Taxes
Taxes questions can initially appear intimidating but have the benefit of always working in the same way. You may be presented with a lot of background information, which will always talk about:
- How taxes work
- If needed, the amount that is considered personal allowance
Unless stated otherwise, you can assume taxes to be calculated on annual income.
The Basics
Let’s use the tax table below:
- Personal allowance: £5,000
| Annual Taxable Income Bracket (£) | Tax Rate |
|---|---|
| 0 < x ≤ 15,000 | 10% |
| 15,000 < x ≤ 30,000 | 20% |
Taxable income doesn’t include “personal allowance”. Someone earning 30,000 will have a taxable income of 25,000.
How do we calculate tax?
You only pay tax on the amount of money above the minimum of the bracket. For our theoretical earner with a taxable income of £25,000, the amount of tax they’ll pay will be:
- 10% on the first 15,000 = £1,500
- 20% on any remaining amount of money above 15,000:
- 25,000 – 15,000 = 10,000
- Only paying 20% tax on this 10,000 = 2,000
- The total tax paid will be 1,500 + 2,000 = £3,500.
Different Tax Tables
A tax table might look like this instead:
| Annual Income Bracket (£) | Tax Rate |
|---|---|
| 0 < x ≤ 5,000 | 0% |
| 5,000 < x ≤ 20,000 | 10% |
| 20,000 < x ≤ 35,000 | 20% |
Instead of the table being just about taxable income, it includes overall income, and there is no personal allowance stated. This is accounted for by the first row in the table: there is no tax on the first £5,000 earned. If we wanted to calculate tax for someone earning £30,000, we would follow the exact same steps as above.
Sometimes, we can have a third row:
| Annual Income Bracket (£) | Tax Rate | Total Tax Paid (£) at the Top of This Income Bracket |
|---|---|---|
| 0 < x ≤ 5,000 | 0% | 0 |
| 5,000 < x ≤ 20,000 | 10% | 1,500 |
| 20,000 < x ≤ 35,000 | 20% | 4,500 |
This is telling you what someone who earns exactly the highest amount in the bracket will pay, no further calculations needed. Someone earning £20,000 would pay exactly £1,500 in taxes, and someone earning £35,000 would pay exactly £4,500 in taxes.
This is handy as it allows you to skip a step. In our calculation from below, we wouldn’t have had to work out the first 10% of 15,000. Similarly, if someone earned £45,000 we’d only have to calculate the tax on the £10,000 above £35,000, and add this to £4,500.