Employment: Understanding PAYE income tax deductions from pay — knowing how personal allowance and tax rates work means you can check your payslip is correct.
Shopping: Calculating VAT on purchases and business invoices — VAT at 20% appears on every receipt, and being able to work backwards from a VAT-inclusive price is an essential skill.
Business: Pricing products to include VAT correctly — a business must add 20% to the net price so the customer pays the right amount and the VAT can be reclaimed or paid to HMRC.
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Income tax is charged on earnings above your personal allowance. The personal allowance (2024/25) is £12,570 — this portion of income is tax-free. Earnings above £12,570 up to £50,270 are taxed at 20% (the basic rate).
Taxable income = Annual salary − £12,570 (personal allowance)
Income Tax = Taxable income × 20%
Example 1 — Calculate income tax on a salary of £25,000
Step 1
Taxable income = salary − personal allowance = £25,000 − £12,570 = £12,430
Step 2
Income Tax = taxable income × 20% = £12,430 × 0.20 = £2,486 per year
Step 3
Monthly tax = £2,486 ÷ 12 = £207.17 per month
Example 2 — Salary below personal allowance
Ben earns £10,000 per year. How much income tax does he pay?
Step 1
Ben's salary (£10,000) is below the personal allowance (£12,570)
Step 2
Taxable income = £0 → Income Tax = £0
Common mistake: Tax is only charged on earnings above the personal allowance — not on the full salary. On a £25,000 salary you do NOT pay 20% × £25,000 = £5,000; you pay 20% × £12,430 = £2,486.
✓ Quick Check 1 — Income Tax
Question 1 of 10
National Insurance (NI) Contributions
National Insurance (NI) is a separate deduction from income tax, also paid to HMRC. Employees pay NI at 8% on earnings between £12,570 and £50,270 per year (the same thresholds as basic rate income tax).
NI = (Salary − £12,570) × 8% [for earnings up to £50,270]
Example 3 — Calculate NI and total deductions on £25,000
Step 1
NI earnings = £25,000 − £12,570 = £12,430 (same as taxable income)
Step 2
NI = £12,430 × 8% = £12,430 × 0.08 = £994.40 per year
Step 3
Income Tax = £12,430 × 20% = £2,486
Step 4
Total tax + NI = £2,486 + £994.40 = £3,480.40 per year
Tip: Income Tax and NI both use the same threshold of £12,570, but different rates — 20% for tax and 8% for NI. Calculate them separately, then add together for total deductions.
✓ Quick Check 2 — National Insurance and combined deductions
Question 1 of 10
VAT — Value Added Tax
VAT (Value Added Tax) is charged on most goods and services in the UK, at a standard rate of 20%. This is the same multiplier method from Lesson 5.3 (adding a percentage) and Lesson 5.5 (working backwards), applied here at a fixed 20% rate: add VAT to a price, find the VAT amount, and work backwards (reverse VAT) to find the pre-VAT price.
Price including VAT = original price × 1.2 | VAT amount = original price × 0.2
Original price (reverse) = price including VAT ÷ 1.2
Example 4 — Add VAT to a price
A service costs £250 before VAT. What is the price including 20% VAT?
Common mistake: To reverse VAT, divide by 1.2 — do NOT subtract 20% from the total. £480 − 20% = £384, which is wrong. The correct pre-VAT price is £480 ÷ 1.2 = £400.
✓ Quick Check 3 — VAT calculations
Question 1 of 10
Practice: Tax and VAT Calculations
Enter your answers as numbers (e.g. 2486 or 120.00).
#
Question
Answer
Result
1
Salary £20,000 → annual income tax (20%)
2
Salary £30,000 → annual NI (8%)
3
Price ex-VAT £150 → price including 20% VAT
4
Price ex-VAT £85 → VAT amount
5
Price inc. VAT £360 → pre-VAT price (reverse VAT)
6
Salary £25,000 → annual income tax (20%)
7
Salary £22,000 → annual NI (8%)
8
Price ex-VAT £200 → price including 20% VAT
9
Price ex-VAT £45 → VAT amount
10
Price inc. VAT £600 → pre-VAT price (reverse VAT)
⚠ Things to Watch Out For
Applying tax to the full income: Income tax applies only to income ABOVE the personal allowance (£12,570). Tax = (income − £12,570) × 20%, not income × 20%.
Confusing income tax and National Insurance: These are separate deductions with different rates and thresholds. Calculate each independently and add them.
Adding VAT to a price that already includes VAT: If a price is "VAT-inclusive", VAT has already been added. To find the pre-VAT price, divide by 1.20 — don't add another 20%.
VAT reversal — multiplying instead of dividing: To find the pre-VAT price from a VAT-inclusive price: divide by 1.20. Multiplying by 0.80 gives the wrong answer.
Rounding tax to whole pounds prematurely: Keep pence throughout the calculation. Round only the final tax figure to 2 decimal places.