Income tax

Published Monday 22 June 2026

Table of contents

• Income tax (definition)
• What is income tax used for?
• Who pays income tax?
• Personal Allowance
• UK income tax rates and bands 2026/27
• 3 types of income tax
• How to calculate income tax
• Reporting and paying business income tax
• What info does a business need to calculate income tax?
• Simplify your income tax with Xero
• FAQs on income tax

Key takeaways

• Income tax is a government levy on your earnings, and the rate you pay depends on how much you earn. For the 2026/27 tax year, the Personal Allowance is £12,570, the basic rate is 20%, the higher rate is 40%, and the additional rate is 45%.
• If you're a sole trader or in a partnership, your business profits are added to your personal income and taxed through Self Assessment. Companies pay corporation tax on their profits instead, at rates ranging from 19% to 25%.
• HM Revenue and Customs (HMRC) collects income tax, and you're responsible for reporting your income accurately. Keeping your records organised throughout the year makes filing simpler and helps you avoid penalties.
• Making Tax Digital (MTD) for Income Tax is an upcoming requirement that will change how self-employed individuals and landlords report their income to HMRC. Using accounting software like Xero can help you stay compliant and prepared.

Income tax (definition)

Income tax is a government levy on the earnings of individuals and businesses. The money collected funds public services such as the NHS, schools, and infrastructure.

Individuals and businesses submit returns declaring their taxable income. Complying with tax rules and filing accurately helps you avoid penalties from HMRC. Check the HMRC website for details on penalties.

What is income tax used for?

The income tax you pay goes directly towards funding public services across the UK.

These services include the National Health Service (NHS), state education, public transport infrastructure, social welfare programmes, and defence. Income tax is one of the largest sources of government revenue, and the amount collected each year shapes how much the government can invest in these areas.

For small business owners, understanding where your tax contributions go can help frame income tax as part of doing business in the UK rather than simply a cost to minimise.

Who pays income tax?

Most people who earn above a certain threshold pay income tax. This includes employees, self-employed individuals, company directors, and pensioners.

Taxable income covers a range of sources:

• employment wages and salaries
• self-employment and sole trader profits
• pension income (state and private)
• rental income from property
• savings interest above your Personal Savings Allowance
• dividend income above the dividend allowance

If your total income from all sources stays below the Personal Allowance (currently £12,570), your income tax bill is £0. Once your earnings exceed that threshold, you start paying tax on the amount above it.

Personal Allowance

The Personal Allowance is the amount you can earn each tax year before you start paying income tax. For the 2026/27 tax year, it's set at £12,570.

This means the first £12,570 of your income is tax-free, regardless of whether it comes from employment, self-employment, or other sources. You only pay income tax on earnings above this threshold.

There's an important taper to be aware of if your income is higher. Once your total income exceeds £100,000, your Personal Allowance is reduced by £1 for every £2 you earn above that figure. This means the allowance is fully eliminated at £125,140.

Married couples and civil partners may also be eligible for Marriage Allowance, which lets one partner transfer up to £1,260 of their unused Personal Allowance to the other. This can reduce the receiving partner's tax bill by up to £252 per year.

UK income tax rates and bands 2026/27

Income tax in the UK is progressive, meaning you pay different rates on different portions of your income. Here are the current rates for England, Wales, and Northern Ireland for the 2026/27 tax year.

• Personal Allowance: 0% on income up to £12,570
• Basic rate: 20% on income from £12,571 to £50,270
• Higher rate: 40% on income from £50,271 to £125,140
• Additional rate: 45% on income over £125,140

Scotland sets its own income tax rates and bands, which differ from the rest of the UK. Check the HMRC income tax rates page for the latest Scottish rates and any changes for future tax years.

The UK tax year runs from 6 April to 5 April. All rates and thresholds apply within that period.

3 types of income tax

The type of income tax you or your business pays depends on your situation.

Personal income tax

Individuals pay taxes on their personal income. These taxes are progressive, meaning you pay higher rates as your income rises through each tax band.

Business income tax for sole traders and partnerships

Profits (or losses) from the business are combined with your other income and reported on your personal Self Assessment return. You pay personal income tax on the total amount.

Partnerships file a separate business tax return as well, which HMRC checks against the personal returns of each partner.

Business income tax for companies

Companies pay corporation tax on their net profits rather than income tax. In the UK, the corporation tax rate depends on the level of taxable profits. For the 2026/27 tax year, companies with profits under £50,000 pay a small profits rate of 19%, while those with profits over £250,000 pay the main rate of 25%. Marginal relief is available for profits in between.

Any dividends or salaries the company pays its owners are then taxed as part of the recipient's personal income tax.

How to calculate income tax

The basic formula to calculate income tax is straightforward, but the details depend on whether you're calculating personal income tax or corporation tax.

Income tax = Taxable income x Tax rate

You may need to apply several tax rates when calculating progressive income taxes. See the examples below.

Example corporation tax calculation

A company with revenue of £240,000 and expenses of £140,000 has taxable profits of £100,000. Because this falls between the small profits threshold (£50,000) and the main rate threshold (£250,000), the company qualifies for marginal relief.

Taxable profits (revenue minus expenses) x Main rate

(£240,000 minus £140,000) x (25/100)

= 100,000 x 0.25

= 25,000

After marginal relief of £2,250, the company owes £22,750 of corporation tax.

If the company distributes after-tax profits to its owners, they'll need to declare that income on their personal tax return as well.

Example progressive income tax calculation

An individual earns £70,000 in wages and makes £30,000 in profits from a sole trader business. The total income of £100,000 touches 3 tax bands.

This person would pay:

• 0% on the first £12,570 (Personal Allowance)
• 20% on the next £37,700 (basic rate: £12,571 to £50,270)
• 40% on the remaining £49,730 (higher rate: £50,271 to £100,000)

(£12,570 x 0) + (£37,700 x 0.20) + (£49,730 x 0.40)

= 0 + 7,540 + 19,892

= 27,432

This individual owes £27,432 of income tax.

Reporting and paying business income tax

All forms of businesses pay income tax only on their net profit (before taxes). When filing a return, you're expected to report revenue and expenses, and may be asked to provide copies of the corresponding invoices and receipts.

Timely invoice collection supports accurate reporting. Xero Small Business Insights data from the March quarter of 2026 shows UK small businesses wait an average of 29 days to be paid, with invoices arriving 8.2 days late on average. These delays can complicate end-of-year revenue reconciliation.

If you're an employee, your employer deducts income tax from your pay through PAYE (Pay As You Earn) before you receive it. Self-employed individuals and sole traders report their income through Self Assessment, filing a tax return each year by 31 January following the end of the tax year.

You may also be asked to prepay taxes in instalments throughout the year to avoid big end-of-year bills. These instalment plans, known as payments on account, are typically based on the previous year's tax bill.

Revenue can shift between periods, which affects how accurately you can project your instalments. According to Xero Small Business Insights, UK small business sales growth slowed to +2.9% year-on-year in the March quarter of 2026, down from +5.2% the previous quarter.

MTD for Income Tax is an upcoming HMRC requirement that will change how self-employed individuals and landlords earning over £50,000 report their income. Instead of filing a single annual return, you'll need to send quarterly updates to HMRC using compatible software. Xero accounting software is designed to support MTD requirements, helping you work towards compliance as the rules change.

What info does a business need to calculate income tax?

You'll need a few key pieces of information to calculate your income tax accurately.

• Revenue and expenses, found on your income statement (also known as a profit and loss report)
• Depreciation claims for assets owned by the business
• Tax credits, if applicable, which can be subtracted from the taxes you owe

Software like Xero can help simplify your income tax by capturing transaction data, including copies of invoices and receipts. It can also automate depreciation calculations and generate financial reports. Hubdoc, included with all Xero business plans, can help make paperless record-keeping straightforward by pulling in bills and receipts automatically.

It's a good idea to get support from a tax professional. You can find one in the Xero advisor directory.

Simplify your income tax with Xero

Staying on top of your income tax is straightforward when your financial records are organised throughout the year. Filing your return becomes a matter of pulling together the figures rather than scrambling to find paperwork.

Xero can give you real-time visibility into your income and expenses and help automate bank reconciliation. You can also generate reports to support you at tax time. With MTD for Income Tax on the horizon, having compatible software in place now can help you prepare for when the requirements take effect. Get one month free.

FAQs on income tax

Here are answers to some common questions about income tax in the UK.

What is the Personal Allowance for 2026/27?

The Personal Allowance for the 2026/27 tax year is £12,570. If your income exceeds £100,000, the allowance reduces by £1 for every £2 earned above that amount.

Do I need to pay income tax on savings interest?

It depends on how much interest you earn. Basic rate taxpayers get a £1,000 Personal Savings Allowance, higher rate taxpayers get £500, and additional rate taxpayers don't get an allowance.

What is the difference between income tax and National Insurance?

Income tax is charged on your total taxable income across all sources. National Insurance is a separate contribution linked to employment and self-employment earnings that helps fund specific benefits like the State Pension.

When is the Self Assessment deadline?

The deadline for online Self Assessment returns is 31 January following the end of the tax year. For paper returns, the deadline is 31 October.

What is Making Tax Digital for Income Tax?

MTD for Income Tax will require self-employed individuals and landlords earning over £50,000 to send quarterly income updates to HMRC using compatible software. The threshold is expected to lower over time, eventually covering more businesses.