David Redfern, director of DSR Tax Claims, explains how HMRC determines employees’ tax codes and calculates how much tax should be deducted from income
Millions of payslips are issued each month and most taxpayers will be used to seeing the collection of numbers and letters which make up a tax code. However, many people are unaware of what that code means and consequently will not be able to determine whether their tax code is correct.
Each year, millions of tax code errors occur and left uncorrected can cost thousands in overpaid tax each year.
Tax codes are used by employers or pension providers to work out how much tax to deduct from income, whether wages or pension. Unless you are wholly self-employed, unemployed or receive the state pension only, you will have a tax code which is issued by HMRC.
However, because tax codes can change throughout a tax year due to changes in employment or personal circumstances, millions of tax code errors occur each year.
Since tax codes tell employers or pension providers how much tax is to be deducted, even small errors can cost hundreds of pounds over the course of a tax year. People very often have no idea what their tax code signifies, nor whether it is the correct tax code for their circumstances.
Tax code errors are incredibly common but pretty simple to rectify once spotted and any overpaid tax will be refunded.
Standard tax code format
Most tax codes are made up of a number and a letter, the most common tax code for tax year 2019/20 being 1250L.
The number refers to the personal tax free allowance that the taxpayer is entitled to earn before being subject to income tax and is set for the current tax year at £12,500 (the last digit is removed in a tax code making 1250).
If you receive any taxable benefits or are repaying underpaid tax from a previous year, the personal allowance may be reduced.
The letter denotes the individual taxpayer’s personal situation. L means that there are no special circumstances which impact on the personal allowance so the full personal allowance is in play before any income tax is deducted.
If the tax code ends with an M, it means there is transfer of a partner's personal allowance through the marriage allowance and the partner's tax code will end with an N to denote they are transferring part of their allowance to the other taxpayer.
Those ending with T signify that further calculations need to be made to work out the personal allowance, in the case where earnings are over £100,000 and the taxpayer is not entitled to the full personal allowance.
Other tax code letters include BR, which means that all of the income for that particular job or pension is to be taxed at the basic rate, usually because it is a secondary employment or pension.
0T signifies that the taxpayer has used all of their personal allowance, whereas NT signifies that no tax is to be deducted.
Scottish taxpayers will have a tax code suffix beginning with S, while Welsh taxpayers should see that their tax code suffix begins with C.
Emergency tax codes
Emergency tax codes are denoted by the suffix W1, M1 or X and mean that the employer or pension provider does not have enough information to determine which tax code to be applying, usually due to a change in employment.
These tax codes are used until HMRC informs the employer about the correct tax code to be used.
Emergency tax codes usually mean that more tax will be paid while the employer or pension provider and HMRC calculate the correct tax code. In these instances, once the correct tax code is known, any overpaid tax is usually refunded through the salary or pension.
However, as happens in more cases than HMRC might like to admit, tax code errors slip through the net so it is important to check the tax code and how circumstances might affect it, such as any taxable benefits from employers, such as private health care or car allowances.
Tax codes can be checked on the HMRC website.
About the author
David Redfern is Tax preparation specialist and director of DSR Tax Claims Ltd