What's a tax band and how do they work?
It's commonly accepted that most of us will be taxed on our income. However, not everyone can afford to pay the same amount. HMRC uses a system of tax bands to make income tax fairer and charge different rates to people earning different amounts of money.
In England and Wales there are four different bands for income tax:
- Tax-free allowance
- Basic rate
- Higher rate
- Additional rate
It all starts with an allowance
The first band, the tax-free allowance, is the amount of money you can earn before paying tax.
The standard worker in the UK has a tax free allowance of £12,570 for the tax year 2021/22. Your tax-free allowance can go up or down depending on your marital status, your total income, or other specific circumstances. For example:
- If you earn over 100,000 your tax-free allowance is reduced by £1 for every £2 you earn over 100k
Incremental tax bands
After the tax allowance, income is split into bands, each of which is taxed at a different rate. It's important to remember that moving into another band doesn't mean you pay more tax on all your income, just the bit that's over the threshold.
The Basic rate band
The Basic rate applies to all income you earn above your tax-free allowance and before you are charged the higher rate. In the 21/22 tax year, this is between £12,571 and £50,270. Anything you earn within the band is taxed at 20%.
As an example, if someone earns £13,570 a year, they pay 0% tax on the first £12,570, then on the additional £1000, they pay 20% (or £200).
Higher and Additional rate bands
The Higher and Additional rates work in a similar way.
- the Higher rate (40%) applies to the band of income from £50,271 to £150,000
- the Additional rate to those earning very high salaries above £150,000
To give another example, take someone earning £55,000. They would pay:
- 0% on the first £12,570
- 20% on the £37,699 income in the band between £12,571 and £50,270 - this would come to £7,540
- 40% on the £4,730 above £50,270 - which would come to £1,892.
- So their total income tax would be £7,540 + £1,892 = £9,432 (not including National Insurance)
Why does it work like this?
The system is designed to tax people more on their higher earnings. The logic being that as people earn more, they can afford to pay more tax to HMRC.
How does my self employed or side income play into this?
Your income tax is based on your total income. If you have a side income, it's everything from your employer plus your profit from your side income. While your employment income is taxed monthly through PAYE, your side income is taxed when you submit your tax return.
Consider someone earning £15,000 from employment and £5,000 from their side income:
- Their tax allowance is applied (in full) to the first £12,570 of their income, they pay 0% on that.
- The remaining £2,430 of their income is taxed at 20% in the basic rate band - that's £486.
- The £5,000 of side hustle income also falls in the basic rate band and is taxed at 20% - that's £1,000
- Their total income tax is £486 + £1,000 = £1,486.