How income tax is calculated

One of the most common taxes UK residents will pay is income tax. It is levied at a rate of between 20% and 45%, depending on the amount you earn.

If you receive money from a job, pension, or any other form of income, you will have to pay income tax once your taxable income goes above the £12,570 tax-free personal allowance.

Income tax is used by the government to fund public services such as the NHS, schools and prisons, as well as to pay off debt.

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The government is expected to rake in around £329 billion in income tax alone in the 2025/26 tax year, according to estimates by the Office for Budget Responsibility (OBR), making up around 27% of all tax receipts.

With the average household paying around £11,450 in income tax each year, according to the OBR, it is important that you understand how it is raised and how your bill is calculated.

How much income tax will I pay?

The amount of income tax you pay depends on how much you earn in a given tax year, be that through employment, self-employment, pension income, or more.

Income tax rates differ depending on where you live.

There are four main tax bands in England, Wales, and Northern Ireland, with tax rates ranging from 0% on the first £12,570 you earn, to the top rate of 45% on earnings over £125,140.

These rates are shown in the table below.

The rates above apply only to earnings you have within their band. For example, if you earn £90,000, you will be classed as a higher rate taxpayer but you do not have to pay 40% tax on all of your earnings.

Instead, you will pay £0 in tax on the first £12,570 you earn, 20% on the portion of your earnings between £12,571 and £50,270, and 40% on just the earnings you have between £50,271 and £90,000.

This effectively means that while your marginal tax rate may increase when you take a pay rise, you will never have less take-home pay if you increase your earnings.

You start to lose your personal allowance once you earn over £100,000. This reduces at a taper rate, and is lost entirely once you earn over £125,140.

Income tax rates in Scotland

Income tax rates are calculated slightly differently in Scotland, as there are more tax bands than elsewhere in the UK, though everyone still has the £12,570 tax-free personal allowance.

The below table shows Scotland’s income tax bands for the 2026/27 tax year.

How does the personal allowance work?

The £12,570 personal allowance is the amount of taxable income you can receive without paying any income tax at all.

That means that if you have an income of £12,500 in a given year, you will most likely not have to pay any tax.

For incomes up to £100,000, you will receive the full personal allowance. For example, if you earn £30,000 you will not have to pay any tax on the first £12,570 of that.

However, higher earners will see their personal allowances slowly erode when they breach the £100,000 earnings threshold. They will fall victim to what’s known as the 60% tax trap.

Under HMRC rules, for every £2 you earn over £100,000 per year, you lose £1 of your £12,570 tax-free personal allowance until it is fully removed at an income of £125,140.

This leads to higher earners paying a marginal tax rate of 60% on their earnings between £100,000 and £125,140.

For example, imagine someone earns a salary of £100,000, and they receive a bonus of £10,000, giving a total of £110,000.

The higher rate of 40% is payable on the bonus, which means that £4,000 would be deducted.

Since the bonus tips them over the £100,000 threshold, their personal allowance is reduced – in this instance by £5,000. This means there is an additional £5,000 brought into the higher rate income tax bracket.

This results in a further £2,000 of income tax being due, meaning £6,000 is deduced in tax from the £10,000 bonus. This is equivalent to a 60% tax rate on the portion of income above £100,000.

Successive governments have frozen tax thresholds at 2021 levels in recent years, with chancellor Rachel Reeves recently extending the freeze to at least 2030/31. As thresholds are not being raised in line with inflation, as had previously been the norm, it is expected that an increasing number of people will fall victim to this quirk of the tax system.

This is a phenomenon known as “fiscal drag”.

Figures from Rathbones show HMRC expects around 2 million taxpayers to be stuck in the 60% tax trap in the 2026/27 tax year alone, up around 6% from the previous year.

Do dividends count as income for tax purposes?

Dividends are treated as income when the government calculates your income tax unless the investments that are generating you dividends are held in an ISA.

You do not have to pay any tax on your dividend income if it falls within your £12,570 personal allowance, and there is an additional annual tax-free dividend allowance of £500 per person.

So, if you had a taxable income of £13,070 that was made up solely of dividends, you would not have to pay any income tax.

This is because the first £12,570 would be covered by the personal allowance, and the remaining £500 by the dividend allowance.

When you exceed these allowances, you need to pay tax on any dividend income from outside an ISA. This is charged at different rates according to the highest rate of income tax you pay.

The rate for basic rate taxpayers is 10.75%. If the taxable dividend income tipped into the higher rate tax band, the rate of tax applied would be 35.75%, and for additional rate taxpayers, a 39.35% tax rate would apply.

Does the personal allowance apply to capital gains?

The personal allowance does not apply to capital gains. Individuals have a separate annual capital gains tax exemption of £3,000 per person, per tax year.

If the total of all gains and losses in the tax year fall within this amount you don’t need to pay any tax.

Are you charged income tax on savings?

You may have to pay income tax on your savings interest. It will depend on how much money you have in savings and how much interest you are earning on that cash.

You will not have to pay any tax on interest earned on money held in a cash ISA, as this is protected within the tax-wrapper, but if you have savings outside an ISA, you might have to pay tax on your interest.

Basic rate taxpayers receive a personal savings allowance (PSA) of £1,000 each year. This means you can earn up to £1,000 in savings interest without it being subject to tax.

The personal savings allowance is halved to £500 for higher rate taxpayers and additional rate taxpayers receive no PSA.

Any income from savings interest over your PSA is treated as income and is taxed at the same rate as the rest of your income.

The rate your savings are taxed is also set to increase from April 2027, rising to the same rate as your income tax band plus two percentage points.

What is the marriage allowance, and how can it help me lower my tax bill?

The marriage allowance is a mechanism that allows married couples and those in civil partnerships to transfer 10% of their personal allowance to the other partner, who can then claim the value of that allowance.

This means £1,260 of your personal allowance can be transferred to your spouse or civil partner if they earn more than you. However, there are certain eligibility rules that apply.

Who can apply for the marriage allowance?

You must be married or in a civil partnership and one of you must be a non-taxpayer and one must be a basic-rate taxpayer. Higher or additional-rate taxpayers aren't eligible for this allowance.

The marriage allowance could reduce a tax bill by up to £252. It is also worth checking if you are eligible to backdate your claim, as in some cases you may be eligible to claim from tax years since 6 April 2021 (the 2021/22 tax year).

To be eligible for the marriage allowance in Scotland, your partner must pay the starter, basic or intermediate rate, which usually means their income is between £12,571 and £43,662.

How to transfer the personal allowance

The quickest way to apply for marriage allowance is online. You’ll need your National Insurance number and your partner’s National Insurance number.

There is also the option to apply by post, completing a MATCF form –– available on gov.uk.

You can also opt to do it through a self-assessment tax return if you’re already registered and file tax returns anyway.

What is National Insurance?

Alongside income tax, National Insurance (NI) is another tax paid on your earnings. It is paid by both employees and employers, while the self-employed pay it on profits.

You must pay National Insurance contributions to qualify for certain benefits and the state pension.

The rates of National Insurance are different for employed and self-employed people.

For those employed, you pay class 1 National Insurance contributions and the levels are tiered according to your earnings.

You pay no NI on earnings up to £242 a week. Then you pay 8% NI on earnings between £242.01 and £967 a week, and 2% on earnings above £967 a week.

The self-employed pay class 4 NI which is 6% on profits of £12,570 up to £50,270 and 2% on profits over £50,270.

Your NI contributions will be on your self-assessment tax return and are due at the same time as income tax.

You do not pay NI once you reach the state pension age. If you are self-employed you stop paying class 4 NI from the start of the tax year after the one in which you reach state pension age.