Millions of UK workers are set to endure years of 'fiscal drag' after the Government confirmed income tax thresholds will remain frozen until 2031. However, a little-known HMRC scheme offers a legal lifeline, allowing some households to significantly boost their tax-free earnings.
The Personal Allowance Freeze and Fiscal Drag
The basic Personal Allowance has been frozen at £12,570 since 2021. This is the amount most people can earn before starting to pay income tax, which begins at a 20% rate for earnings between £12,570 and £50,270. The rate then jumps to 40% for income above that, and hits 45% for every pound earned over £125,140 for additional rate taxpayers.
With wages rising due to inflation, this prolonged freeze means more people are being pulled into paying tax for the first time or pushed into higher tax bands. This process, known as fiscal drag, is driving households to seek legitimate ways to reduce their tax liability.
How the Rent a Room Scheme Boosts Your Allowance
Homeowners can legally increase their tax-free income through HMRC's Rent a Room Scheme. This initiative allows you to earn up to £7,500 per year tax-free from letting out furnished accommodation in your own home.
This rental income sits on top of the standard Personal Allowance. Therefore, a single person who meets the scheme's conditions could receive a total of £20,070 (£12,570 + £7,500) without paying any income tax, provided they declare the income correctly.
It is crucial to note that the scheme only applies to rooms let in the property you live in as your main residence. It cannot be used to offset income from separate buy-to-let properties.
Sharing the Benefit with a Partner
If the rental income from the room is shared with a partner or another person, the tax-free allowance is split. In this case, each person can claim £3,750 tax-free. This would raise each individual's effective Personal Allowance from £12,570 to £16,320.
Who Needs to File a Tax Return?
The tax exemption is automatic if your gross rental income from a room is £7,500 or less (or £3,750 if shared). However, anyone who completes a self-assessment tax return must still declare this income to HMRC.
If you earn above the threshold, you must submit a tax return. At that point, you can choose whether to opt into the Rent a Room Scheme and claim your tax-free allowance, or to pay tax on the profit in the usual way by declaring income and expenses.
HMRC notes that some landlords may choose not to use the scheme if they wish to offset losses or expenses, such as refurbishment costs, against other taxable property income.
With the tax burden increasing for many, understanding and utilising schemes like Rent a Room can provide valuable financial relief during the ongoing threshold freeze.
