receive tax relief each tax year. For 2025/26, this is £60,000 or 100% of earnings (whichever is lower). If contributions exceed this, a tax charge may apply. Unused allowances from the previous three years can be carried forward.
The Lifetime Allowance, which previously limited the total value of pension savings without incurring additional tax charges, was abolished from April 2024. However, other limits may still apply to lump sum withdrawals and total tax-free cash.
3. Tax Treatment of Pension Withdrawals
From age 55 (rising to 57 from 2028), individuals can begin to access their pension. The first 25% of most pension pots can usually be withdrawn tax-free, while the remaining 75% is taxed as income.
Options for accessing pensions include:
- Lump sum withdrawals
- Drawdown (flexible access over time)
- Purchasing an annuity (guaranteed income)
These withdrawals are added to your income and taxed according to the relevant band, so careful planning can help manage tax liability across multiple tax years.
Section I: Income Tax on Investments and Savings
Investments and savings generate income that may be subject to income tax. Understanding the tax treatment of ISAs, dividends, interest, and capital gains ensures that individuals can plan tax-efficiently and avoid unnecessary liabilities.
1. ISAs (Individual Savings Accounts)
Income and capital gains from ISAs are entirely tax-free. There are several types of ISA:
- Cash ISAs: Tax-free interest
- Stocks & Shares ISAs: Tax-free dividends and capital gains
- Innovative Finance ISAs: Tax-free peer-to-peer lending returns
- Lifetime ISAs (LISA): For first-time homebuyers and retirement
The total ISA allowance for 2025/26 is £20,000, which can be split across different ISA types.
2. Dividends
Dividends received from shares are taxed once they exceed the £500 dividend allowance (2025/26). Tax rates on dividends are lower than on other income:
- Basic rate: 8.75%
- Higher rate: 33.75%
- Additional rate: 39.35%
Dividends received within an ISA are not taxable. Outside ISAs, they must be declared via Self Assessment if they exceed the allowance.
3. Interest Income
Interest earned from savings accounts, bonds, or gilts is generally taxable. However, most people benefit from the Personal Savings Allowance (PSA):
- Basic rate taxpayers: £1,000
- Higher rate taxpayers: £500
- Additional rate taxpayers: £0
Interest income above the PSA is taxed at your marginal income tax rate (20%, 40%, or 45%).
4. Capital Gains vs Income Tax
Income tax and Capital Gains Tax (CGT) apply to different types of income:
- Income tax: Applies to wages, interest, dividends, and rental income
- CGT: Applies to gains from selling assets such as shares, property, and valuables
For 2025/26, the CGT annual exempt amount is £3,000. Any gains above this threshold are subject to CGT at 10% (basic rate) or 20% (higher/additional rate), or 18%/24% for residential property.
Knowing the distinction helps investors allocate assets and realise gains or income in a tax-efficient manner.
Section J: Filing, Payments & Compliance
Managing your income tax obligations involves not just calculating what’s owed, but also filing correctly and on time. HMRC offers tools to support this, but failing to comply can lead to penalties and unnecessary stress.
1. Self Assessment Deadlines
If you are required to complete a Self Assessment tax return, the deadlines are:
- Register for Self Assessment: By 5 October after the end of the tax year
- Paper tax return: By 31 October
- Online tax return: By 31 January
- Tax payment due: By 31 January (and 31 July if payments on account apply)
Missing these deadlines triggers automatic penalties, regardless of whether tax is owed.
2. HMRC Tools and Online Services
HMRC’s online services portal allows taxpayers to:
- Register for Self Assessment
- View and update tax codes
- Submit tax returns
- Make payments
- Communicate securely with HMRC
HMRC’s app and online calculators can help estimate your tax liabilities, check PAYE codes, and track deadlines.
3. Common Mistakes to Avoid
Some common errors made by taxpayers include:
- Using the wrong tax code
- Forgetting to include all sources of income
- Missing deadlines
- Claiming non-allowable expenses
These mistakes can lead to penalties or overpayments, which can often be avoided with simple checks or professional help.
4. Record-Keeping Requirements
Self-employed individuals and landlords must keep financial records for at least five years after the 31 January filing deadline. Employees should keep payslips, P60s, and P45s for at least 22 months after the end of the tax year.
Digital record-keeping is increasingly encouraged, especially under HMRC’s Making Tax Digital (MTD) programme. It’s essential to store accurate receipts, invoices, and bank records to substantiate any claims or deductions.
Section K: Income Tax Planning Tips
Effective tax planning can reduce your overall tax liability, ensure you use all available allowances, and help you structure your finances more efficiently. Below are key strategies for individuals and families looking to optimise their tax position.
1. Efficient Use of Allowances
Make full use of your tax-free allowances each year. These include:
- Personal Allowance: £12,570 of income is tax-free (unless reduced for high earners)
- Dividend Allowance: £500 of dividend income tax-free
- Personal Savings Allowance: Up to £1,000 tax-free interest for basic rate taxpayers
- Capital Gains Tax Allowance: £3,000 tax-free gains (2025/26)
- ISA Allowance: £20,000 tax-free savings or investments
Strategic use of these allowances — for instance, by holding income-producing investments inside ISAs — can reduce your overall tax bill.
2. Tax Planning for Couples and Families
Married couples and civil partners can benefit from income splitting and allowances:
- Marriage Allowance: Transfer £1,260 of unused Personal Allowance to a basic rate spouse/partner
- Hold income-producing assets in the name of the lower-earning spouse to reduce tax
- Utilise each spouse’s dividend and savings allowances
Families may also benefit from using Junior ISAs or pensions for children, which grow tax-free over time.
3. Working with an Accountant or Adviser
For complex income situations, changes in business structure, or significant investment or pension decisions, a qualified tax adviser or accountant can:
- Ensure compliance and accurate reporting
- Identify deductions, reliefs, and planning opportunities
- Assist with HMRC correspondence or disputes
- Provide advice on long-term planning strategies, including inheritance tax and retirement
Their insight can help reduce costly errors and ensure you’re making the most of your tax position each year.
Section L: Recent and Upcoming Tax Changes
Introductory Overview: As of mid‑2025, headline income tax rates remain unchanged—but tax burdens are rising due to threshold freezes, higher employer NICs, and CGT reform. New headlines may emerge in the Autumn Budget 2025.
1. Fiscal Drag & Threshold Freezes
Both the Personal Allowance (£12,570) and the higher-rate threshold (£50,270) remain frozen until April 2028, even as earnings rise. This policy has pushed over 7 million taxpayers into higher-rate bands and is expected to continue raising revenue through “fiscal drag” rather than formal rate increases.
2. Budget 2024 & Spring Statement 2025 Measures
- From April 2025, employers’ National Insurance contributions rise to 15% with a lowered secondary threshold (£5,000)
- Capital Gains Tax rates were increased to 18% and 24% from 30 October 2024; carried interest is set to be taxed as income (with interim CGT at 32%) from April 2026
- The remittance basis for non-dom individuals ended in April 2025, replaced by a residence-based regime
3. Future Tax Policy Developments
The Autumn Budget 2025 is expected between late October and early November. While Chancellor Reeves has ruled out increases to headline rates, key areas under consultation include:
- Further freezing of thresholds beyond 2028—potentially raising £8–9 billion annually via fiscal drag
- Reforms to ISA limits and pension tax reliefs, especially affecting higher earners.
- Potential introduction of a targeted wealth tax, along with inheritance tax reform on agricultural estates exceeding £1 million from April 2026
Significant welfare policy reversals have created a £10 billion fiscal hole, increasing pressure on future budgets. Analysts anticipate measures may include threshold freezes, pension or ISA relief changes, or new levies on wealth or gambling.
Conclusion
Although core income tax rates remain unchanged for the 2025/26 tax year, the cumulative effect of frozen thresholds, rising National Insurance costs, and Capital Gains Tax reforms is placing heavier burdens on many taxpayers. The forthcoming Autumn Budget may introduce new measures targeting higher earners or asset-rich individuals, including possible tax relief reductions or wealth regimes. Proactive planning remains key—staying informed, using allowances wisely, and seeking professional advice can help mitigate future tax exposure.
Glossary of Income Tax Terms
Term | Definition |
|---|---|
PAYE | Pay As You Earn — HMRC’s system for collecting income tax and NICs from employees via payroll. |
Self Assessment | System used by individuals to report income and pay tax directly to HMRC, typically for self-employed or non-PAYE income. |
Personal Allowance | The amount of income you can earn each tax year without paying income tax (£12,570 for 2025/26). |
Dividend Allowance | The tax-free amount you can receive in dividends before paying dividend tax (£500 for 2025/26). |
Personal Savings Allowance | The amount of interest you can earn tax-free on savings — £1,000 for basic rate, £500 for higher rate taxpayers. |
Basic Rate Taxpayer | Someone whose taxable income falls within the 20% tax band (up to £50,270 for 2025/26). |
Higher Rate Taxpayer | Someone whose income falls in the 40% band (£50,271 to £125,140). |
Additional Rate Taxpayer | Individuals with taxable income over £125,140, taxed at 45%. |
Capital Gains Tax (CGT) | A tax on the profit made when selling certain assets (e.g. property, shares), separate from income tax. |
Blind Person’s Allowance | An additional tax-free allowance (£3,070 in 2025/26) for people who are registered blind or severely sight-impaired. |
Marriage Allowance | Allows a non-taxpaying spouse to transfer £1,260 of unused Personal Allowance to their partner. |
Annual Allowance (Pension) | The maximum amount that can be contributed to pensions with tax relief in a tax year (£60,000 for most people in 2025/26). |
HMRC | His Majesty’s Revenue & Customs — the UK government body responsible for tax collection and enforcement. |
Tax Code | A code issued by HMRC to employers or pension providers to determine how much tax to deduct via PAYE. |
Making Tax Digital (MTD) | A government initiative requiring digital tax records and online submissions, being rolled out to income tax from 2026. |
Fiscal Drag | A situation where frozen tax thresholds cause more people to pay more tax as wages rise with inflation. |
Authoritative Sources & References (2025/26)
Topic | Source / Link |
|---|---|
HMRC official tax guidance | |
PAYE explained | |
Self Assessment overview | |
Income tax rates & bands | |
Dividend tax rules | |
Savings income & PSA | |
Capital Gains Tax | |
Personal Allowance rules | |
Marriage Allowance | |
Blind Person’s Allowance | |
HMRC digital services | |
Pension annual and lifetime limits | |
Rent-a-Room Scheme | |
Record-keeping rules | |
Making Tax Digital (MTD) | |
Budget and Spring Statement 2025 | |
HMRC compliance and investigations |
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services Limited - a Marketing & Content Agency for the Professional Services Sector.
