10 ways to reduce your income tax

It may not come as a surprise, but did you know that income tax makes up the largest source of funds for the UK government, coming in at around 30% of the entire revenue? National Insurance (NI) closely follows as the second largest source, and although it may feel very similar to income tax because how much you pay in NI is based on how much you earn, NI remains its own distinct type of tax. Whilst collecting income tax is essential and necessary to financing public services, it’s just as important to taxpayers that you never pay more than you need to. Our team have created this checklist on 10 ways to reduce your income tax to help you legitimately reduce the amount of tax you have to pay and keep more of what you earn.

How does income tax work in the UK?

In the UK, every taxpayer starts off with an entitlement to an annual allowance called the personal allowance. This allowance determines how much can be earnt tax-free each tax year before the rest of your earnings become subject to income tax.

Income tax is then charged at three different rates depending on your total annual earnings. Earnings are made up from various sources including but not limited to:

• PAYE income
• Benefits-in-kind
• Self-employment income
• Casual trading
• Pension income
• Savings and interest
• Dividends (although this is subject to its own rates and holds its own separate annual allowance)
• Foreign earnings
• Rental income
• Capital gains (whilst not subject to income tax, the amount of gain earned is taken into account for income tax purposes)

The three different rates are often referred to as the different income tax bands or tax brackets. Each portion of your income that falls into a different tax band will be subject to the applicable rate.

How much is the personal allowance?

For the current tax year, the personal allowance is £12,570. It has been at this level since 2022 and is due to remain at this amount until at least April 2028.

What are the different income tax rates?

Once you earn above the personal allowance, your income will be charged at:

• The basic rate of 20% on earnings between £12,570 – £50,270
• The higher rate of 40% on earnings between £50,271 – £125,140
• The additional rate of 45% on earnings above £125,141

What’s more, once you are earning £100,000 or more, you begin to lose £1 for every £2 over this amount. Effectively, it means that you will have no tax-free personal allowance once your income is at £125,140 and the entirety of your income is subject to all three income rates.

How income tax is calculated

To give you an example on how the different tax rates work together, let’s create a scenario to illustrate how income tax is calculated:

Let’s say you earn £73,500 a year. The first £12,570 of this is your personal allowance and therefore tax-free. The next £37,700 of your income is charged at the 20% basic rate which is £7,540. This then brings you up to the higher rate tax bracket so the remaining £23,230 of your earnings is charged at 40%. This equals to £9,292 in income tax. Your total income tax bill for the year would be £16,832.

How is income tax collected?

Income tax is collected through two possible ways. The first is most common and that is through PAYE income. PAYE stands for Pay As You Earn. This occurs when you are employed or receive pension income from a pension provider. Your employer or pension provider will calculate how much income tax you are due to pay and will automatically deduct this before you receive the remaining amount. There is nothing that you need to do in order to ensure you are paying your income tax.

However, for those who are not employed or have other streams of income that are  not taxed through PAYE you will have to complete a self-assessment tax return each year. This requires you to report all your earnings and calculate how much tax is due. You must do this each year by 31^st January and ensure the tax is paid by the same deadline.

How to reduce your income tax

There are legitimate means to reducing your income tax so that you can ensure you’re not paying more than you have to. Our team of expert accountants share the top 10 ways to reduce your income tax to help you ensure you’re utilising every possible solution to minimise your tax burden:

1. Don’t overlook marriage allowance

Despite an allowance that is exclusively available to married couples and civil partners, HMRC estimates that around half of eligible couples are missing out on this tax break. Marriage allowance can help couples reduce their overall income tax bill by enabling the person who is not fully utilising their personal allowance to transfer some of it to their partner who is already fully utilising their own allowance.

To be eligible for marriage allowance, one partner must be a non-taxpayer (due to earning less than the personal allowance of £12,570) and the other partner must be a basic rate taxpayer. Marriage allowance is not available to any couple where at least one person is a higher or additional rate income taxpayer.

When eligible, it means £1,260 of the personal allowance can be transferred to the basic rate income taxpayer increasing the amount they can earn tax-free from £12,570 up to £13,830. The non-taxpayer does not need to have no income whatsoever but must be merely earning below the personal allowance threshold. Even if they are working part-time and earn £12,000 a year, they are still able to transfer £1,260 to their partner as this is a fixed amount.

To claim marriage allowance, apply directly to HMRC online and once registered, this will continuously be applied until your circumstances change such as you are earning over the personal allowance or are no longer married. You can even backdate your marriage allowance claims to the previous 4 tax years for a lump sum tax rebate of just over £1,000.

2. Earn a little more tax-free with trading allowance

Although the general rule when it comes to income tax is that the more you earn, the more you are taxed, there is one legitimate exception to this. HMRC does offer an annual allowance that enables you to earn a little more without having to pay any tax on it.

The trading allowance is ideal for anyone making extra money on the side through casual earnings such as a hobby or side hustle. It allows you to earn up to £1,000 tax-free without having to report it through a self-assessment tax return or any other reporting method.

Even if you do earn over this amount, you can still claim the trading allowance instead of claiming for your actual business expenses. This can be beneficial where your actual expenses are less than £1,000. However, if you earn more, in order to claim the trading allowance, you will have to report it through a personal tax return.

Not only does the trading allowance mean you can make more money without it being subject to tax, but it also means you don’t have to pay National Insurance (NI) on the £1,000 you earn which is tax-free.

3. Save for your future to reduce your income tax bill through pension contributions

Making pension contributions is an effective way to not only save for your future but to reduce your income tax in the present where you are a higher rate or additional rate taxpayer. When you make pension contributions, you extend your basic rate threshold by the same amount.

So, for example, where you earn £65,000 a year – £12,570 of this is tax-free (your personal allowance), £37,700 is taxed at the basic rate of 20% (up to the normal basic rate threshold of £50,270) and the remaining £14,730 of your income is taxed at the higher rate of 40%. Your total income tax liability would be £13,432. Were you to make £10,000 in pension contributions, you extend your basic rate threshold up to £60,270 which means £47,700 is taxed at 20% and the remaining £4,730 is taxed at 40%. Your total income tax liability becomes £11,432 saving you £2,000. It is important to note that basic rate taxpayers do not receive this benefit because their earnings are below the threshold and therefore there is no advantage to increasing this threshold. However, basic rate taxpayers still receive the benefit of a top up to their pension pot from the government every time they make a personal pension contribution. So, if you were to pay £80 into a pension scheme, the government would top this up by £20 which essentially means you receive 20% tax relief.

4. Charitable giving is both rewarding and rewarded with tax relief

Every time you donate to a UK registered charitable organisation, you’ll not only have supported a meaningful cause but effectively reduced your income tax if you’re  a higher or additional rate taxpayer. This works in the exact same way to pension contributions where the amount you have donated extends your basic rate threshold by the same amount.

As an example, say you earn £75,000 a year. You make a donation of £4,000 to a charity of your choice and through Gift Aid the charity receives a 25% top up from the government which means they receive a total of £5,000. Doing this means your basic rate threshold has now increased from £37,700 to £42,700 (not including your personal allowance) and this amount will be taxed at 20%. The remaining £19,730 of your salary remains taxable at your higher rate personal income band of 40%. Your total tax bill is £16,432 whereas without the donation it would be £17,432 thereby saving you £1,000.

There is a limit to this, however. You can only receive tax relief up to the total amount of income tax you actually owe. This does not mean you cannot donate more, but it simply means that donating more will not help you reduce your income tax further. In other words, Gift Aid enables your donation to go further but it will not create a tax refund of more than what you owe. In the example above, where you earn £75,000 you would ordinarily have to pay £17,432 tax so you would not receive tax relief of more than this amount. You may also want to explore our article on three different ways you can give to charity to reduce different tax liabilities.

5. Claim work expenses as tax relief if your employer doesn’t reimburse you

Did you know that if you spend on your own money on work-related costs that are not reimbursed by your employer, then you could claim them as allowable business expenses? Doing so means you reduce your taxable income and therefore income tax. So, if you earn £40,000 and spend £250 in the year on qualifying business related expenditure then you’ll only be taxed on £39,750.

What you can claim for may not be immediately obvious to you, but some common allowable expenses include professional subscriptions to professional bodies or organisations, licence registrations, working from home, and even laundering your uniform. Each type of business expense does have its own rules though, so be sure you understand any restrictions or limitations. For example, you can only claim working from home costs if you your job requires you to live far away from your office or your employer does not have an office and not simply given the option to work from home as a benefit.

You can claim these business expenses through a self-assessment tax return if you are usually required to complete one or HMRC’s P87 form (you can only use this form where your annual expenses are no more than £2,500 otherwise you must register and file a self-assessment tax return to claim). 

6. Pay yourself in dividends as well as a salary if you own your own limited company

One of the many benefits of operating your business through a limited company is the potential option of paying yourself both a director’s salary as well as dividends. Dividends are available from your company’s profits once corporation tax has been deducted and are taxed at lower rates than a director’s salary. For the tax year 2025/26 the dividend tax rates are 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers.

In addition to this, there is an annual dividend allowance of £500 which is tax free and entirely separate from your personal allowance. Not only that, but unlike your director’s salary, dividends are not subject to NI and therefore a highly effective way to reduce your income tax and NI liability together. For further tax savings, you may want to consider making your spouse or partner a shareholder in your company in order to utilise their dividend allowance as well.

A word of warning however: dividends must only be declared  where the company has sufficient profits to do so. Doing so otherwise may result in HMRC treating the unlawful dividends as a director’s loan account instead which can come with high tax, interest, and penalties for late repayment.

7. Maximise rental profits with the Rent a Room Scheme

Earning rental income is not just exclusively for landlords. If you’re a homeowner that has a lodger, rents out spare rooms to students, or take occasional Airbnb bookings in your own home then you’ll have access to a generous tax relief scheme known as the Rent a Room scheme. It allows you to earn up to £7,500 a year through renting a furnished room in your own main residence tax-free (or £3,750 if you own the property with a spouse or partner and split this income).

If your rental income stays below this threshold, the relief applies automatically, and there’s no need to complete a tax return. If you earn more, you’ll need to report it through self-assessment, paying tax only on the amount above £7,500 at your own personal income tax rate. Alternatively, if your expenses are higher than the allowance, you can choose to opt out of the scheme and instead deduct your actual costs — often the better option for those with significant running or maintenance expenses.

The Rent a Room Scheme is a simple, flexible way to reduce your income tax and boost your household income. Plus, rental income under this scheme isn’t subject to National Insurance, making it even more tax efficient.

8. Opt into salary sacrifice arrangements

If your employer ever offers a salary sacrifice scheme, it’s worth paying attention to it because it’s often a simple and effective way to cut your income tax bill. It’s fairly straightforward: you agree to forgo part of your salary in exchange for a non-cash benefit such as a new electric car, a bicycle through the cycle-to-work scheme, extra pension contributions, or childcare vouchers.

Once agreed you’ll receive a lower salary and therefore be subject to less income tax and NI, all whilst getting to keep your benefit. If you were intending to buy a new electric car or upgrade your bicycle anyway, it can often result in getting a more expensive model then you’d be able to afford if bought privately.

Having said that, it’s important to weigh up the pros and cons before agreeing to these salary sacrifice schemes because a lower salary can affect your statutory benefits such as a parental leave pay or sick pay. A lower salary will often restrict how much you can borrow for a mortgage or loan as well.

It’s also worth noting that not all benefits-in-kind (BIKs) are treated in the same way and only certain approved salary sacrifice schemes will help reduce your income tax. Be sure to look out for this.

9. Consider SEIS or EIS investments

Smart investments may not only provide strong returns but can actually save you money in reducing your income tax liability if you choose the right types of investments. HMRC-approved schemes such as the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) are both powerful options that allow you to reduce your income tax bill in exchange for taking the risk of support early-stage small UK businesses.

Under SEIS you can claim income tax relief of up to 50% on investments of up to £200,000 per tax year. This means if you invest £10,000 you could reduce your income tax bill by £5,000. EIS offers 30% tax relief on investments of up to £1 million per tax year or £2 million if at least £1 million is invested in knowledge-intensive companies.

The further benefit is that should you make a loss on your investment; there is further income tax relief available. Suppose you invest £10,000 in a qualifying SEIS company. You claim 50% Income Tax relief, so your initial out-of-pocket cost is effectively £5,000. If the company unfortunately fails and your shares become worthless, you can claim loss relief on the remaining £5,000. If you’re a higher rate taxpayer, the loss relief could save you another £2,000 (40% of £5,000). This works in the same way for EIS investments.

10. Offset your trading losses against other income streams

If you’re a sole trader or run a business through a general partnership and have a difficult year where you have made a loss, then there is tax relief available for you so long as you have other streams of income. Trading loss relief is when you make a loss through your own self-employment but helps you reduce your overall income tax bill if you also earn a salary, receive rental income, or receive dividends.

There are a few ways to use trading losses to reduce tax. First, you can offset the loss against other income in the same tax year. For example, if you have a £10,000 trading loss and also earn £30,000 from employment, you could reduce your taxable income to £20,000, lowering your income tax for that year.

Second, if it is more advantageous, you can carry back the loss to the previous tax year. This allows you to reclaim tax you’ve already paid on other income in that year, which can be particularly useful if your earnings were higher previously.

Finally, any remaining losses can generally be carried forward and offset against profits in future years, though this only applies to profits from the same trade.

Get advice for managing your income tax

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