What is Income Tax?

Income Tax is the UK's primary tax on earnings and applies to almost all forms of income you receive. The main types of taxable income include employment income (salary, wages, bonuses), self-employment profits, pension income, rental income, savings interest (above your Personal Savings Allowance), and dividends (above your Dividend Allowance). Different types of income are taxed at different rates and in a specific order.

For 2025/26, the tax bands for England, Wales, and Northern Ireland are: the Personal Allowance of £12,570 (income tax-free), the basic rate of 20% on income from £12,571 to £50,270, the higher rate of 40% on income from £50,271 to £125,140, and the additional rate of 45% on income above £125,140. Scotland has its own rate bands with starter, intermediate, and advanced rates. The Personal Allowance is tapered by £1 for every £2 of income above £100,000, meaning it is completely lost at £125,140.

Dividend income sits on top of other income but is taxed at lower rates: 8.75% (basic), 33.75% (higher), and 39.35% (additional). The first £500 of dividend income is covered by the Dividend Allowance and is tax-free. Savings income has its own rates too, with the Personal Savings Allowance providing £1,000 tax-free interest for basic-rate taxpayers and £500 for higher-rate taxpayers.

For company directors, understanding Income Tax is crucial for tax planning. The combination of salary (subject to Income Tax and National Insurance) and dividends (subject to dividend tax rates but not NI) is the most common way to extract money from a limited company. Setting your salary at the optimal level -- typically around the NI Secondary Threshold or the Personal Allowance -- and taking the rest as dividends can save thousands in tax each year.

Income Tax is collected in two main ways. Employment income is collected at source through PAYE (Pay As You Earn), where your employer deducts tax before paying you. Your tax code determines how much tax-free income you get each pay period. Self-employment income, rental income, and other untaxed income is collected through Self Assessment, where you file a tax return after the end of each tax year.

The tax calculation stacks your income in a specific order: non-savings income first (salary, self-employment, pensions, rental), then savings income, then dividend income. Each band is used up in this order, so dividends effectively sit at the top of your income stack. This ordering matters because dividend rates are lower than employment income rates at each band.

If you are employed and also have other income, HMRC may adjust your tax code to collect the additional tax through PAYE, or you may need to file a Self Assessment return. You must file Self Assessment if your income exceeds £150,000, you have untaxed income over £2,500, or you are a company director with taxable benefits.