Income tax explained Income tax: what it is and who pays it

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Tax is charges on earnings and income from other sources.

We've all seen a big chunk of our monthly earnings disappear in tax each month, but how much are you paying and why is it deducted?

Income tax is an annual charge on your earnings and income from other sources, such as savings, pensions and investments. It is collected by Her Majesty’s Revenue & Customs (HMRC), formerly Inland Revenue.

This guide explains how income tax works 

Income tax: what's it used for?

Income tax is the main source of government revenue, raising over £150bn a year. 

The next highest contributions come from National Insurance (£18bn) and VAT (£17bn). After this, fuel duties, alcohol and tobacco duty are government’s biggest earners.

Tax-free income

Some forms of income are tax-free, regardless of how much you receive from other sources. 

These include: lottery winnings and premium bond prizes, income received under the rent-a-room scheme, most insurance policy payouts, redundancy payments (below £30,000), tax credit and pension  credit.

Tax-free personal allowance

Not all income you receive is taxed. Individuals have an annual personal allowance, which is an amount of income they can keep tax-free. 

  • For most people it is £11,000 for 2016-17 (£10,600 for 2015-16)
  • If your income is above £100,000 you lose allowance, at the rate of £1 for every extra £2 you earn. 
  • If your income is above £122,000 in 2016-17 (£121,200 in 2015-16), you get no tax-free allowance and are taxed on everything you earn. 

From April 2016, age-related allowance ends- older taxpayers get standard personal allowance. For income received between April 2015 and April 2016, those born before 6 April 1938 are eligible (depending on income) for up to £60 extra allowance. This is withdrawn once their income exceeds £27,700, at the rate of £1 for every extra £2 they earn.

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