In the UK, employers are legally bound to deduct income tax from their employees in advance of wage and salary payments through PAYE (pay as you earn). Self-employed workers are subject to the same system, but instead must calculate and pay their own tax directly to HMRC.
As an employee, the chances are that you rarely check your tax code, (it doesn’t sound overly exciting) but it does determine how much tax you pay out of your salary or pension. If you don’t check that the code is correct, or don’t understand your tax code, then you could be paying too much tax(!), or even too little (which may cause problems later down the line).
This blog explains what those letters and numbers mean, why it matters, and what to do if you think your tax code is wrong.
Why do we have tax codes?
While some employees will be subject to basic rate tax, others will be higher or additional rate taxpayers, and many will also have benefits-in-kind to be considered.
With so many possible variations, the tax code provides a simple way to show employers (or pension providers) how much personal tax allowance the employee is entitled to, so that the correct amount of tax can be calculated and deducted.
Why check the tax code?
HMRC is responsible for determining the tax code and in doing this, they generally take any tax paid or benefits-in-kind in the previous year as an indicator of how much the person will receive in the current year. This in turn, helps them to determine the tax code and once calculated, HMRC passes this to the employer and the individual.
Checking a tax code is important because there could be an instance when it is out of date or incorrect due to an error when processing or HMRC may have incorrect or missing taxpayer information.
Where to find your tax code?
Your tax code can be found in the following places:
- Pay slips – The format of this will vary across different employers, but the tax code is usually found in the top right of the pay slip near your name.
- P45 – When you leave a job, you will be issued you with a P45 by your employer. Your last tax code with this employer can be found on the P45.
- P60 – Issued at the end of every tax year, a P60 shows how much taxable salary you paid throughout the tax year with your employer and how much tax was deducted from your salary. A P60 will therefore show your final tax code for the tax year.
- HMRC Correspondence – If you have received any recent correspondence from HMRC, they will inform you if your tax code has changed.
- GOV.UK – Your tax code can be checked on the gov.uk website using the free ‘check your income tax for the current year’ service. Here a taxpayer can see their tax code and personal allowance and they can also see if their tax code has changed and inform HMRC and their employer of any changes. An estimate of how much tax is payable for the year based on their tax code is also available.
Interpreting your tax code
Tax codes consist of four numbers and one letter. The default (most common) tax code for this financial year (2022/23) is 1257L.
The numbers represent the amount of personal allowance available to the taxpayer. Standard personal allowance for 2022/23 is £12,570, and a tax code of 1257 shows that the individual has £12,570 available to them. Therefore ‘1257’ is just the personal allowance minus the zero at the end.
An example: Using the tax code 1257L – the taxpayer is entitled to a tax-free allowance of £12,570. If they earn £10,000, none of their income is taxable, but if they earnt £13,000, £430 of their income would be taxable.
In most cases the tax code will contain one of 20 different letters at the end. However, some may contain a letter at the start. Those letters most commonly used include:
L: Shows that you are entitled to the standard tax-free Personal Allowance
BR, DO, D1: Indicates that all your pay from this source of earnings is taxed at the basic (BR), higher (DO) or additional (D1) rate. These codes are usually reserved for a second job or pension.
K: Indicates that the additional income needing to be taxed through the tax code is higher than the personal allowance for the year. This may occur if prior years’ tax is being collected through the tax code, or the taxpayer has high value company benefits.
M: Indicates that you are receiving extra personal tax-free allowance from your partner. (Conversely, ‘N’ indicates that you are transferring some of your unused personal allowance to your partner.)
W1, M1 or X: These are emergency tax codes and may be used when starting a new job, among other instances. These codes are generally used on a temporary basis.
T: Indicates that your tax code includes other calculations to determine your Personal Allowance.
C or S: Indicates you are resident in Wales, or Scotland, and that your income is being taxed according to the rates in those countries.
What to do if your tax code is wrong or you think you have overpaid
If you think that your tax code is wrong (beyond short term use of an emergency tax code) then you should contact HMRC to discuss this with them. If necessary, they will issue a refund, and provide your employer/s with a revised tax code.
HMRC reviews all taxpayer income at the end of each tax year (5 April) to check that the correct amount of income tax has been collected during the course of the year. If you have paid too much tax, HMRC will write to you to inform you that you are entitled to a refund. If the overpayment relates to the current tax year, then your tax code will simply be adjusted so that you pay less tax for the remainder of the year. If the overpayment relates to a previous tax year, you can usually expect to receive a cheque or direct bank payment for the amount owed.
More advice on tax codes and payroll
Understanding tax codes and deductions can be challenging for employers and employees. As an employer it is particularly important that you understand what is involved and that your business is auto-enrolment and HMRC compliant. If need support with your payroll function, please contact Kingston Burrowes and our specialist payroll team will be happy to help.