Tax & Admin

How Do Tax Brackets Work?

Business Advice | 5 June 2023 | 11 months ago

There is a lot of information out there about tax brackets, but some of it can be confusing and unclear. This leaves a lot of people wondering how tax brackets work and not knowing how a change in income could affect how much tax they pay. Plus, tax relief and allowances need to be taken into account. To help the many people that are confused about how tax brackets work, we have created a helpful guide.

Personal Allowance

In the UK, everyone is entitled to something called Personal Allowance, which is a tax-free amount that you can earn without paying anything. For the 2022/2023 tax year, the Personal Allowance amount is set at £12,570 but this does change slightly each year. This means that £12,570 of your income is tax-free and it’s not until you earn more than the Personal Allowance that you start paying tax. Even then, you only pay tax on earnings above this, and the £12,570 remains tax-free.

However, your Personal Allowance decreases gradually when you earn over £100,000. It goes down by £1 for every £2 that your income is above £100,000, meaning that your Personal Allowance is zero if you earn over £125,140.

Progressive Taxation

Tax brackets refer to the varying income ranges at which different tax rates are applied, meaning that the amount of tax that you pay in the UK is based on your earnings. Though everyone is entitled to a Personal Allowance – unless you earn over £125,140, as explained above – the amount of tax you pay over this amount can vary, depending on what income range you fall into. You will need to pay more tax as your income increases, ranging from 20% to 45%.

This is called a progressive taxation system, and it centres on applying a higher tax rate to those who earn more. There are three bands of tax in the UK; basic, higher and additional.

  • Basic Tax Rate – Once your earnings have surpassed the Personal Allowance, you fall into the Basic Rate category. The tax rate for this bracket is 20%, but you only pay Basic Rate on the portion of your income that falls into this band, and not on your Personal Allowance. For the 2022/2023 tax year, Basic Rate applies to earnings up to £50,270.
  • Higher Tax Rate – The Higher Rate of tax applies to income between £50,271 and £150,00. You will pay a tax rate of 40% on any earnings between these amounts, and only on the income that falls into the Higher Tax bracket. You will continue to pay the Basic Rate of 20% for income below this rate.
  • Additional Tax Rate – The highest tax bracket in the UK is the Additional Rate, and this applies to income over £150,000. You will pay a tax rate of 45% on any earnings over £150,000 and you will continue to pay the Basic Rate and Higher Rate on income that falls into the other categories.
As well as paying tax, everyone also needs to pay National Insurance contributions. These are used to fund state benefits and pensions, and they are payable on top of the tax that you need to pay. It’s important to remember that tax brackets and rates can change from one tax year to the next, so it’s important to stay up to date with the most recent information. Everything you need can be found on the HMRC website. There are also a number of calculators online aimed at working out how much tax you will pay, depending on your income and allowances.

Tax Relief

Depending on your circumstances, you might be entitled to tax allowances or tax relief. These reduce the amount of tax you have to pay on your income. There are a range of tax relief and allowances available, but not everyone is eligible for them.

  • Blind Person’s Allowance (BPA) – This reduces the amount of taxable income that you have to pay tax on, and this is added on top of the personal allowance. Currently, the BPA is £2,870 and you can use it yourself or transfer some to your partner.
 

  • Marriage Allowance – The Marriage Allowance is a transferable tax allowance for married couples and civil partners, and it’s £1,260. This allows a spouse or partner who is not liable to pay Higher Rate or Additional Rate tax to give up some of their personal allowance, which creates a tax credit of £252 for their partner.
 

  • Married Couple’s Allowance (MCA) – This is different to the Marriage Allowance, and it’s only available if you are married or in a civil partnership, and one of you was born before 6th April 1935. MCA reduces the amount of your tax bill, and does not reduce the amount of taxable income you have.
 

  • Maintenance Payments Relief – Maintenance Payments Relief reduces the amount on your tax bill by 10%, but it’s something that is being phased out slowly. You need to meet a lot of criteria to be eligible for Maintenance Payments Relief and the maximum relief is £4,010.
To calculate your taxable income, you first need to determine your total income. This is done by adding up all of your income – including investment income and rental income – and determining how much you earned in the tax year. Then you need to decide if you are entitled to any tax relief or allowances, and if you are, deduct these from your income. The figure you are left with is your taxable income.

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