How does Income Tax Work?
If you work through a compliant UK Umbrella Company your tax and national insurance deductions will be processed through PAYE (Pay As You Earn). It’s quite a complicated subject so we have produced a guide which we hope will make things a little clearer. In this document we will cover the topic of how Income Tax works.
Extract from The Guide to PAYE Tax:
The first thing you need to understand is your tax code and how it relates to a tax-free allowance. The tax-free allowance for 2012 is £8,105, which means that you can earn up to this amount in a tax year (April to April) without being liable for income tax. This tax free allowance is indicated by the tax code 810L; the letter ‘L’ being replaced with ‘5’. In 2010 the tax free allowance was £7,479 and therefore the standard tax code was 747L.
The tax-free allowance each year is determined by HMR&C (Her Majesty’s Revenue and Customs). If they are not certain what your tax code should be your umbrella company may use an emergency or week 1/month 1 tax code which means the basic tax free allowance will be applied to your earnings but on a weekly or monthly basis and not cumulatively i.e. you would not benefit from an accumulation of your tax free allowance in periods when you did not work.
In most cases the tax-free allowance is applied cumulatively to your earnings over a period of 12 months or 52 weeks and is referred to as ‘free pay’. Your earnings for the period less the allowance for free pay will give you the amount that is then liable for income tax deductions...
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