Understanding UK Tax Codes: A Comprehensive Guide

What are tax codes?

UK tax codes are a unique identifier assigned to each taxpayer (usually employees) by HM Revenue and Customs (HMRC). It acts as a communication tool between HMRC and employers, instructing the employer on how much income tax to deduct from an employee's salary before paying them their net pay.

Here's a breakdown of how tax codes work:

• HMRC assigns a tax code: Based on an employee's income tax situation, including their personal allowance, additional income sources, and benefits, HMRC assigns a unique tax code.
• Employer receives the code: The employer receives the tax code electronically or through a tax code notice.
• Tax code dictates deductions: During payroll processing, the employer uses the tax code to determine the exact amount of income tax to deduct from the employee's gross pay.
• Employee receives net pay: The employer then deducts the calculated income tax and other deductions (like National Insurance) and pays the remaining amount (net pay) to the employee.

Essentially, the tax code ensures the correct amount of income tax is withheld at source, streamlining the tax collection process.

List of tax codes and what they mean in UK

The letter part of your tax code is used to show a change to a particular code to your circumstances. The following are common letters and definitions in the tax code:

L tax code: if you are young and get a basic income allowance before age 65.

K tax code: Usually used when you are given a company benefit like a car and do not have any tax-free allowance for your personal use.

BR tax code: This refers to the introductory rate, which is currently 20%. You will receive this code if you work a second job.

Y tax code: You're over 75 and get the highest personal allowance.

DO tax code: You are a Higher Rate Taxpayer, currently set at 40%.

NT tax code: Income you are not required to pay taxes on.

W1, M1, and X tax codes: indicate emergency tax codes, which means you will have to pay tax on your income over the tax-free personal allowance.

Check your tax code.

Your employer or pension provider uses your tax code to collect tax on your behalf. HMRC assigns your tax code. A tax code is usually found on your payslip, along with information about your pay or pension. HMRC will include it on your coding notice, P60 and P45 if you change jobs, and the coding notice you might receive.

There are letters and numbers in every tax code. 1257, for example, represents the tax-free income you can earn in a tax year - as a general rule, multiply it by 10 to determine the total amount you can earn tax-free. It is estimated that 1257 employees will receive a personal allowance of £12,570 in 2022-23. The tax code letter provides your employer additional information concerning allowances or tax rates.

How do tax codes work UK?

Tax codes in the UK function as a system for employers to efficiently deduct the correct amount of income tax from their employees' salaries before paying them their net income. Here's a breakdown of the process:

HMRC assigns the tax code:

• HM Revenue and Customs (HMRC) assigns a unique tax code to each employee based on their individual tax situation. This considers factors like:
• Personal Allowance: The amount an employee can earn tax-free each year.
• Additional Income: Income from other sources besides their main job (e.g., rental income, part-time jobs).
• Benefits: The value of certain benefits received through employment (e.g., company car, private health insurance).

Employer receives the code:

• The employer typically receives the employee's tax code electronically through payroll software or on a separate "Tax Code Notice" letter from HMRC.

Tax code guides deductions:

• During payroll processing, the employer uses the employee's tax code to determine the exact amount of income tax to withhold from their gross pay.
• The code translates the employee's tax-free allowance into a numerical value.
• Letters within the code indicate how the remaining income is taxed (e.g., basic rate, higher rate).

Employee receives net pay:

• After deducting income tax (based on the code) and other deductions like National Insurance, the employer pays the remaining amount (net pay) to the employee.

Understanding the code:

• A tax code typically consists of letters and numbers.
• The numbers represent the employee's tax-free personal allowance for the year.
• The letters indicate how the remaining income is taxed based on their circumstances.

Example:

• Consider a tax code of 12570L.
• The number 12570 signifies the employee's personal allowance for the year.
• The letter L indicates they receive the standard personal allowance and no adjustments are needed.

Benefits of tax codes:

• Streamlines tax collection for HMRC.
• Ensures employees pay the correct amount of income tax throughout the year.
• Provides transparency for employees regarding tax deductions on their payslips.

Understanding tax codes is crucial for employers to guarantee accurate tax deductions for their employees and avoid potential issues with HMRC.

What should my tax code be?

Every individual has a tax code, so deciding what to use can be tricky. Many things impact your tax code, such as your personal allowance, income from another job, any taxable benefits, and money owed from previous years.

Usually, HMRC will notify you of your tax code annually if you qualify for one. This will include pages explaining why your code differs from the standard tax code.

You can find your tax code on the government website if you are still waiting for a tax code notice - but this tool is only available to employed people (paid via PAYE). A tax code calculator is also available on MoneySavingExpert.

Then you should contact HMRC directly to discuss and request an amended tax code if you believe your tax code is incorrect, as HMRC may still include previous years' taxable benefits.

The most important thing to remember at the end of the day is that if you are working on the wrong tax code, it could mean you are paying too much or too little tax as a result. Either way, you should take care of this as soon as possible.

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Why has my tax code changed? 

HMRC gives each worker a new tax code at the beginning of every tax year. You will only get contacted if your standard tax code stays the same. If your tax code changes, you'll get a P2 form (by post or e-mail) that details your new income tax code. 

How is my tax code going?

Tax offices determine your tax code by:

• The first thing you do is figure out your tax allowances. Usually, this is your personal allowance, other allowances, and job expenses.
• A second calculation is made on any untaxed income. This includes working part-time or claiming certain benefits. They are called 'deductions.'
• After deductions have been made, your tax allowances are subtracted. Calculated is the total amount of income you can earn before you have to start paying taxes. Your Allowance equals the sum of your deductions and allowances minus your total deductions.
• Your tax code is numbered according to your Personal Allowance multiplied by 10.

Useful Read: UK Tax Deductions: The Employer's Guide

An example of a tax code would be 1100L: £11,000 for your Personal Allowance. You will be required to subtract £11,000 from your total taxable income. You will be required to pay taxes on the remaining amount.

Why did you change your tax code?

Several reasons might lead HMRC to change your tax code. These include:

• When you start a new job and your employer doesn't give you a P45, you'll trigger an emergency tax code because you lack enough information to determine your earnings and taxes.
  
  
• The tax treatment of an additional job or pension can vary if your first job exhausts your allowance.
  
  
• The amount of tax you pay can change if you earn more or less money.
  
  
• You may owe more tax if you receive benefits while working, which affects how much you are paid in your payslips.
  
  
• Taxable state benefits may be started or stopped, including state pensions, widow pensions, widowed parent pensions, bereavement allowances, incapacity benefits, employment support allowances, and carer allowances.

If you've been put on an emergency tax code, HMRC will adjust it once it has enough information. An update to your tax code will be notified via coding notice.

What if you use the wrong tax code?

An underpayment may occur if you operate PAYE incorrectly, for example, if you don't apply the tax code that HMRC provides.

For example, let's say your employee starts a new job in 2022/23 and gives you a Starter Checklist that specifies using code BR (since it's a second job).

This code is not used; the standard 1257L code is used instead. This will result in an underpayment for the year because your employee will receive extra personal allowances.

Therefore, HMRC should request payment from you rather than from your employee. In getting things wrong, we provide further guidance. As we understand, you may then have a right of recovery against the employee if HMRC recovers this from you, but you should seek legal advice.