Earning before tax explained: How much can you earn tax-free?

When it comes to managing your finances as a sole trader or small business owner, understanding your earning before tax is essential. Knowing how much you can earn before paying income tax can help you to plan ahead and avoid surprises when tax season rolls around.

The good news is that there’s a specific threshold—called the Personal Allowance—that allows you to earn a certain amount tax-free. In this article, we’ll explain what counts as taxable income, how to calculate your income tax, and the steps you can take to reduce your tax bill.

What counts as taxable income?

First things first: not all the money you earn is automatically subject to income tax. The tax system in the UK allows you to earn a certain amount tax-free, and only income above this threshold is taxed. Let’s take a closer look at what counts as taxable income.

Income from your business activities is taxed, but HMRC allows you to deduct certain costs, called allowable expenses, from your total earnings. These expenses include things like equipment, office supplies, and even business travel costs.

The Personal Allowance: How much you can earn before paying tax

The most important figure to know is the Personal Allowance—this is the amount you can earn in a tax year before you need to start paying income tax. For most people, the Personal Allowance is £12,570 for the 2024/25 tax year. This means you can earn up to this amount without paying any income tax.

If your income is above this threshold, you will pay tax on the excess. The rate you pay depends on how much you earn, for example:

• Basic rate (20%): earnings between £12,571 and £50,270
  
• Higher rate (40%): earnings between £50,271 and £150,000
  
• Additional rate (45%): earnings over £150,000
  

The Personal Allowance applies to most taxpayers, but there are some exceptions. If you earn over £100,000, your Personal Allowance starts to decrease by £1 for every £2 you earn above that threshold. So, if your income is £125,140 or more, you won’t receive any Personal Allowance. This is something to keep in mind if your earnings start to push towards the higher end of the income scale.

Example: How tax works in practice

Let’s break it down with a quick example. Imagine you’re a sole trader and you earn £20,000 in the 2024/25 tax year. Here’s how your tax might look:

• First, you subtract your Personal Allowance (£12,570) from your total earnings, which leaves you with £7,430 in taxable income.
  
• Next, you’ll pay the basic rate of 20% on that £7,430, which comes to £1,486.
  

So, while your total earnings are £20,000, you’ll only pay tax on £7,430 of that, and your total tax bill will be £1,486. This doesn’t include any other potential deductions or allowances, like if you’re eligible for Marriage Allowance or Blind Person’s Allowance.

Want to find out more about allowable expenses and other ways to reduce your taxable income? Take a look at our helpful guide.

What happens if your income increases?

If your income exceeds the Personal Allowance and moves into the higher tax bands, you’ll pay tax at a higher rate. Let’s say your income rises to £35,000 in the same tax year. Here’s how that would affect your tax:

• First, you’ll subtract the Personal Allowance (£12,570) from your £35,000 income. That leaves you with £22,430 in taxable income.
  
• The first £22,430 will be taxed at the basic rate of 20%, which gives you £4,486 in tax.
  
• In this case, since your income doesn’t reach the higher rate tax band, you won’t pay any higher rate tax.
  

Your total tax bill would be £4,486. As you can see, increasing your income will naturally lead to a higher tax bill, but there are still opportunities to reduce this by properly claiming allowable expenses.

Tax-free income and specific deductions

The Personal Allowance isn’t the only tax break available to you. There are a few other things that can reduce your taxable income, such as:

1. Business expenses: as mentioned earlier, any money you spend on running your business can be deducted from your earnings. This can include things like marketing costs, rent for office space, and even your business insurance premiums. If you’re unsure what qualifies, be sure to check out the guide on allowable expenses for Self Assessment. These deductions lower your taxable income and, as a result, reduce the tax you owe.
   
2. Tax-free savings allowances: if you have savings, you may also benefit from certain tax-free allowances, like the Personal Savings Allowance (up to £1,000 for basic-rate taxpayers). For instance, if you earn interest on your savings, you won’t pay tax on the first £1,000 of interest (for basic-rate taxpayers) or £500 (for higher-rate taxpayers).
   
3. Pension contributions: paying into a pension scheme not only helps you save for the future, but it can also reduce your taxable income for the current year. Contributions to a personal pension scheme are tax-deductible, so you’ll be taxed on a smaller income, which can reduce your tax bill significantly.
   
4. Marriage Allowance: if you’re married or in a civil partnership, and one of you earns below the Personal Allowance threshold, the other partner can transfer part of their unused allowance. This can reduce the overall tax burden for couples.
   
5. Blind Person’s Allowance: if you are registered as blind, you are eligible for an additional allowance. This can increase the amount of money you can earn tax-free.
   
6. Research and development tax relief: if your business is involved in research and development (R&D) activities, you may be eligible for R&D tax credits. This can result in a reduction in your taxable income and a refund from HMRC.
   

These deductions and allowances can add up, so it’s worth investigating all of them to ensure you’re not paying more tax than necessary.

Missed deadlines and avoiding penalties

If you’ve missed the Self Assessment deadline, don’t panic—there are steps you can take to minimise penalties. For example, HMRC offers a 30-day “grace period” for late filings, so make sure you file your tax return as soon as possible. It’s always better to file late than not at all, and if you need help getting back on track, you can find more details in our blog on missed Self Assessment deadlines.

HMRC charges a £100 plus interest, late filing penalty if you miss the deadline, but this can increase the longer you leave it. After 3 months, additional daily penalties of £10 plus interest, per day can apply, up to a maximum of £900. After 6 months, further penalties are applied based on the amount of tax you owe.

The key is to file as soon as possible to avoid further penalties. If you’re struggling to meet deadlines or have missed one, reach out to HMRC or consult a tax advisor for advice.

Final thoughts

Now that you know how much you can earn before paying tax, the next step is to make sure you’re filing your Self Assessment tax return correctly. Knowing how much tax you’ll need to pay will help you plan your finances better and avoid any unexpected bills down the line.

Remember, the Personal Allowance for the 2024/25 tax year is £12,570, so as long as your income stays below that, you won’t owe any income tax. If you’re not sure about your situation, it’s always a good idea to talk to an accountant or check out resources like our Self Assessment guides for more advice.

It’s also worth noting that Making Tax Digital is changing the way sole traders and small business owners file their taxes. As these new rules take effect in the coming years, staying compliant will mean keeping digital records and submitting updates online.

Tax can be complicated, but with the right knowledge, planning, and support, you can keep your finances running smoothly.