What is income tax?

What exactly is income tax?

The easiest way to explain income tax is this: it’s the tax paid on your personal income.

A huge range of incomes are liable for income tax – here are a few examples:

• Employment income
• Self-employment income
• Rental or Property income
• Investment income – such as dividends
• Certain state benefits – Employment and Support Allowance, Jobseekers Allowance for example
• Income from trusts and/or estates

For most of us, income tax is deducted at source. That means that it’s handed straight from the paying authority (that’s usually your employer) to HMRC without ever reaching you. However, if you’re self-employed income tax isn’t deducted at source – you have to assess how much income tax you owe and it’s then up to you to pay it to HMRC.

Taxable vs non-taxable income

Income tax is only charged on your taxable income so it’s really important to know the difference between taxable and non-taxable income – and as always you should seek advice if you’re not sure.

There are lots of different factors that could affect what income is taxable and how much of it is charged to UK income tax – such as residence status, reliefs available (such as losses or personal allowance) and legislation.

Income can be received either gross (before tax is taken off) or net (after tax is taken off) but it’s important to remember that when you’re calculating your final figure of taxable income for the year, you always use the gross figure.

Below are some examples of taxable income and beneath that we take a look at non-taxable income.

Taxable income

Employment related Income

• Salary – including wages, bonuses, commissions etc.
• Benefits in Kind – such as company cars or health insurance
• Reimbursed expenses – where your employer reimburses you for expenses and tax legislation prohibits a deduction
• Statutory payments such as maternity or sickness pay
• Redundancy/termination payments – the first £30,000 is usually tax-free, with anything above this amount subject to income tax
• Certain share schemes or gifts of shares from employers
• Retainers
• Vouchers that can be exchanged for cash

Basically anything where there is a direct correlation between your employment, service provided and reward will be treated as employment income and charged to Income Tax (and generally National Insurance too!).

Self-employment income

• Trading profits including but not limited to:
  • Sales
  • Gifts over certain limits
  • Post cessation receipts
  • Grants and compensation payments
• Royalty receipts or other intellectual property receipts

Rental or Property Income

• Receipts from letting out a property
• Part of premium received on granting a lease on property
• Renting parking space, or land for other use
• Renting a room in your house – provided more than £1,000

Investment/Savings Income

• Interest received on savings
• Dividends received from companies
• UK government stocks/gilts/bonds income
• Personal income (i.e. income from employment or self-employment)
• Unincorporated business profits
• Investment and savings income
• Rental income
• Pension income
• Some social security benefits

Examples of Non-taxable Income

• Most state benefits – such as Universal Credit, Tax credits, maternity allowance etc.
• Lottery, gambling or NS&I premium bond winnings
• Trading or property rental income less than £1,000 per annum
• Overseas income if not resident in the UK
• ISA income
• Educational grants and scholarships

For an even more exhaustive list, check the What income is taxable? article on tax basics.

As if that weren’t enough, there are also different types of reliefs and allowances that apply to each of these revenue streams. There are also different tax rates depending on whether the income is classified as Non-Savings, Savings or Dividend Income.

Current tax bands for 2025/26 (England, Wales and Northern Ireland):

• Personal Allowance: £12,570 (tax-free, reduced if income exceeds £100,000)
• Basic rate (20%): £12,571 – £50,270
• Higher rate (40%): £50,271 – £125,140
• Additional rate (45%): over £125,140

Note: these thresholds have been frozen until 2028, so more taxpayers are moving into higher bands due to rising incomes (“fiscal drag”). Scotland has a different set of tax bands and rates.

Dividend and savings allowances (2025/26):

• Dividend allowance: £500 (reduced from previous years). Dividends above this are taxed at 8.75% (basic rate), 33.75% (higher rate) or 39.35% (additional rate).
• Personal savings allowance: £1,000 for basic rate taxpayers, £500 for higher rate taxpayers, none for additional rate taxpayers.
• Capital Gains Tax annual exempt amount: £3,000. Gains above this are taxed at 10%/20% (or 18%/24% for residential property, depending on income band).

National Insurance Contributions (NICs):

Income tax is only part of the picture. Employees, employers and the self-employed also pay NICs. In 2025/26 the main employee rate is 8% on earnings between £12,570 and £50,270, and 2% above that. Self-employed pay different Class 2 and Class 4 NICs, based on profits.

High Income Child Benefit Charge (HICBC):

If one partner in a household has income over £60,000, Child Benefit starts to be clawed back. By £80,000 it is fully withdrawn. Families in this range need to factor this into their effective tax rate.

Effective 60% marginal rate:

Because the Personal Allowance is withdrawn by £1 for every £2 of income over £100,000, the effective tax rate on income between £100,000 and £125,140 can reach 60%. This is important for financial planning.

As we always say – if in doubt you should always ask a professional.