Topic 12: Earnings Flashcards
This topic focuses on laws and regulations that apply to people who work, employers and the workplace; in particular:
- the national minimum wage and the national Iiving wage
- maximum working hours
- income tax and National Insurance
- the documents that employees receive relating to income tax and National Insurance
- income tax returns
Introduction:
The legislation and regulations surrounding the minimum wage, the living wage and maximum working hours have been introduced to protect employees who might otherwise be exploited by employers
Everyone who earns money from work on an employed or a self-employed basis must pay income tax and National Insurance (NI) contributions. The government uses the money raised from these payments to pay for essential services such as the National Health Service (NHS), education, police and defence. The NI contributions in particular are used to pay for benefits that working people will use themselves, such as the state pension, and for benefits for others such as the unemployed. Income tax is also paid on unearned income including most pensions, the interest on savings and dividends paid on investments
The amount of tax and NI that must be paid is set by the Chancellor of the Exchequer in the Budget and tends to change each tax year. The tax year runs from 6 April in one calendar year to 5 April in the following year. People who work or receive income from unearned sources are responsible for ensuring they pay the correct amount of income tax and NI contributions. There are penalties for people who pay too little; they may be fined or, in more extreme cases, receive prison sentences. People who pay too much tax and NI can claim the additional amounts back. These are called tax rebates
National minimum wage:
The national minimum wage (NMW) was introduced in the National Minimum Wage Act 1998. This Act established the Low Pay Commission, which advises the government what the NMW and the national living wage (NLW) should be every year. The NMW applies to most types of employed workers aged 22 and under, including full-time, part-time, casual workers and apprentices. It is expressed as a ‘per hour’ rate that varies according to the employee’s age and applies from 1 April in one calendar year to 31 March in the following year
People must be of school leaving age to get the minimum wage. This is defined as the last Friday of June in the school year when they had their sixteenth birthday. Apprentices under the age of 19 or who are in their first year are entitled to the apprentice rate. People aged 23 and over must be paid at least the national living wage, which was introduced in April 2016
Employment contracts that specify a wage lower than the minimum are not binding. There are some exceptions to the NMW, however, including voluntary workers, people on work experience who are not trainees such as interns, trainees on some government schemes, prisoners and members of the armed forces. Workers who are entitled to the minimum wage but do not receive it have rights under the Act to examine their employer’s records and claim missing wages. They can also take their employer to an industrial tribunal. The government offers a confidential helpline for workers who are in dispute with their employer
Some employers, especially in the retail and hospitality industries, offer ‘zero hours’ contracts which mean people agree to be available for work as and when required but do not have any guarantee of hours or times of work. Workers who have these contracts are entitled to the NMW when they are ‘on-call’ at the employer’s premises. It is illegal for employers to insist these workers are on site and then not use them and refuse to pay them
Maximum working hours:
The Working Time Regulations were introduced in 1998 and specify the following:
- An employee can work a maximum of 48 hours work per week, averaged over 17 weeks, unless they choose to work longer
- An employee who works five days a week is entitled to at least 5.6 weeks’ paid holiday per year. Employers can choose to include bank holidays in this figure. People who work less than five days a week are entitled to the pro rata equivalent, for example if they work three days a week, 3 × 5.6 = 16.8 days per annum
- An employee is entitled to at least 11 consecutive hours’ rest in any 24-hour period
- If the working day is longer than six hours, they are entitled to a minimum 20-minute rest or lunch break
- An employee is entitled to at least one day off each week
The regulations do not apply to all types of employment. For example, they do not apply to the armed forces, emergency services, domestic workers in private households (such as nannies) or where 24-hour staffing is required. An employee’s working hours, annual leave (holidays) and rest periods should be set out in the employee’s contract of employment
Income tax and NI:
Everyone who receives an earned or unearned income must pay income tax and NI contributions once they earn more than a minimum amount called a personal allowance. There are no age limits for paying income tax: the amount people earn determines whether they pay it or not. Income tax is one of the oldest taxes in the UK, having been introduced in 1799 to raise money to fight Napoleon. The Income Tax Act 2007 is the most recent legislation. The amount of income tax and NI people must pay is set out every year by the Chancellor in the Budget
Income tax - personal allowance:
Most people get a personal allowance - that is, a certain amount of money that they can earn before they pay income tax. The exceptions are people who were born before 6 April 1938, blind people, and married couples where one partner was born before 6 April 1935
People calculate how much income tax they owe by:
- subtracting their personal allowance from their gross annual income to find their taxable income
- working out which tax bands apply to their taxable income
- calculating the amount of tax using the tax rates for each band
Income tax rates and bands may change on 6 April each year
Income tax on savings interest:
Income tax on savings has changed significantly since April 2016. The income tax you pay on savings interest depends on what you earn, as it has always done, but new allowances apply (GOV.UK, 2017). Taxpayers can earn a certain amount in savings interest tax free, known as the personal savings allowance
- People who have a taxable income of less than £5,000 after other allowances have been deducted pay no income tax on savings interest. This is the starting-rate band
- Basic-rate taxpayers have a personal savings allowance of £1,000 before they start to pay income tax on their savings interest
- Higher-rate taxpayers have a personal savings allowance of £500
A reason for these changes is to encourage people to save and to rely less on the state. With so few savers paying income tax on their savings, since 6 April 2016 providers no longer deduct basic income tax at source. This means savings interest is now paid gross (ie before tax)
Individual savings accounts (ISAs) are tax-free, so the interest earned on a cash ISA does not count towards a saver’s personal savings allowance and they do not owe any income tax on it, regardless of how much they earn elsewhere (GOV.UK, 2017)
National Insurance:
People who work pay NI contributions if they are:
- aged between 16 and the state pension age
- an employee earning more than a specified amount per week
- self-employed and making a profit over a specified amount each year
Since April 2016, NI contributions are not payable for young apprentices. People are issued with an NI number in the months before they reach the age of 16 and all the contributions they make during their working life are recorded against this number
The number of years over which people have paid NI has an impact upon their entitlement to certain state benefits, such as Jobseeker’s Allowance, Maternity Allowance and bereavement benefits. In April 2016 the government introduced a new state pension. People need to have made NI contributions to be eligible for the full amount of the new state pension, and they need ten qualifying years to receive any new state pension. People with no NI record before 6 April 2016 need 35 qualifying years to get the full new state pension (GOV.UK, no date b)
The amount of National Insurance that an individual pays depends on their employment status and their income
National Insurance contributions may change on 6 April each year
Paying income tax and NI:
Employees’ income tax and NI contributions are paid by their employer direct to Her Majesty’s Revenue and Customs (HMRC) through the Pay As You Earn (PAYE) scheme. The employer pays the employee net of these payments
People who are self-employed receive gross income from their clients - in other words, without tax and NI being deducted. Self-employed people must pay the correct income tax and Class 4 NI contributions themselves through a system called self-assessment. This involves completing income tax forms called tax returns. They pay the flat rate Class 2 contributions throughout the year, often by monthly direct debit. More information can be found on filling in a tax return for self-employees who owe additional income tax on their savings interest can pay this amount in monthly instalments through their employer’s PAYE system by an adjustment made to their tax code, or they can pay it in a single payment direct to HMRC. Self-employed people pay any additional tax on savings interest as part of their self-assessment
PAYE documents:
Under the Employment Rights Act 1996, employers must provide employees with details about the income tax and NI paid on their wages. There are three different documents involved:
• a payslip, which is produced every time someone is paid, such as once a month
• a P60, which is prepared at the end of every tax year to show all the income tax and NI contributions paid during the preceding 12 months
• a P45 that is prepared when an employee leaves an employer. It summarises the employee’s tax and NI details for their next employer
Payslips:
A payslip must show earnings before and after deductions, explain deductions and show how the wage is paid. Employers can provide payslips on paper or electronically. Most employers use payroll software to generate payslips and make salary payments into employees’ current accounts
Employers use the employee’s tax code to work out how much tax to deduct from their earnings. These tax codes show the individual’s personal allowance and are provided by HMRC. The format for a tax code is three or four numbers and one letter; for instance, 1257L is a common tax code for the tax year 2022/23, as most people have a personal allowance of £12,570. People who have more than one employer are given two tax codes so that HMRC can ensure they get the correct personal allowance
P45:
By law, an employer must issue a P45 to an employee who stops working for them. The employee gives the P45 to their new employer so that their new employer can calculate how much income tax and NI they need to deduct. If people do not have a new job to go to, they give the P45 to Jobcentre Plus for use in benefit calculations. Sometimes people have more than one job at the same time - for instance, someone might work part-time in a shop during the daytime and then take another part-time job in a restaurant in the evenings. In this situation the person would not have a P45 to give to the restaurant; the second employer would have to calculate the tax and NI payable based on information provided by the employee
A P45 shows an employee’s:
• tax code and PAYE (Pay As You Earn) reference number
• National Insurance number
• leaving date
• earnings in the tax year so far
• income tax paid in the tax year so far
It comes in four parts:
• the old employer sends part 1 to HMRC
• the employee keeps part 1A for their records
• the employee gives parts 2 and 3 to their new employer or Jobcentre Plus
P60:
An employer must issue a P60 at the end of every tax year to any employee who is working for them on 5 April. A P60 summarises the tax paid by the employer for the tax year that has just ended. It can be provided on paper or electronically
Employees use P60s to prove how much they have earned and how much income tax and NI contributions have been deducted from their salary. They might need this information to:
• complete a self-assessment tax return
• claim back overpaid income tax or NI contributions;
apply for tax credits
• apply for a loan or a mortgage
Filling in an income tax return:
In the March 2015 Budget, Chancellor George Osborne announced plans to abolish tax returns and replace them with digital tax accounts during the next Parliament (GOV.UK, 2015)
As it stands, however, some people need to complete a tax return to tell HMRC about their earned and unearned income - for example, people who need to pay extra income tax on their savings interest or who are self-employed. A tax return covers income received in one tax year, that is from 6 April in one calendar year to 5 April in the following calendar year. A tax return can be completed on paper or online at the HMRC Online Services website
HMRC provides guidance for completing tax returns on paper and online; for example, there is detailed guidance on how to complete the section on interest received from UK banks and building societies
The tax return requires just one total figure in whole pounds. Taxpayers round down all figures to do with income
