Income tax for employees
What pay is taxable?
By Joe Elvin
Article 7 of 9
What pay is taxable?
Find out how your take-home pay is calculated, which payments are subject to income tax and which payments are tax-free.
As an employee, most of the tax you pay disappears from your pay packet before you ever see it.
You ‘pay as you earn’, or PAYE. Your employer deducts income tax straight from your pay - called 'at source' - along with National Insurance contributions and any other deductions.
Here, we explain how your take-home pay is worked out and which payments from your employer are tax free.
- Get a head start on your 2016-17 tax return with the Which? tax calculator. Tot up your tax bill, get tips on where to save and submit your return direct to HMRC with Which?.
Your payslip explained
The example of a payslip below from the 2015-16 tax year includes the most common deductions from your salary.
PAYE is the automatic deduction of income tax.
You'll be charged at either 20%, 40% or 45% - depending on how much you earn - on all taxable income, less your personal allowance and any deductions that qualify for tax relief.
In the example above, income tax is charged at 20%, less a personal allowance of £10,600 (demonstrated by the tax code 1060L), pension contribution and a charitable donation giving.
The personal allowance for 2017-18 is £11,500, so would be demonstrated in this case by the tax code 1150L.
Find out more: PAYE explained - how tax is automatically deducted
National Insurance is deducted each pay period if your earnings are over a certain amount. In 2017-18, the threshold is £8,164 (so £157 a week or £680 a month). Although some payments, such as pension contributions, qualify for income tax relief, there is no relief from National Insurance.
In the example above, Class 1 National Insurance Contributions are deducted at a rate of 12%.
Find out more: National Insurance rates - work out how much you'll pay
This may be contributions to your employer's pension scheme (including any voluntary contributions) or contributions that will be passed to a personal pension provider.
Student loan repayment
Plan 1: If you started university before 1 September 2012, you’ll start making student loan repayments once you’re earning £17,335 a year (or £1,444 a month). This threshold tends to increase at the start of every new tax year.
Plan 2: If you started university in England or Wales after 1 September 2012, the student loan repayment threshold currently stands at £21,000 a year (or £1,750 a month).
Repayments are worked out as 9% of your income above the threshold, rounded down to the nearest pound.
In the example above, the employee makes monthly Plan 1 repayments, so 9% x (£2,435.50-£1,444) = £89.23 (rounded to £89.00).
A tax-efficient way of giving to charity through a scheme at work. Your donations qualify for full income tax relief. A widely used scheme is called Give As You Earn (GAYE).
Other deductions could include subscriptions to a trade union, or deductions under a court order to repay debts or pay child maintenance.
Though you pay income tax on most of your earnings (including overtime, bonuses, commission, tips and holiday pay), some payments from your employer are tax-free.
These do not count towards your taxable income, and do not have to be declared if you are sent a tax return.
- reimbursed expenses for which your employer has a formal agreement (a ‘dispensation’) with HMRC
- reimbursed expenses where your employer makes a voluntary agreement with HMRC to pay tax on your behalf
- mileage allowance up to HMRC-approved rates (45p per mile for the first 10,000 business miles and 25p per mile thereafter) if you use your own car for work
- payments of up to £4 per week or £18 per month for extra household costs if you regularly work at home by arrangement with your employer (your employer may pay more if you can supply evidence that it is justified)
- various allowances paid to members of HM forces, for example: operational allowance for members serving in combat zones, such as Afghanistan; mess allowance and travel to and from leave expenses; and council tax relief payments.
Find out more: income tax explained - how much tax will you pay?
Reimbursed expenses that are free of income tax are not automatically free of National Insurance.
The general rule is that if the reimbursement is a distinct payment specifically aimed at reimbursing, or making a contribution towards, expenses that you have actually incurred, then the payment should be National-Insurance-free.
However, some expenses are always National-Insurance-free. This includes mileage allowance up to HMRC-approved rates if you use your own car for work, and operational and mess allowances and council tax relief payments for members of the Armed Forces.
Find out more: National Insurance explained - more on how this tax works
Tax-free lump sums
Extra payments, such as bonuses, from your employer are normally treated as salary and taxed in the normal way. However, some lump-sum payments are tax-free. These include:
- money your employer pays into a registered pension scheme or uses to buy an annuity for you
- most lump sums from a registered employer’s pension scheme, including death benefits paid to your dependants
- pension gratuities you receive on leaving the armed forces
- the first £30,000 of most redundancy payments
- compensation paid by your employer if they break your contract, but not pay in lieu of notice if it is part of your contract or customary
- compensation for an injury or disability that means that you are unable to continue with your job
- suggestion scheme awards under formal schemes and up to a maximum £25 if your idea is not adopted, or £5,000 if it is
- relocation expenses up to a maximum of £8,000.
A genuine personal gift from your employer – for example, on getting married – is also tax-free, but the onus will be on you to show that it really was personal and not as a result of your being an employee.
If there is no income tax on a lump sum you receive, there will usually be no National Insurance contributions either.
- Last updated: April 2017
- Updated by: Gareth Shaw