What is Income Tax?

Definition of Income Tax

Income Tax is tax that's payable on an individual's income. It's charged at different rates depending on what kind of income it relates to, for example dividend income is taxed at lower rates than most other kinds of income.

You pay Income Tax on income such as:

  • Profits when you're self-employed
  • Wages from a job
  • Interest you receive from your bank
  • Dividends you are paid on shares
  • Money you earn from renting out a property

You don't usually pay Income Tax when you sell personal items; capital gains tax may be due on these instead.

How Income Tax works

Every individual can receive a certain amount of income tax-free each year; this is the Personal Allowance which reduces if your income is high. You pay Income Tax on any income you receive in a tax year over and above your Personal Allowance.

If you are being paid a salary, your employer will allow for a certain amount of your salary to be tax-free each pay period – so for example, if you are paid monthly, and have no income other than your wages, then each month, you'll pay Income Tax on the remainder of your salary above a twelfth of the Personal Allowance.

Your tax code shows your employer how much of your salary to keep tax-free each pay period. If you have a second job, or you're receiving non-cash benefits such as a company car, HMRC will change your tax code so that you pay the right amount of tax on your income.

Check out the current Income Tax rates and bands with our UK tax rates tracker.

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FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.

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