Income Tax is the most widely encountered tax in the UK, but many founders moving from employment to self-employment encounter it in a different context for the first time — one where they are responsible for calculating and paying it themselves rather than having it deducted automatically. Understanding how Income Tax works for self-employed individuals and directors is an important part of managing a business's finances.
Income Tax is levied on an individual's taxable income, which includes earnings from self-employment, employment, dividends, and certain other sources. The tax is calculated on income above the personal allowance — the amount of income an individual can receive tax-free each year. Above that threshold, income is taxed at rates that increase in steps as income rises. The specific rates and thresholds are set by the government and may change, so current figures should always be verified with HMRC or an accountant.
For sole traders, Income Tax on business profits is reported and paid through Self Assessment. For limited company directors, Income Tax applies to salary and dividends, each taxed differently. The interaction between these income types can be complex, making professional advice valuable when planning how to extract income from a company. Our guide to Income Tax for UK founders explains the key principles for each business structure.