Debitoor Dictionary

Accounting terms explained simply

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  1. National Insurance
  2. PAYE
  3. Personal allowance
  4. Self assessment
  5. Tax accounting

Income Tax – What is Income Tax?

Income Tax is a tax paid on the money you receive through employment, interest, running business, or benefits.

As a small business owner, Income Tax is just one of the taxes you might need to pay. Find out more about taxes for freelancers and entrepreneurs on our blog!

The money generated through Income Tax is usually spent on public services such as healthcare, public transport, the welfare system, and state education.

Which types of income are taxable?

Income isn’t just the money you earn through a job – it also applies to some state benefits, money you earn as a business owner, and certain types of interest. Not all types of income are taxable. Some of the things you do pay Income Tax on include:

  • Certain state benefits, such as the State Pension and Jobseeker’s Allowance
  • Salary or wages you earn through employment (including tips, bonuses, or benefits)
  • Profit you earn if you’re self-employed
  • Interest on savings that exceed your savings allowance.

Among other things, Income Tax isn’t applicable to:

  • Tax-exempt savings accounts, such as Individual Savings Accounts (ISAs) or National Savings Certificates
  • Winnings from premium bonds or the National Lottery
  • Certain state benefits, including Disability Living Allowance (DLA) and Universal Credit.

Income Tax across the UK

In the UK, the country you live in determines the rates you pay for Income Tax, as well as the authority you pay it to. In England, Wales, and Northern Ireland, Income Tax is collected by HMRC. If you live in Scotland, you will pay Scottish Income Tax to the Scottish Government.

As of April 6th 2019, anyone living in Wales will pay Welsh Income Tax to the Welsh Government. Until then, Welsh residents follow the same rules as anyone living in England and Northern Ireland.

The information below only applies to England, Wales, and Northern Ireland; the rates, thresholds, and regulations for Scottish Income Tax vary slightly from the rest of the UK. You can read more about this on the Scottish Government's website.

How much is Income Tax?

Income Tax is a progressive tax, which means that the rate increases as the taxable amount increases. In England, Wales, and Northern Ireland, Income Tax is usually charged at the following rates:

  • Up to £11,850: 0%
  • £11,851 to £46,350: 20%
  • £46,351 to £150,000: 40%
  • Over £150,000: 45%

Bear in mind that these are the standard rates, different bands may apply if you have a very high income.

Income Tax and tax-free allowances

Income Tax has several tax-free allowances, meaning that you can earn up to a certain amount of money before being taxed. The main tax-free allowance is the Personal Allowance. For the 2018-19 tax year, the standard Personal Allowance is £11,850; however, this may change if you earn over a certain amount.

There are several other allowances for different types of income, including:

  • Trading allowance: the first £1,000 of income generated through self-employment
  • Dividends allowance: the first £2,000 of dividends from company shares
  • Rent a Room Scheme: if you rent out a room in your house, the first £7,500 you recieve in rent is untaxed.

How to pay Income Tax

The most common way to pay Income Tax is through PAYE, which is the system used by employers and pension providers to take taxes from employees’ wages. However, individuals with complicated or high levels of income will need to pay Income Tax through Self Assessment.

If you were required to submit a Self Assessment tax return for the last tax year (2017-18), you must meet the following deadlines:

  • 5th October 2018: registering for Self Assessment
  • 31st October 2018: submitting a paper tax return
  • 31st January 2019: submitting an online tax return and paying the tax you owe.

Paying Income Tax as an employee

If you are an employee, Income Tax is usually deducted on your behalf through PAYE. However, the process of paying Income Tax is different for employees with high incomes. If you have an annual income of £100,000 or earn more than £2,500 in tips or bonuses, you will need to complete a Self Assessment tax return.

Paying Income Tax if you're self-employed

If you’re self-employed with income of more than £1,000, you will need to manage your own Income Tax through Self Assessment. If you have employees, you will also be responsible for managing their Income Tax through PAYE.

Income Tax in Australia

In Australia, both businesses and individuals pay income tax; however, there are different rates and thresholds for personal and company income tax.

For individuals, the rates you pay and the threshold at which you start paying depends on whether you are considered ‘a resident for tax purposes’. The Australian Taxation Office has a detailed list of individual income tax rates. Individual income tax rates apply to both sole traders and individuals who are employed by someone else.

For business registered as companies, income tax is paid at the company tax rate. The standard company tax rate is 30%, but companies that qualify as ‘base rate entities’ pay a reduced rate of 27.5%. In Australia, there is no threshold for company income tax, which means that company tax is charged on an business’s entire income (not including allowable deductions).