What Is Income Tax in the UK? Income Tax Rates and How They Work

This guide cuts through that fog. Whether you run a limited company, operate as a sole trader, or juggle multiple income streams, the aim here is to give you a clear, actionable understanding of income tax for the 2025/26 tax year – including the practical steps that can reduce what you pay.

How UK Income Tax Works

Income tax is a progressive tax on individual earnings. Rather than applying a single flat rate to everything you earn, the system stacks your income into bands, each taxed at a higher rate than the last. The first slice of income is tax-free (the Personal Allowance), and only income above that threshold enters the taxable bands.

The tax year runs from 6 April to 5 April the following year. The current year – 2025/26 – started on 6 April 2025 and ends on 5 April 2026.

HMRC collects income tax in two main ways. Employees and pensioners have it deducted automatically through PAYE (Pay As You Earn), while the self-employed and those with more complex affairs file a Self Assessment return. If you run a limited company and pay yourself a mix of salary and dividends, you'll likely deal with both systems.

Who pays income tax?

If you're a UK resident, you're generally liable on your worldwide income. Non-residents pay tax only on UK-source income (such as rental income from a UK property). Residency is determined by the Statutory Residence Test – a set of rules based on the number of days you spend in the UK and the connections you maintain here. The old domicile-based system was largely replaced from April 2025 by a new residence-based regime.

Even children with income above the Personal Allowance are technically liable, though in practice this rarely applies outside trust or investment income.

What counts as taxable income?

Most income falls within the tax net: employment earnings, self-employment profits, pension income (including the State Pension), rental income, savings interest, dividends, and certain state benefits.

Notable exceptions include ISA interest and growth, Premium Bond prizes, most gambling winnings, the first £1,000 of trading or property income (via the respective allowances), and some state benefits such as Universal Credit, Housing Benefit, and Disability Living Allowance.

Income Tax Rates and Bands for 2025/26

England, Wales, and Northern Ireland

These thresholds have been frozen since 2022/23 and will remain unchanged until at least April 2028 – with the freeze now extended to April 2031. As wages rise, more people are pulled into higher bands, a phenomenon known as fiscal drag.

Scottish income tax rates

Scotland sets its own income tax rates on non-savings, non-dividend income. The bands are more granular and, for higher earners, slightly steeper.

Scottish rates apply only to earnings and pension income. Savings and dividends are taxed at UK-wide rates regardless of where you live.

Dividend tax rates (2025/26)

The annual Dividend Allowance is £500 – a fraction of the £5,000 it was when introduced in 2016. Any dividends above this amount are taxed according to your overall income band.

⚠️ Incoming change: From April 2026, the basic and higher dividend tax rates will each rise by 2 percentage points (to 10.75% and 35.75% respectively). If you're a company director taking dividends, this is worth planning for now.

Savings income

Most people benefit from the Personal Savings Allowance (PSA), which lets basic-rate taxpayers earn up to £1,000 of savings interest tax-free and higher-rate taxpayers up to £500. Additional-rate taxpayers receive no PSA.

There's also a 0% starting rate for savings covering up to £5,000, but it only applies if your non-savings income is below £17,570. For many business owners earning above that threshold, the starting rate is irrelevant.

Allowances, Reliefs, and Tax-Free Amounts

Personal Allowance and the £100,000 taper

The standard Personal Allowance for 2025/26 is £12,570. However, for every £2 of adjusted net income above £100,000, the allowance reduces by £1. It disappears entirely at £125,140. This creates an effective marginal tax rate of 60% on income between £100,000 and £125,140 – a trap that catches many business owners off-guard.

One of the most effective responses is to increase pension contributions or use salary sacrifice to bring adjusted net income back below £100,000, restoring the full Personal Allowance.

Marriage Allowance

If one spouse or civil partner earns below the Personal Allowance and the other is a basic-rate taxpayer, the lower earner can transfer up to £1,260 of their unused allowance. That saves the couple up to £252 a year. Claims can be backdated up to four previous tax years, so a first-time claim in 2025/26 could be worth over £1,000 in total.

Other allowances at a glance

The Blind Person's Allowance adds £3,130 to the Personal Allowance for those registered as severely sight impaired. The Trading Allowance and Property Allowance each provide a £1,000 tax-free threshold for casual income from those sources. And Rent-a-Room relief lets you earn up to £7,500 a year tax-free from letting furnished accommodation in your own home – useful if you're supplementing business income.

Pension contributions and salary sacrifice

Pension contributions are one of the most powerful tax-planning tools available to small business owners. Contributions made to a registered pension scheme attract tax relief at your marginal rate, and employer contributions are deductible against Corporation Tax for limited companies.

Salary sacrifice arrangements – where an employee agrees to a lower salary in exchange for the employer contributing the difference into a pension – reduce both income tax and National Insurance liabilities. For a director earning between £100,000 and £125,140, this approach can simultaneously restore the Personal Allowance, reduce Employer NICs, and build a pension pot.

Gift Aid

When you donate to charity through Gift Aid, the charity claims back basic-rate tax (adding 25p to every £1 you give). If you're a higher or additional-rate taxpayer, you can claim the difference between your marginal rate and the basic rate through Self Assessment. That makes a £1,000 donation cost a 40% taxpayer just £600 in real terms.

Business expenses

Self-employed individuals can deduct allowable expenses from their profits – things like office costs, travel, stock, professional fees, and a proportion of home-running costs. Employees can claim for certain unreimbursed expenses too, including flat-rate amounts for uniform maintenance and professional subscriptions.

How Income Tax Is Calculated: Step by Step

The ordering rules matter. HMRC treats different types of income as occupying different "slices" of your tax bands. Non-savings income (earnings, pensions, rental profits) fills the bands first. Savings income sits on top. Dividends sit at the very top.

Worked example: employee with savings interest

Imagine you earn £45,000 from employment and receive £1,200 in savings interest.

1. Deduct the Personal Allowance (£12,570) from earnings, leaving £32,430 of taxable employment income – all within the basic-rate band.
2. The £1,200 savings interest sits on top. Of that, £1,000 is covered by the basic-rate PSA. The remaining £200 is taxed at 20%.
3. Total income tax: £32,430 × 20% = £6,486, plus £200 × 20% = £40. Grand total: £6,526.

Worked example: company director with salary and dividends

A common arrangement for owner-directors is to take a salary of £12,570 (covered entirely by the Personal Allowance, so no income tax due) and draw £40,000 in dividends on top.

1. The first £500 of dividends falls within the Dividend Allowance – tax-free.
2. The remaining £39,500 of dividends falls within the basic-rate band (since £12,570 + £40,000 = £52,570, of which only £2,300 spills above the £50,270 higher-rate threshold).
3. Tax on £37,200 at 8.75% = £3,255. Tax on £2,300 at 33.75% = £776.
4. Total income tax: £4,031.

This is considerably less than the income tax on a £52,570 salary – one reason the salary-plus-dividends model remains popular, though rising Employer NICs and the 2026 dividend rate increases are narrowing the gap.

Worked example: the £100,000 taper

A sole trader earning £110,000 loses £5,000 of their Personal Allowance (half of the £10,000 excess above £100,000). On that £5,000 slice, they effectively pay 40% income tax plus lose the 0% allowance – a combined marginal rate of 60%. A £10,000 pension contribution would bring adjusted income back to £100,000, restoring the full allowance and saving around £6,000 in tax.

PAYE, Tax Codes, and Benefits in Kind

Understanding your tax code

Your tax code tells your employer how much tax-free income to apply before deducting tax. The most common code – 1257L – reflects the standard £12,570 Personal Allowance. Letters at the end indicate adjustments: "L" for standard allowance, "BR" for basic rate on all income (used for second jobs), "K" for negative allowance (where benefits in kind or unpaid tax reduce your tax-free amount below zero), and "0T" when there's no allowance at all.

If your code looks wrong, you can check and update it through your Personal Tax Account on GOV.UK or by calling HMRC. An incorrect code can mean months of over- or underpayment.

Benefits in kind

Company cars, private medical insurance, gym memberships, and other non-cash perks provided by an employer are known as benefits in kind. These are valued according to HMRC rules and taxed either through your tax code (if "payrolled") or reported separately on a P11D form after the tax year ends. As an employer, you'll also pay Class 1A NICs at 15% on the taxable value of any benefits you provide.

Year-end reconciliation and P800s

After the tax year ends, HMRC checks whether each PAYE taxpayer has paid the right amount. If there's a discrepancy, you'll receive a P800 letter explaining whether you've overpaid (and are due a refund) or underpaid (and owe more). Refunds can be claimed online through your Personal Tax Account, and underpayments are typically collected by adjusting next year's tax code.

Self Assessment: Who Files, When, and How

Who must file?

You'll need to register for Self Assessment if you're self-employed, a company director receiving dividends, a landlord with rental income above £1,000, a higher earner claiming Child Benefit, or if you have significant savings or investment income exceeding your allowances. Foreign income and capital gains can also trigger a filing requirement.

Key dates and penalties

Late filing incurs an automatic £100 penalty, rising to daily penalties after three months and potentially more after six and twelve months. Late payment attracts interest (currently above 7%) and additional surcharges.

Payments on account

If your Self Assessment tax bill exceeds £1,000 and less than 80% of your tax is collected at source, HMRC will ask you to make payments on account – two advance instalments, each equal to half of last year's bill, due on 31 January and 31 July. A balancing payment (or refund) follows once the actual liability is known.

If you expect your income to be significantly lower this year, you can apply to reduce your payments on account – but undershoot it and you'll pay interest on the shortfall.

Record-keeping

Self-employed individuals must keep records of all income and expenses for at least five years from the 31 January filing deadline. HMRC doesn't prescribe a format, but digital records – whether a simple spreadsheet or dedicated accounting software – are increasingly expected, especially as Making Tax Digital for income tax approaches.

National Insurance vs Income Tax

National Insurance contributions (NICs) and income tax are separate charges that serve different purposes, though they both appear on your payslip and are collected by HMRC. Income tax funds general public spending. NICs contribute towards specific benefits: the State Pension, Statutory Sick Pay, Maternity Pay, and the like.

⚠️ Key change for 2025/26: Employer NICs rose from 13.8% to 15%, and the secondary threshold (the point at which employers start paying) dropped from £9,100 to £5,000 per year. This is a significant cost increase for businesses – though the Employment Allowance has doubled to £10,500 to offset some of the impact for smaller firms.

Current NIC classes at a glance

One critical distinction: employees stop paying Class 1 NICs when they reach State Pension age, but they keep paying income tax on all earnings regardless. Self-employed individuals below the Small Profits Threshold (£6,845) don't need to pay Class 2, but can do so voluntarily to protect their State Pension record.

Types of Income Subject to UK Tax

Employment and pension income is collected through PAYE. All salary, wages, bonuses, and most pension payments are taxable – including the State Pension, which catches many retirees by surprise since no tax is deducted at source.

Self-employment and partnership profits are taxed via Self Assessment. You calculate your taxable profit by deducting allowable business expenses from your turnover. Class 4 NICs apply on top.

Rental and property income is taxable after deducting allowable expenses such as insurance, repairs, letting agent fees, and (for residential properties) a 20% tax credit on mortgage interest. Gross rental income below £1,000 is tax-free under the property allowance.

Savings interest from bank and building society accounts is taxable, though most taxpayers are shielded by the PSA and 0% starting rate. Banks no longer deduct tax at source.

Dividends are taxed after the £500 Dividend Allowance at the rates set out above. This applies to both UK and foreign dividends, though foreign dividends may also attract overseas withholding tax (potentially offset by double taxation relief).

State benefits vary. The State Pension, Carer's Allowance, and Jobseeker's Allowance are taxable. Universal Credit, Disability Living Allowance, and Personal Independence Payment are not.

Residency, Working Abroad, and Double Taxation

If you trade internationally or have staff working overseas, residency rules become relevant. The Statutory Residence Test uses a combination of day-counting and "connection factors" to determine your tax residence. Split-year treatment may apply if you arrive in or leave the UK part-way through a tax year, limiting your UK tax liability to the portion of the year you were resident.

Non-residents remain liable to UK income tax on UK-source income – most commonly rental income and certain pension payments.

The UK has a wide network of Double Taxation Agreements (DTAs) with other countries. Where income is taxed in both jurisdictions, you can usually claim foreign tax credit relief to avoid being taxed twice.

How to Check, Estimate, and Reclaim

HMRC provides a free online tax checker and income tax calculator at GOV.UK. These are useful for estimating your liability, but they can't account for every nuance. For anything complex, consider a reputable independent calculator or professional advice.

If you've overpaid tax – whether through an incorrect tax code, a gap in employment, or an unexpected change in income – you can claim a refund through your Personal Tax Account, by writing to HMRC, or via the R38 repayment form. HMRC sometimes issues refunds automatically after a P800 review.

If you're struggling to pay a tax bill, contact HMRC as early as possible. The "Time to Pay" arrangement allows you to spread payments over up to 12 months. Free debt advice is also available from organisations like StepChange and Citizens Advice.

What to Watch This Year

Frozen thresholds and fiscal drag

The ongoing freeze of income tax thresholds means that even modest wage growth pushes more of your income into higher bands. By 2030/31, the government estimates that the freeze will bring an additional 5.2 million people into income tax and 4.8 million more into the higher rate compared to indexed thresholds.

For small business owners, this means your own tax bill – and your employees' expectations around take-home pay – will be affected even without any headline rate change.

Upcoming rate changes

From April 2026, the basic and higher rates of dividend tax will each rise by 2 percentage points. From April 2027, new higher rates will apply to savings income (up 2 percentage points) and property income will be taxed at its own separate rates (22% basic, 42% higher, 47% additional). These changes deserve forward planning, especially for landlords and company directors who rely heavily on dividend income.

Scottish developments

Scotland's starter and basic rate bands were widened for 2025/26, raising the thresholds before the intermediate rate kicks in. The higher, advanced, and top rate thresholds remain frozen. Business owners operating across the border should note that Scottish rates apply based on the employee's residence, not the employer's location.

Key Forms, Codes, and Documents

P60 – Annual summary of pay and tax deducted, issued by your employer after the tax year ends. Check it matches your records.

P45 – Issued when you leave a job. Contains your tax code and year-to-date earnings; hand it to your new employer to avoid emergency tax.

P11D – Reports benefits in kind and expenses not payrolled. Employers submit it to HMRC by 6 July; employees see the values reflected in their tax code.

P2 (Coding Notice) – HMRC's notification of your tax code for the coming year. Read it carefully – errors here propagate through the entire year.

SA100 – The main Self Assessment tax return. File online or on paper.

SA302 – Tax calculation summary, often requested by mortgage lenders as proof of income.

UTR (Unique Taxpayer Reference) – Your 10-digit identifier for Self Assessment. Keep it safe; you'll need it every time you deal with HMRC.

Common Mistakes to Avoid

Ignoring your coding notice. A wrong tax code can cost you hundreds or thousands of pounds across a full year. Check every P2 notice you receive.

Missing Self Assessment deadlines. The £100 late filing penalty arrives the day after the 31 January deadline, even if you owe nothing. Set calendar reminders well in advance.

Confusing National Insurance with income tax. They are separate charges with separate thresholds. A common error is assuming that because you've paid NI, you've covered your income tax obligations.

Failing to claim the Marriage Allowance. Millions of eligible couples don't claim it. If one of you earns below £12,570 and the other is a basic-rate taxpayer, you're leaving money on the table.

Overlooking pension contributions as a tax tool. Particularly in the £100,000 – £125,140 income range, pension contributions can dramatically reduce your effective tax rate.

Not adjusting payments on account. If your income has dropped, you can reduce these advance payments – but many business owners forget and only discover the overpayment months later.

FAQ

Do I pay income tax on crypto staking or airdrops?

Generally, yes. HMRC treats income from crypto staking, mining, and airdrops as taxable – either as trading income or miscellaneous income, depending on the scale and nature of the activity. You'll need to report it through Self Assessment. Capital gains tax applies separately when you dispose of crypto assets.

How does the High Income Child Benefit Charge work?

If either parent in a household earning Child Benefit has income above £60,000, a tax charge claws back 1% of the benefit for every £200 of income above that threshold. At £80,000, the benefit is fully repaid through tax. You can opt out of receiving the payments, but it may be worth continuing to claim for National Insurance credit purposes.

How are redundancy payments taxed?

The first £30,000 of a genuine redundancy or termination payment is tax-free. Anything above that is taxed as earnings. Payments for notice pay, holiday pay, and contractual benefits don't qualify for the exemption and are taxed in full.

If I have two jobs, how is my tax split?

HMRC assigns a tax code to each employment. Normally, your full Personal Allowance is applied to your main job, and your second job is taxed at basic rate on all earnings (code BR). If you'd prefer to split the allowance, you can ask HMRC to do so. Getting this wrong can lead to surprise bills at year end.

Are ISA interest and Premium Bond prizes taxable?

No. ISA returns and Premium Bond prizes are entirely tax-free and don't count towards your income for any tax purpose, including band calculations and the Personal Allowance taper.

Sources and Where to Get Help

HMRC: gov.uk/income-tax for rates, guidance, and your Personal Tax Account. HMRC's helpline for general enquiries: 0300 200 3300.

MoneyHelper (formerly the Money and Pensions Service) provides free, impartial guidance on tax and financial planning.

TaxAid and Tax Help for Older People offer free tax advice to those on lower incomes.

For anything beyond the straightforward – international income, complex business structures, or tax disputes – consider engaging a chartered accountant or chartered tax adviser. The cost of getting it right is almost always less than the cost of getting it wrong.

This article reflects UK income tax rules for the 2025/26 tax year. Tax legislation changes regularly; always verify current rates and thresholds before making financial decisions.