One of the most often used and valuable of the Capital Gains Tax (CGT) exemptions is...
Unless you are an accountant, income tax is a subject that few people understand in depth. When you receive your pay slip you may do a quick calculation to check how much has been deducted, but do you know how the calculation has been made - or even if it is correct?
Income tax can seem like a mystery but once you understand the various tax brackets, and the deductions that are made in each, it is surprisingly easy to work out.
This guide will walk you through every step of calculating your income tax so you will always be able to work out exactly what to expect.
What is Income Tax?
To recap on the basics, income tax is a type of tax which most people pay on the income they receive. Not all income is subject to income tax, and when it is, different rates of income tax may apply.
Income tax is payable on income such as:
- Employed earnings
- Self-employed earnings or profits
- Most pension income, including retirement annuities, personal pensions, company pensions and the state pension
- Certain state benefits
- Some benefits included with your job
- Trust income
- Savings interest (which is over your allowance
- Some types of rental income
- Certain types of grant provided to you or your business due to COVID-19
This is not an exhaustive list, just some of the main examples.
There are some exemptions to income tax and there are certain types of tax relief which may be available.
If you are in receipt of an income which is subject to income tax, you are usually allowed to receive a certain amount before tax becomes payable. This is known as your personal allowance and we are going to look at that next.
Tax Rates and Allowances
The amount of tax which you will need to pay is calculated based on your total income, and how much of this falls above your personal allowance. There are different rates of tax payable, these are known as tax bands. The amount of income you receive will determine which tax band it falls into and, therefore, how much tax will be deducted.
The personal allowance is set by the government and any changes to it are usually announced in the Budget. Your personal allowance is the amount that you can receive without paying any income tax.
If you receive more than your personal allowance, tax will only usually apply to the income which is surplus to your personal allowance.
For the year 2022/2023, the standard personal allowance is £12,570. Your personal allowance can increase or decrease depending on circumstances. For example, if you claim Blind Person’s Allowance or Marriage Allowance your personal allowance may increase by this additional allowance.
Conversely, if you receive more than £100,000 as an income your personal allowance may be less since higher rate taxpayers lose this personal allowance as their income goes above £100,000.
The personal allowance may be increased or frozen every year by the government. When it is increased, if there are no other changes to income tax, it means that you will pay less income tax.
The personal allowance in recent years has been:
- 2018/2019: £11,850
- 2019/2020: £12,500
- 2020/2021: £12,500
- 2021/2022: £12,570
- 2022/2023: £12,570
As these figures demonstrate, sometimes there is no change to the personal allowance at all, or only a minor adjustment. When there is a change, an after tax calculator can help to show you what the impact of any changes will be.
In the past, the personal allowance was different for individuals born in a certain year, or of a certain age. This is no longer the case and the standard personal allowance applies to everyone whose income falls within the bracket.
At the opposite end of the spectrum, the personal allowance decreases by £1 for every £2 of income which is over the £100,000 threshold. It is possible for the personal allowance to decrease to zero. This means that all of the income received will be subject to income tax at the various rates applicable.
Once you know the personal allowance that applies to your salary, you will be able to use an income tax calculator to ascertain the amount of tax that will be payable. To do this you will need to know the tax band that your income falls into.
There are several different rates of tax, and these vary depending which part of the UK you are in. For 2022/2023 these are as follows, after the personal allowance:
- Basic: 20% (Up to £50,270)
- Higher: 40% (£50,271 to £150,000)
- Additional: 45% (Over £150,000)
- Basic: 20% (Up to £50,270)
- Higher: 40% (£50,271 to £150,000)
- Additional: (Over £150,000)
- Starter rate: 19% (up to £14,732)
- Basic: 20% (£14,733 to £25,688)
- Intermediate: 21% (£25,689 to £43,662)
- Higher: 40% (£43,663 to £150,000)
- Top: 46% (Over £150,000)
- Basic: 20% (Up to £50,270)
- Higher: 40% (£50,271 to £150,000)
- Additional: (Over £150,000)
The above figures reflect the taxable income AFTER the personal allowance has already been deducted.
Similarly to personal allowance, these tax bands are subject to change. Unlike the personal allowance which only increases, the tax bands could move up or down depending on whether the government is seeking to increase or decrease income tax.
What is a Tax Code?
As can be seen from the information above, there are various different rates of tax that can be applied. If your employer deducts the wrong amount of tax you could end up receiving far less money than you were expecting, or you could end up owing HMRC back payments of unpaid tax.
It is therefore imperative that the correct amount of tax is deducted, and this is managed with the use of tax codes.
Your employer does not decide what tax code to put you in; they use the classification given to them by HMRC. In theory, this means you should be always classified correctly but it is a good idea to check because errors can be made.
You can check your tax code to see if it is correct on your HMRC online personal tax account. This is a service which is available to everyone for free, but you will need to register and prove your ID first. This is done through the Government Gateway; if you have a login for this already, you will be able to process to your personal tax account without needing to reregister.
Your personal tax account will show you what your tax code is for the present tax year, but you can also check to see what your code was in previous years too. Where there has been a change you should see an explanation of the reason that your code was altered.
Although you can also find your tax code on your pay slip, the online personal tax account has much more information. As well as checking what code you have been assigned, you can also find out how much tax you are likely to be paying.
Changes to your tax code
In most cases, HMRC is very accurate when issuing tax codes but it is not unknown for there to have been a mistake. One of the most common reasons for this is records which have not been kept up to date.
This is one of the big benefits of the personal tax account; you can notify HMRC of any changes right away. This ensures that your tax code is changed quickly so you will not end up with an incorrect tax code for months - or longer - at a time.
If you think that your tax code looks wrong, checking and updating your employment information is the best place to start. You can do this via the income tax checking service within your personal tax account.
You might notice that HMRC automatically changes your tax code. This could be for one of many different reasons, such as:
- You get a second job or start receiving a pension
- The benefits you get from your employment either start, stop or change
- You receive state benefits which are taxable
- You submit a claim for Marriage Allowance
- You receive tax relief for expenses that you have claimed
- You change your job - you may be put on a temporary Emergency Tax code. This should be a last resort as emergency tax tends to be a higher rate.
Interpreting your tax code
To be sure that you are using the salary calculator correctly you will need to know whether you have the right tax code. However, it is not possible to tell at a glance what the code means because it is made up of a series of numbers and a letter.
Luckily, HMRC publishes information which removes the mystery from the code and allows you to see exactly what the individual elements mean. This will enable you to check to see whether your tax code is correct.
The majority of people who have either one source of employment or pension income are given the tax code 1257L for 2021/22 and 2022/23.
The numbers in your tax code relate to the amount of income you are eligible to receive free of tax in that year. If you recall further up in this guide, we mentioned the standard personal allowance is currently £12,570 - removing this last 0 allows the numbers in the tax code to directly match this figure.
However, although most people will be classed as 1257, it is possible to have a different numerical tax code. For example, if you receive benefits from your employer, such as a company car, your tax code may be different.
The letters included in your tax code are more complex, but the vast majority of people will be classed as L. This is what all the tax codes letters mean:
|L||You are entitled to receive the standard personal allowance for the purposes of tax|
|M||You have received a 10% transfer from your spouse or partner under the Marriage Allowance|
|N||10% of your personal allowance under the Marriage Allowance has been transferred to your spouse or partner|
|T||Other calculations have been included in your tax code to reach your personal allowance|
|QT||This could mean that you have used up your personal allowance, or that you have started with a new employer and they don’t have the information required to give you a permanent tax code|
|BR||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the basic rate|
|D0||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the higher rate|
|D1||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the additional rate|
|NT||This income is not being subjected to tax|
|S||This is a prefix which denotes that the tax code arises from Scotland|
|S0T||This could mean that you have used up your personal allowance in Scotland, or that you have started with a new employer and they don’t have the information required to give you a permanent tax code|
|SBR||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the Scottish basic rate|
|SD0||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the Scottish intermediate rate|
|SD1||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the Scottish higher rate|
|SD2||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the Scottish top rate|
|C||This is a prefix which denotes that the tax code arises from Wales|
|C0T||This could mean that you have used up your personal allowance in Wales, or that you have started with a new employer and they don’t have the information required to give you a permanent tax code|
|CBR||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the Welsh basic rate|
|CD0||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the Welsh higher rate|
|CD1||Typically used if you have more than one job or source of earned income, income from this job/pension is being taxed at the Welsh additional rate|
You might also notice that your tax code ends with X, M1 or W1; these are all emergency tax codes and should only be used temporarily.
The final tax codes to mention are those that begin with a K. These are more complex as it means that you are in receipt of income that is not being taxed via any alternate means, and it has got a value which exceeds your personal allowance.
In most cases the reason to have a K tax code is because you are repaying tax from a previous tax year via your pension or salary, or you are receiving benefits which are taxable. These benefits may either be from the state or from your company/employer.
When a K code is in use, an employer cannot deduct more than 50% of your earnings or pension pre-tax.
What is National Insurance?
A take home pay calculator needs to include National Insurance as well as income tax in order to provide an accurate figure. National Insurance is a separate deduction to income tax so needs to be added on top of any income tax which is payable.
National Insurance is payable for anyone who is aged over 16, once their earnings reach a certain level. You need to be allocated a National Insurance number in order to make contributions.
Unlike tax, it is in the individuals’ best interests to ensure that they are paying enough National Insurance. This is because HMRC keep a record of the contributions, and this will determine what benefits, like state pension, the individual is entitled to receive.
There are different classes of National Insurance contributions and each corresponds to different types of state benefits. You may not ever need to claim the state benefits they correlate to, such as Maternity Benefit or Jobseekers Allowance but if you do not contribute, you will not be able to claim the benefits should the need arise. Even more importantly, National Insurance contributions determine how much state pension you will receive.
It is possible to have gaps in your contribution record and still be entitled to receive a full state pension; it all depends on how much you have contributed and how many full years of National Insurance are on your record. You can find out if you are on track by checking your personal tax account online; this is the HMRC hub that contains all your personal data.
National Insurance Classes
Not all types of National Insurance contributions fall into the same class. There are currently five different classes for National Insurance which are as follows:
- Class 1 - contributions for employers who are below state retirement age but earning more than £190 per week. These contributions are deducted automatically at source.
- Class 1A or 1B - contributions paid by the employer based on the salary and/or benefits
- Class 2 - contributions paid by the self-employed who earn £6,725 per annum or more
- Class 3 - voluntary contributions. You can pay these to fill in gaps in your record or to avoid getting a gap if you are self-employed and earning less than £6,725 per annum
- Class 4 - paid by self-employed individuals who are earning more than £9,881 per annum or more.
Note: these figures are correct as at 2022/2023 tax year but may be subject to change by the government in the future.
How Much National Insurance Will I Pay?
If you are looking for a wage calculator, you will be the most interested in Class 1 contributions. These are the deductions made from your gross wages and shown on your pay slip. It is your Class 1 National Insurance contributions and income tax which will need to be calculated to work out your take home pay.
The amount of National Insurance deducted depends on the proportion of your earnings which fall into the different bands, and the category letter which has been assigned to you.
Let us look firstly at the different National Insurance bands.
For the year 2022/2023, the bands were as follows:
|Letter Category||£123 to £190 per week (£533 to £823 per month)||£190.01 to £967 per week (£823.01 to £4,189 per month)||Over £967 per week (£4189 per month)|
As can be seen from the table above, to fully calculate the amount of National Insurance contributions you will be expected to pay, you need to know your category letter.
You should be able to see your National Insurance category letter on your payslip, but most employees will fall within Category A.
The full list of categories are:
- Category A - all employees apart from those listed as B, C, H, J, M, V and Z
- Category B - married women and widows who are entitled to pay a lower rate of National Insurance
- Category C - employees who are above the state pension age
- Category F - all employees who work in freeports, other than those listed as I, L, and S
- Category H - any apprentices who are under the age of 25
- Category I - married women and widows who work in freeports and who are entitled to a lower rare of National Insurance
- Category J - employees who are able to defer payment of National Insurance because it is already being deducted from their earnings in another job
- Category L - employees in freeports who are able to defer National Insurance as they are already paying at another job
- Category M - employees who are below 21 years of age
- Category S - employees at a freeport who are above state pension age
- Category V - employees who are in their first paid position since leaving the armed forces (veterans)
- Category Z - employees who are below 21 years of age and are able to defer payment of National Insurance because they are already paying it in another job.
Category letter X can also be found on payslips for some workers. This category is generally used for anyone who is not liable for National Insurance, such as workers younger than 16 years old.