How Tax Brackets Work

We all need to pay into the state purse. Not all of us, however, are making the same amount of money. To make the contributions fairer, income tax brackets decide how much you’re meant to give to HMRC.

How tax brackets work is a subject that often requires clarification. Thankfully, it doesn’t need to be complicated. GoSimpleTax are here with everything you need to know about tax bands, including the thresholds for 2022/23.

The proportional increases for higher earners

Every UK taxpayer has a Personal Allowance of £12.570, unless you claim Marriage Allowance or Blind Person’s Allowance (which can make your Personal Allowance bigger) or your taxable income is over £123,000 (which makes your Allowance decrease gradually until it hits zero at an income of £125,140). You can earn up to this amount for the tax year 2022/23 without paying a single penny back to HMRC.

Beyond that, you are classed as either a basic rate, higher rate or additional rate taxpayer. Earnings over £12,571 and below £50,270 are subject to 20% income tax, which is either deducted from your wage slip by your employer or declared on your Self Assessment if you earn outside of PAYE.

Your status will change yet again when you hit several tax brackets. Let’s take a look:

Those earning £12,570 or less pay nothing.

Basic rate tax (20%) applies to earnings over £12,571 a year, but less than £50,270.

This rises to 40% when you earn more than £50,271.

A final jump (called the additional rate) is liable for people with an income greater than £150,000 – pegged at a 45% tax rate.

Let’s see how tax brackets work in practice. If an individual earns £25,000 taxable income in a year, they would be taxed on the basic rate. Their Personal Allowance of £12,570 deducted from this total means that the individual would be taxed at 20% on the remaining figure – £12,430.

How tax brackets work for capital gains

Capital Gains Tax (CGT) applies to anyone who sells an asset – such as a business, your own property or shares in a company – and makes a profit from it. You are only taxed on the profit and, again, there is a tax-free allowance (called the Annual Exempt Amount) every financial year. This is currently £12,300 for 2021/22 & 2022/23 tax year.

The tax bands are decided on your earning status, so your total taxable income needs to be figured out first. Once this has been done, the following rates apply:

10% and 20% tax rates for individuals. This is not including residential property and carried interest, which would bump up the rates to 18% and 28% respectively;

20% for trustees or for personal representatives of someone who has died. This is not including residential property, which would increase the rate to 28%;

Providing you meet certain stipulations, Entrepreneurs’ Relief can be available for the sale of business assets. This brings down the CGT tax rate to 10%;

28% on property where the Annual Tax on Enveloped Dwellings is paid – the Annual Exempt Amount is not applicable; and

20% for companies (non-resident CGT on the disposal of a UK residential property).

It’s important to note that the rate applied utilises the available tax brackets we’ve mentioned. This means that parts of a gain could be taxed at different rates.

Let’s take an individual with £27,270 PAYE income as an example. If he or she sells shares with a taxable gain of £30,000 (after the Annual Exempt Amount has been applied), the 20% CGT rate would apply on £7,000 of it, and the remaining amount would be taxed at 10%. This is because, with their PAYE income already taxed at the basic rate of 20% (minus Personal Allowance), their total taxable income (with the gains included) would reach the £50,271 amount required to put them in the higher rate band.

Building a full image of how tax brackets work is crucial to paying HMRC the right amount. Follow these tips to ensure you save the right amount of tax for 2022/23, and avoid nasty surprises when you come to complete your Self Assessment.

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Blog content is for information purposes and over time may become outdated, although we do strive to keep it current. It's written to help you understand your Tax's and is not to be relied upon as professional accounting, tax and legal advice due to differences in everyone's circumstances. For additional help please contact our support team or HMRC.