What Is Income Tax and How Does It Work?

Income Tax is a tax you pay on various types of income you receive throughout the year. Understanding what Income Tax is, which income is taxable, and how you pay it is essential whether you're employed, self-employed, a landlord, or receiving a pension. This guide explains the basics of how the UK Income Tax system works.

What is Income Tax?

Income Tax is a tax charged on money you earn and other income you receive. However, you don't have to pay tax on all types of income—some are tax-free, and many people benefit from allowances that reduce the amount of tax they owe.

Most people in the UK receive a Personal Allowance of tax-free income. This is the amount of income you can receive before you pay any tax. The amount of tax you pay can also be reduced by tax reliefs if you qualify for them.

What income is taxable?

You pay Income Tax on:

• Money you earn from employment
• Profits you make if you're self-employed, including income from services you sell through websites or apps
• Some state benefits (see below for details)
• Most pensions, including state pensions, company and personal pensions, and retirement annuities
• Rental income (unless you're a live-in landlord receiving less than the Rent a Room Scheme limit)
• Benefits you receive from your job
• Income from a trust
• Interest on savings over your savings allowance

What income is tax-free?

You don't pay Income Tax on:

• The first £1,000 of income from self-employment—this is your 'trading allowance'
• The first £1,000 of income from property you rent (unless you're using the Rent a Room Scheme)
• Income from tax-exempt accounts, such as Individual Savings Accounts (ISAs) and National Savings Certificates
• Dividends from company shares under your dividends allowance
• Some state benefits (see below for details)
• Premium Bond or National Lottery wins
• Rent you receive from a lodger in your house that's below the Rent a Room Scheme limit

If you only occasionally sell items or rent out property (for example through auction websites or short-term rental apps), you should check whether you need to tell HMRC about this income.

Taxable and tax-free state benefits

State benefits you pay tax on

The most common taxable benefits include:

• Bereavement Allowance (previously Widow's pension)
• Carer's Allowance or (in Scotland only) Carer Support Payment
• Contribution-based Employment and Support Allowance (ESA)
• Incapacity Benefit (from the 29th week you receive it)
• Jobseeker's Allowance (JSA)
• Pensions paid by the Industrial Death Benefit scheme
• The State Pension
• Widowed Parent's Allowance

Tax-free state benefits

The most common tax-free benefits include:

• Attendance Allowance
• Bereavement support payment
• Child Benefit (though this is income-based—you may need to use the Child Benefit tax calculator to check if you'll have to pay tax)
• Disability Living Allowance (DLA)
• Free TV licence for over-75s
• Guardian's Allowance
• Housing Benefit
• Income Support (though you may have to pay tax on Income Support if you're involved in a strike)
• Income-related Employment and Support Allowance (ESA)
• Industrial Injuries Benefit
• Lump-sum bereavement payments
• Maternity Allowance
• Pension Credit
• Personal Independence Payment (PIP)
• Severe Disablement Allowance
• Universal Credit
• War Widow's Pension
• Winter Fuel Payments and Christmas Bonus

How you pay Income Tax

There are two main ways you pay Income Tax, depending on your circumstances.

Pay As You Earn (PAYE)

Most people pay Income Tax through PAYE. This is the system your employer or pension provider uses to deduct Income Tax and National Insurance contributions before they pay your wages or pension. Your tax code tells your employer how much to deduct.

Your tax code can also take account of taxable state benefits. If you owe tax on them (for example on the State Pension), it's usually deducted automatically from your other income.

If the State Pension is your only income, HMRC will write to you if you owe Income Tax. You may need to fill in a Self Assessment tax return.

Self Assessment tax returns

If your financial affairs are more complex (for example you're self-employed or have a high income), you may pay Income Tax and National Insurance through Self Assessment. You'll need to fill in a tax return every year.

You must fill in a Self Assessment tax return if you earned more than either:

• £1,000 from self-employment
• £2,500 from other untaxed income, for example from tips or renting out a property

If your income from renting out a property was between £1,000 and £2,500, you should contact the Income Tax helpline for guidance.

Working out if you need to pay Income Tax

To work out if you should be paying Income Tax, follow these steps:

1. Add up all your taxable income, including taxable state benefits

2. Work out your tax-free allowances

3. Take your tax-free allowances away from your taxable income

If there's anything left after deducting your allowances, you're a taxpayer. If you're not already paying tax, contact the Income Tax helpline.

If there's nothing left, you should not be paying tax and may be due a refund.

Checking you're paying the right amount

For the current tax year (6 April 2025 to 5 April 2026), you can check your Income Tax payments and work out how much Income Tax you should be paying online.

You can also check how much Income Tax you paid last year (6 April 2024 to 5 April 2025) or estimate how much you should have paid in a previous year.

If you cannot use these online services, you can check you've paid the right tax by contacting HMRC or getting help from an accountant.

Sources

• Income Tax: introduction

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.