Finance · Topic 3 of 19
Income Tax
Theory
Income tax is paid to the government to help fund public services. For most employees, this is automatically deducted from their wages throughout the year through a system called PAYE (Pay As You Earn).
1. The Pension Trap (The Ultimate Exam Trick)
Unlike National Insurance, which is calculated before pension deductions, Income Tax is strictly calculated on a person's Taxable Income.
Crucial Exam Rule:
If a question states that an employee pays a percentage into a pension, you must subtract that pension amount from their gross salary before you even look at the tax bands. Failing to do this will result in losing several marks!
2. The 2025/26 Scottish Tax Bands
In the Higher Applications 2026 exam, you will be expected to use the 2025/26 tax year bands provided in your data booklet. Like National Insurance, income tax uses a progressive "chunking" system:
- Personal Allowance (0%): Up to £12,570. This is tax-free.
- Starter rate (19%): £12,570 – £15,397.
- Basic rate (20%): £15,397 – £27,491.
- Intermediate rate (21%): £27,491 – £43,662.
- Higher rate (42%): £43,662 – £75,000.
- Advanced rate (45%): £75,000 – £125,140.
- Top rate (48%): Over £125,140.
Strategy: Calculate the maximum physical amount of money that can fit inside each individual band, and then multiply it by the percentage for that band.
Worked examples
Example 1
Example 1: Basic Income Tax Calculation
Callum earns a gross annual salary of £22,000. He has opted out of his workplace pension scheme. Calculate his annual income tax deduction for the 2025/26 tax year.
Because Callum has no pension, his gross salary is his taxable income. His earnings cross through the 19% band and finish in the 20% band.
Starter Rate (19%):
- Maximum in band: £15,397 - £12,570 = £2,827.
- Tax: 0.19 × £2,827 = £537.13.
Basic Rate (20%):
- Amount in band: £22,000 - £15,397 = £6,603.
- Tax: 0.20 × £6,603 = £1,320.60.
Total Annual Tax:
£537.13 + £1,320.60 = £1,857.73.
Example 2
Example 2: The Pension Trap (Calculating Monthly Tax)
Sarah earns a gross annual salary of £36,000. She contributes 6% of her gross annual salary into her workplace pension scheme. Calculate the amount of income tax Sarah expects to pay each month for the 2025/26 tax year.
Trap Check: We must calculate her taxable income by deducting her pension first!
Calculate Taxable Income:
- Pension: 0.06 × £36,000 = £2,160.
- Taxable Income: £36,000 - £2,160 = £33,840.
Starter Rate (19%):
- Amount in band: £15,397 - £12,570 = £2,827.
- Tax: 0.19 × £2,827 = £537.13.
Basic Rate (20%):
- Amount in band: £27,491 - £15,397 = £12,094.
- Tax: 0.20 × £12,094 = £2,418.80.
Intermediate Rate (21%):
- Amount in band: £33,840 - £27,491 = £6,349.
- Tax: 0.21 × £6,349 = £1,333.29.
Calculate Total Annual Tax:
£537.13 + £2,418.80 + £1,333.29 = £4,289.22.
Calculate Monthly Tax:
£4,289.22 ÷ 12 = £357.44.
Example 3
Example 3: Higher Earner (Advanced Rate)
Mark is a corporate director earning a gross annual salary of £78,000. He makes no pension contributions. Calculate Mark's total annual income tax deduction for the 2025/26 tax year.
Mark's earnings cross through five different tax bands, reaching the Advanced Rate.
- Starter Rate (19%): (£15,397 - £12,570) = £2,827. Tax = 0.19 × £2,827 = £537.13.
- Basic Rate (20%): (£27,491 - £15,397) = £12,094. Tax = 0.20 × £12,094 = £2,418.80.
- Intermediate Rate (21%): (£43,662 - £27,491) = £16,171. Tax = 0.21 × £16,171 = £3,395.91.
- Higher Rate (42%): (£75,000 - £43,662) = £31,338. Tax = 0.42 × £31,338 = £13,161.96.
- Advanced Rate (45%): (£78,000 - £75,000) = £3,000. Tax = 0.45 × £3,000 = £1,350.00.
Total Annual Tax:
£537.13 + £2,418.80 + £3,395.91 + £13,161.96 + £1,350.00 = £20,863.80.