Income tax is worked out in seven steps set by section 23 of the Income Tax Act 2007: add up your taxable income, deduct reliefs, deduct the Personal Allowance, apply the rates band by band, add the results, take off tax reductions and add any extra charges. The order in which income fills the bands makes little difference for wages, but a great deal for savings, dividends and, from April 2027, rental profits.

What are the seven steps in law?

Section 23 of the Income Tax Act 2007 sets out the calculation of a person’s liability for a tax year:

  1. Step 1. Identify each amount of income charged to income tax. Their sum is “total income” and each amount is a “component”.
  2. Step 2. Deduct the reliefs listed in section 24 to which you are entitled. What is left is “net income”.
  3. Step 3. Deduct your allowances: the Personal Allowance and Blind Person’s Allowance.
  4. Step 4. Calculate tax at each applicable rate on what is left.
  5. Step 5. Add those amounts together.
  6. Step 6. Deduct any tax reductions listed in section 26.
  7. Step 7. Add any extra amounts of tax listed in section 30. The result is your income tax liability.

Tax already deducted, for example through PAYE, is then credited against that liability to find what you still owe or are owed.

Step 1: what goes into total income?

List every taxable source separately, because each component may be taxed at different rates later. Typical components are employment income including taxable benefits, pensions including the State Pension, self employed profits, rental profits, savings interest and dividends. Leave out income that is exempt, such as interest and dividends inside an ISA. Keep savings income, dividend income and, from 2027 to 2028, property income identifiable, because they are taxed in a fixed order.

Step 2: which reliefs come off before allowances?

Section 24 lists the Step 2 reliefs for individuals. The most common are trade loss relief against general income (section 64), carry forward trade loss relief (section 83), property loss relief (sections 118 and 120), relief for qualifying interest payments (Chapter 1 of Part 8), share loss relief, and pension contributions where relief is claimed under section 194(1) of the Finance Act 2004. Pension contributions taken from pay under a net pay arrangement are deducted before tax by the employer, so they are already out of the employment figure.

Section 25(2) says reliefs and allowances at Steps 2 and 3 are deducted in the way that gives the greatest reduction in liability, subject to rules that tie particular reliefs to particular income, such as carried forward property losses which can only be used against property profits.

Step 3: how much Personal Allowance do you get?

The standard Personal Allowance for 2026 to 2027 is £12,570. It is reduced by £1 for every £2 of adjusted net income above £100,000, so it is zero once that income reaches £125,140. Blind Person’s Allowance, £3,250 for 2026 to 2027, is added on top.

The taper creates a high effective rate. Illustration only. With adjusted net income of £110,000, the allowance falls by £5,000 to £7,570. Each extra £100 of income in that range costs £40 of higher rate tax plus £20 on the £50 of lost allowance taxed at 40%.

Step 4: how are the bands applied?

For 2026 to 2027 in England, Wales and Northern Ireland the bands, measured on income after allowances, are:

Band Income after allowances Main rate Savings rate Dividend rate
Starting rate for savings Up to £5,000 Not used 0% Not used
Basic Up to £37,700 20% 20% 10.75%
Higher £37,701 to £125,140 40% 40% 35.75%
Additional Above £125,140 45% 45% 39.35%

Fill the bands from the bottom with non savings income first, then savings income, then dividends, as section 16 requires. Within that, apply the 0% layers: the starting rate for savings, the Personal Savings Allowance of £1,000 or £500 depending on your band, and the £500 dividend allowance. Two things widen the basic rate band: Gift Aid donations, under section 414, and relief at source pension contributions, under section 192(4) of the Finance Act 2004, each increase the basic rate limit and the higher rate limit by the gross amount where you would otherwise pay tax above the basic rate. Scottish taxpayers use Scottish bands and rates for non savings income only; see Scottish income tax.

Steps 5 to 7: what is added and taken away at the end?

Step 6 tax reductions in section 26 include the Marriage Allowance transfer, Married Couple’s Allowance, EIS, SEIS and VCT relief, qualifying maintenance payments, and relief for residential finance costs under section 274A of the Income Tax (Trading and Other Income) Act 2005. Step 7 charges in section 30 include the High Income Child Benefit Charge, the pension annual allowance charge and the Gift Aid charge under section 424, which can arise if you have not paid enough tax to cover what charities reclaim on your donations.

What does a full calculation look like?

Illustration only. Priya lives in England. In 2026 to 2027 she has a salary of £58,000, bank interest of £1,200 and dividends of £2,000, and makes Gift Aid donations of £800, which gross up to £1,000.

  1. Total income is £61,200. There are no Step 2 reliefs, so net income is £61,200, well under £100,000.
  2. The Personal Allowance of £12,570 is set against salary, leaving £45,430 of non savings income.
  3. Gift Aid extends her basic rate band from £37,700 to £38,700.
  4. Non savings income: £38,700 at 20% is £7,740, and £6,730 at 40% is £2,692.
  5. Savings: she is a higher rate taxpayer, so £500 of interest is at 0% and £700 at 40%, which is £280.
  6. Dividends: £500 at 0% and £1,500 at 35.75%, which is £536.25.
  7. Step 5 total: £11,248.25. No Step 6 or Step 7 items apply.

Without the Gift Aid adjustment her bill would be £11,448.25, so the band extension is worth £200 to her, which is 20% of the gross donation. PAYE on her salary may not reflect the interest, dividends or donations, so any difference is settled through her tax code or a Self Assessment return.

What changes from April 2027?

From 2027 to 2028 three things change in Step 3 and Step 4. Property income becomes its own layer, taxed after other non savings income and before savings, under new section 16A, at 22%, 42% and 47%; see property income tax rates from April 2027. Savings rates rise to 22%, 42% and 47%; see savings income tax rates from April 2027. And new section 25(3A) requires reliefs and allowances to be set against income other than property, savings and dividends first, before the most beneficial rule applies to the remainder. The Personal Allowance and the £37,700 basic rate band are frozen to 2030 to 2031.

What mistakes are common?

  • Applying the Personal Allowance to each job. You get one allowance for the year however many sources you have; see why your second job is taxed with no allowance.
  • Measuring the bands on gross income. The £37,700 band is measured after allowances.
  • Forgetting the taper. Income between £100,000 and £125,140 loses allowance as well as paying higher rate tax.
  • Using the dividend allowance as a deduction. Under section 13A it is a 0% rate charged on dividends that would otherwise fall in your bands, not a deduction from income.
  • Treating Gift Aid as a deduction from income. It works by extending the bands, not at Step 2.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.