What is Tax Deducted at Source?

Tax payments from income are typically made in two ways either deducted from your income before you receive it or paid directly to HM Revenue & Customs (HMRC).

If you receive income from an employer or a pension that deducts tax from your earnings before handing it over to you it’s commonly referred to as “tax deducted at source”.

HMRC requires employers and other income sources using PAYE to deducted income tax at source and pay it to them directly on each payment date.

To have tax deducted at source means that you only receive the net amount of income after tax rather than the gross amount before tax deductions.

In some cases if you have income from both PAYE and self employment a portion of your income may be deducted before you receive it and then you may have to pay the remaining amount or claim a refund based on your individual tax situation.

What type of income has tax deducted at source?

The most common types of income which have tax deducted at source are paid through the pay as you earn (PAYE) system.

Under PAYE HMRC expects income providers to automatically deduct income tax at source and pay it to them within strict deadlines after each payment date.

The PAYE systems method of collecting income tax means that HMRC receives the tax that is owed  without delay.

Having your income tax deducted at source through PAYE is compulsory and you can’t opt out to pay at a later date.

Employment income tax deducted at source:

Individuals who are employed will have income tax and national insurance deducted from their wages before being paid.

This applies to all PAYE employees regardless of their employment status encompassing full time, and part time employees, and those working permanently, temporarily or on a casual basis.

Pension income tax deducted at source:

Pension income from both private and occupational pension schemes will be eligible for tax being deducted at source.

Your pension provider will take care of the tax deduction process automatically for you.

State pension income is paid gross with tax not being deducted at source.

If you have other taxable PAYE income at the same time HMRC will normally adjust the tax code with your other income to account for the fact that taxes have not been deducted from your State Pension.

Rental income tax deducted at source:

If you receive qualifying income via the PAYE system (such as a salary or pension) there is a possibility that you can use PAYE to pay the tax you owe on some or all of your rental property income.

The payment of income tax owed on rental income in this way can be arranged when you complete your self assessment tax return.

This option isn’t for all landlords and it’s relevance depends on your own set of circumstances.

Understanding your tax deducted at source

Understanding what tax you will have deducted from your income sources is important so you can anticipate and prepare for the amount you’ll receive after tax.

Knowing what tax will be taken off at source also helps you verify the accuracy of your salary after income tax and national insurance has been taken.

When calculating the amount of tax you owe you need to consider the gross amount of your income which includes any tax that was deducted at source before you received it.

HMRC has different rates of tax which gradually go up and are based on the level of your overall earnings:

  • Tax free personal allowance: £0 to £12,570 @ 0% tax rate.
  • Basic rate: £12,571 to £50,270 @ 20% tax rate.
  • Higher rate: £50,271 to £125,140 @ 40% tax rate.
  • Additional rate: Over £125,140 @ 45% tax rate.

Tax deducted at source and your tax code

To deduct the correct amount of tax at source HMRC uses tax codes to tell employers how much income tax to take off.

HMRC generates a tax code based on your personal allowance which takes into consideration a number of factors including if you have any company benefits or expenses related to your employment.

Because your tax code directly affects how much tax is deducted at source HMRC recommends that you check your code is correct.

A different tax code is created for each form of income under PAYE so for example if you have income from an employer and a pension scheme at the same time you should check both tax codes.

The HMRC app or your personal tax account are trustworthy ways to find your current tax code(s) and they offer advice on how to change your tax code directly with HMRC.

How to check your tax deducted at source

It’s a sensible approach to make sure that the tax deducted from your source(s) of income is right.

When reviewing you should take into account your gross pay before tax, your tax code and personal allowance.

Remember that your personal allowance is used to create your tax code so if it’s wrong your tax code will likely be incorrect too.

In some situations HMRC can only get your tax code correct if they are informed by you of the changes in your circumstances.

For individuals with PAYE income only our income tax calculator can help you work out your take home pay after tax deducted at source has been taken into consideration.

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