What is income tax?
Income tax is charged on an individual’s personal income. The amount and rate of income tax that you pay will depend on the amount that you receive and the way in which you receive it.
The most common forms of taxable income for an individual are as follows:
- Earnings from employment.
- Earnings from self-employment.
- Earnings from pensions, including the state pension.
- Rental income.
- Interest from savings.
- Interest and dividends from shares.
What are the income tax rates for the 2019/2020 tax year?
The tax free personal allowance
The tax free personal allowance is currently £12,500. This means that you can earn up to £12,500 from any of the sources mentioned above before you start paying tax.
If you earn dividend income then your first £5,000 of dividend income is also tax free, regardless of your total taxable income.
If you have income from savings then it is tax free if your total taxable income is £17,500 or less.
However, if your total earnings go over £100,000 then this allowance starts to disappear at the rate of £1 for every £2 over £100,000 that you earn. So when your income reaches £125,000, the tax free personal allowance will have completely disappeared.
There are also more generous allowances for people born before the 5th of April 1948.
Basic rate tax
The next £37,500 of your income falls into basic rate tax which is 20%, apart from dividend income which is taxed at 7.5% after you have exceeded your dividend allowance.
As a basic rate tax payer you can earn up to £1,000 on your savings before having to pay tax.
Higher rate tax
The next £100,000 of your income falls into higher rate tax which is taxed at 40%. This is for everything apart from dividend income which is taxed at 32.5%.
As a higher rate tax payer you can earn up to £500 on your savings before having to pay tax.
Additional rate tax
If your income exceeds £150,000 then you will pay 45% on your earnings after that point, with a rate of 38.1% for dividend income.
As an additional rate tax payer all your savings income is subject to tax (apart from funds held in Individual Savings Accounts, ISAs)
If my income is from my own limited company, how does the above apply?
There are two main factors to consider when your income is derived from your own limited company:
You can opt to be paid by salary, by dividends or by a mix of both. The most tax efficient route is to pay yourself a small salary with the rest of your income taken as dividends.
You do not have to extract all the profit that your company makes. So, if your lifestyle allows you to limit your earnings to the amount of the basic rate tax allowances, you needn’t pay any higher rate tax. You can leave the funds in the company until you eventually decide to close the company or have a period where no income is coming in from contracts.
Further information on the tax efficiencies of leaving funds in a company until it is time to close the company down can be found here: What is Entrepreneurs’ relief?
For more tax information, why not speak to one of our qualified accountants on 0207 0962659 or click here to request a call back.
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