What is income tax?

14 October, 2021 · 6 min read

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Income tax is one of the most common taxes in the UK, is the largest source of revenue for the UK government and almost all of us will end up paying it – but what exactly is it?

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What exactly is income tax?
Taxable vs non-taxable income
Taxable income
Examples of Non-taxable Income

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 – where total is over £30,000 generally
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
• COVID-19 support 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.

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