How much can you earn before paying income tax?
You can earn £12,570 each year before you have to pay tax on your income. This is known as the personal allowance. The personal allowance applies to almost everyone from students to employees, you don’t pay any tax to HMRC on the first twelve and half thousand you make.
It’s helpful to know about the personal allowance for a few reasons. For example, you might run a limited company and pay yourself a salary, so you could set the wage to £12,570 and then take the rest in expenses and dividends. Or maybe you’re a side hustling teen and want to know when your income becomes taxable and whether it’s worth paying 20% of everything above £12,570 to HMRC.
Before we get to working it out though, we should probably go through what exactly income tax is in the first place, how you pay it, and then how you work it out (and how Earnr can do this for you!).
What is income tax?
Income tax is money you pay to HMRC on your earnings. It might not just be your central employment income either; you could pay income tax on other revenue sources like renting out a house or interest on savings. All of it contributes to one single income that gets taxed each year.
Income tax is split into bands depending on how much you earned that year. The idea is this makes the system fairer with those earning more paying more. You can read more about income tax bands in our article here. The structure for what you pay to HMRC is:
- Tax allowance: 0% of earnings (You’ve earned between £0 and £12,570)
- Basic rate: 20% of earnings (You’ve earned between £12,571 and £50,270)
- Higher rate: 40% of earnings (You’ve earned between £50,271 and £150,000)
- Additional rate: 45% of earnings over £150,000
Income tax forms the Government's main source of income, collected by HMRC on behalf of the Government. This money is then distributed to public services and goods, like the NHS, education and infrastructure like roads, parks and street lighting.
There are some tax reliefs for income, such as child tax credits, pension credits and working tax credits. So it could be worth looking into these if any apply to you.
How do I pay income tax?
Paying income tax depends on your employment status. You could either be:
- An employee - In which case you’ll have your income tax taken out of your salary with each pay cheque (along with your national insurance payment) - this is referred to as Pay-as-you-earn (PAYE). It means you don’t need to worry about organising income tax as your employer deducts it for you.
- A sole trader - You’ll need to do a self-assessment tax return, which you can read more about in our article here. The more organised you are about this the better, as you can expense a range of costs, so keep all receipts and bills. The same tax bands apply but you only pay tax on your profit (revenue minus expenses) so really stay on top of what you can expense.
- A limited company - If you set up a limited company then the company will pay 19% corporation tax (which is 19% of all revenue) while any salary you take will be taxed at the usual amounts. You’ll also need to complete a self-assessment tax return each year to cover your corporation tax while a personal salary can follow the PAYE scheme as an employee.
The usual cut off date to complete your self-assessment is the 31st of January if you’re doing it online, and 31st of October if you’re completing the form by post.
How do I work out how much income tax I should pay?
It’s not just about understanding tax bands when it comes to knowing what income tax you should pay. If you’re self-employed or running a side hustle then you’ll need to stay on top of your ingoings and outgoings because these will decide how much you pay.
You’ll have various running costs depending on the work you do. You can deduct these costs from your taxable profit as long as they’re eligible expenses. So if you earn £50,000 and you claim £9,000 in expenses, you’d only be taxed on £41,000 for the year.
You’re also entitled to a £1,000 unclaimed in tax, which can be a bit confusing given the £12,570 allowance. The difference is that if you earn less than £1,000 then you don’t need to do anything about it. If you earn between £1,000 and £12,570 you will still need to complete a self assessment. Note that if you use the £1,000 tax free trading allowance you won’t be able to claim expenses, so it’s worth deciding what brings you more value.
You might expense things like:
- A laptop
- Food and drink from meeting clients
- If you work from home then some of your bills, council tax and wifi
- Your office or workspace if you have one
- Software and hardware
The list can often be more extensive than you think, so making sure you document all receipts can save you a lot of hassle and money.
How can Earnr help?
Earnr allows you to keep track of incomings and outgoings throughout the year, all you have to do is connect your bank accounts and mark your transactions. We can then use this data to project a real-time tax estimate and show you whether or not you need to submit tax return.
Once you know how much you need to pay you can automate the whole self assessment tax return from the app.