How is tax on income worked out?

In this section:
o Working out your taxable income
o Allowances which reduce your tax bill
o Tax paid during the year
o Rates of income tax
o A worked example using the rates for 2009-2010

Working out your taxable income

Working out your tax bill can be very complicated. This summary is meant only to give you an
understanding of the basic principles. If you want to work out your own tax bill, you would be best
advised to use the form ‘Calculating your tax bill’ which HM Revenue and Customs includes with
your tax return. Alternatively, you could ask HM Revenue and Customs or a tax adviser to work
out the figure for you. If you complete your tax return on the Internet, your tax is calculated
automatically.

To work out your tax bill, you first need to work out your taxable income.

To work out your taxable income you need to:

1. If you are self-employed, work out your profits first (income less business expenses)

2. Add together all your different types of income. You need to include the gross amount
(before any tax is deducted) – see the section What sorts of income are taxable for the
amounts to include if you have income from employment, pensions, savings and
investment and rents.

3. Deduct your allowances - the tax-free part of your income. (Personal allowance, age
allowance, and blind person’s allowance see the section What tax allowances can I
claim?)

4. Watch out for certain pension and gift aid payments. People who pay tax at the higher
rate may well need to make adjustments here.

This should give you the figure on which you are due to pay tax - but we haven’t finished yet!

You need to work out the tax due using the right rates and allowances for the tax year. Then you
must take off any married couple’s allowance which reduces the tax bill – this only applies to
couples one of whom was born before 6 April 1935. Finally, you need to allow for any tax which
you have paid during the year. We will look at these issues below.

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Allowances which reduce the tax bill

We saw in the allowances section that married couple’s allowance (now only available to those
who were at least 65 on 5 April 2000) is given as a reduction to the tax bill. If you qualify for
married couple’s allowance, this is the stage to use it. The formula is tax due minus tax saving on
married couple’s allowance.
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Tax paid during the year

The next step is to work out if you already have paid any income tax during the year.

You could have paid tax:

o On a wage or salary as an employee under PAYE
o As a subcontractor in the construction industry
o On savings income
o As payments on account, if you are self-employed

The tax that you have already paid needs to be taken off the total amount of tax due on your
income. When you have done this, you have a figure for the tax you need to pay to HM Revenue
and Customs - or it might be that you are due a refund.
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Rates of income tax

Tax is paid at different rates on different types of income. The rate of tax also changes with the
amount of your income.

The main rates of tax are:

The savings starting rate – a low rate of tax sometimes available on the first slice of savings
income. Since 6 April 2008 this is no longer available on general income, but may be available to
a limited number of people for savings income; typically available to lower income pensioners
The basic rate – the normal rate of tax for most people
The higher rate – a higher rate of tax for those with higher incomes

Savings are taxed slightly differently from other income. Dividend income is treated differently
from other savings income.
The best way to show how this works is by way of a worked example.

For rates and bands of income tax see the Rates and Allowances section.
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A worked example based on 2009-2010

We are going to work out Julie’s tax. Julie has a salary from her job at a supermarket, and some
self-employed income from designing greeting cards. Julie also has a little savings income. She
wants to work out her tax bill for 2009-2010. (Note the rates of tax for 2008/09 are the same as
for 2009/10, but the personal allowances and tax bands are slightly different)

The rates of tax applicable to 2009-2010 are these:

Starting rate band for savings income:

• The first £2,440 of savings income is taxed at 10%; but only if non-savings income is less that
an individual’s tax free personal allowance (£6,475 for those under 65), plus the starting rate
band

Basic rate band: the first £37,400 of income

• Usually taxed at 20%, but special rules apply to savings income
• Dividend income is taxed at 10%
• Other savings income is taxed at 20%

Higher rate band: Taxable income over £37,400

• Is usually taxed at 40%
• But dividend income is taxed at 32.5%

Note: Savings income is treated as the top slice of income, and dividend income as the highest
part of savings income.

Calculating Julie’s income tax

Julie has the following income for 2009-2010:

• salary £11,000; tax deducted under PAYE £905 (National Insurance of £580.80 would also
been deducted, but is not relevant for this calculation). Her employer gives her a form P60
with these figures in May 2010.
• self-employed profits £1,432
• dividends £270; tax credits £30
• bank interest credited £800; tax deducted £200

Julie is single and looks after a child aged seven.

 £ Tax already paid
Salary 11,000 905.00
Self employment 1,432
Dividends, plus tax credits (270 + 30) 300 30.00
Gross interest before tax (800 + 200) 1,000 200.00
Totals 13,732 1,135.00
Less: Personal allowance (6,475)
Taxable income £7,257 1,135.00

Income tax due:

Basic rate at 20% on £6,957 (all income excl divids) 1,391.40

Dividends £300 at 10% 30.00

Total tax due on income 1,421.40

Income tax payable now (tax due, less tax paid) £286.40

Notes:
1) Julie is unable to access the 10% starting rate for savings income as her non-savings
income at £12,432 is greater than he personal allowance of £6,475 plus the savings
starting rate band of £2,440 (= £8,915)
2) Julie could apply for Tax Credits and help with childcare costs. This income would not be
taxed.
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