According to the UK Treasury, HMRC collected £715.5 billion in taxes through 2021/22, with receipts from income tax, capital gains and National Insurance contributions (NICs) accounting for 56% of annual receipts.
Of course, tax remains a controversial talking point in the UK, especially in light of the current cost-of-living crisis and the struggles that households face when trying to optimise their disposable income levels.
But what exactly is tax, and what do you need to know about your liability? Here’s a beginner’s guide to help you on your way!
What is Tax?
Technically speaking, tax describes a compulsory contribution to the state’s revenue, which is levied by the government using a third-party organisation (HMRC in the UK).
Tax can be levied against a number of different income streams, with workers’ earnings and investments the most generative from the perspective of the Treasury. Corporation tax may also be levied against business profits, while value added tax (VAT) is added at a fixed rate to the cost of selected goods, services and transactions.
Not all income earned is taxable, with other categories of income classed as being non-taxable, exempt or tax-free. For example, all workers have a standard personal allowance of £12,570, and it’s only income earned above this threshold that is subject to tax levies.
Similarly, certain investment assets are also free from the burden of taxation, and it’s important to keep this in mind when building your portfolio.
Income Tax and Personal Allowance Explained
We’ve already touched on personal allowances, which describe a starting income tax band and ensure that only income earned above the £12,570 threshold is levied.
There are three further tax bands; namely basic, higher and additional rates. The basic rate is 20% and applies to income earned between £12,570 and £50,270, while a higher rate is charged at 40% of all income earned between £50,271 and £150,000.
The additional rate (often referred to as the 45p rate) is applied to any earnings above £150,000. If you earn this amount in income, you’ll be charged at a rate of 45% and have to contribute significantly more to the Treasury.
It’s important to understand this if you’re to manage your finances effectively, while tax reliefs may also be applied to certain payments and expenses. For example, you can claim tax relief on your pension contributions and all charitable donations, while maintenance payments are also classed as tax deductible.
To understand tax relief in more detail and learn how to optimise your earnings, we’d recommend consulting a reputable tax guide to help you on your way.
This will provide accurate insights that help you to minimise your annual tax burden while continuing to comply with UK law and remaining within the boundaries of HMRC guidelines.
