Understanding Tax Codes

Tax codes are a bit of a mystery for most people. Yet, understanding what they are and how they are worked out could help you realise if you paid the right amount of income tax… or not! 1 in 3 people have overpaid their income tax and a whopping £322million on average is overpaid every year!

What is a tax code?

Tax codes are generated by HMRC and communicated to your employer or pension provider so the correct amount of income tax can be deducted ‘at source’ and then repaid to the taxman (without you having to put your hand in your pocket). Tax codes indicate how much your personal allowance should be in the tax year in relation to your earned income (either from a job or a pension).

Sometimes HMRC will send a ‘Coding Notice’ directly to you. Not everyone needs…to receive this Coding Notice but if you do, don’t throw it away, keep it as you may need to refer to it at a later date.

It’s likely that you will have more than one tax code if you:

  • have two or more jobs at the same time
  • receive an income from two or more pensions
  • receive income from a pension and a job

A new tax code will be used from 6 April to make sure you pay the correct amount of tax.

If you paid too much income tax, then you should be due a tax refund from the taxman. If you didn’t pay enough, then in all likelihood HMRC will recoup the debt via the following year’s tax code.

What is the personal allowance?

A personal allowance is the amount that nearly everyone in the UK is allowed to earn tax free within a tax year.For the 2013-2014 tax year (this current tax year), the personal allowance for people born after 5th April 1948 is £9,400.For the 2014-2015 tax year (starting 6th April 2014), the personal allowance for people born after 5th April 1948 is £10,000. The Chancellor of the Exchequer decides the rates of personal allowance and communicates them to the nation in his ‘Autumn statement’.

How tax codes are worked out

A tax code is usually made up of several numbers and a letter i.e. 944L. The numbers generally refer to your personal allowance. The tax code spreads your tax-free amount equally over the year so that you get about the same take-home pay or pension each week or month. If you multiply the number in your tax code by ten, you will get the total amount of income you can earn in a year before paying tax.The letter in the code refers to your personal circumstances in relation to the allocation of your personal allowance. For example, the letter ‘L ‘indicates that you were born after 5th April 1948 (all letters have a specific meaning, which should reflect your personal circumstances). Therefore, ‘944L’ means you were born after 5th April 1948 and your personal allowance for the 2013-2014 tax year is £944 x 10 = £9,440.Depending on how your personal allowance is worked out, sometimes ‘W1′ or ‘M1’ is added at the end of a code. Nothing to worry about – ‘W1’ generally indicates that your personal allowance is worked out on a weekly basis (because you are paid weekly); ‘M1’ means that your personal allowance is worked out on a monthly basis (because you are paid monthly).Some other tax codes are made up slightly differently. For instance, ‘BR’ is used when all your income is taxed at the basic rate – currently 20%. ‘BR’ is most commonly used for a second job or pension but it could also have been attributed by HMRC on a temporary basis because they are unclear about your tax position (see section ‘Why am I on an ‘Emergency’ tax code?) A more detailed explanation of tax codes and letters is available on HMRC’s official website.

What is an ‘Emergency’ tax code?

An emergency tax code is a code that your employer or pension provider uses on a special basis until HMRC has enough information about your income so they can send them (and you) your correct code. You might get an emergency tax code if:

  • you’ve started a new job and haven’t got a P45 from your previous employer for the same tax year or you haven’t completed a Starter Checklist or provided your employer with relevant information before your first pay day.
  • you’ve started your first job since the start of the tax year and haven’t been receiving any taxable state benefits or a state or company pension.
  • you’ve started a new job but you’ve had another job or other jobs or received taxable state benefits during the year (taxable benefits include Job Seekers Allowance and Employment Support Allowance).
  • you’ve started a new job and were previously self-employed.
  • there’s been a change in your tax code during the year because, for example, you’ve started to get company benefits or the State Pension.

Once HMRC has details of your previous income and tax paid for the tax year, they send your employer (and you) your full (correct) tax code. Your employer will deduct the correct tax in future and refund any overpaid tax through your wages.

What is the procedure to follow when changing jobs?

When you leave a job where you’ve paid tax through PAYE, your employer will give you a P45. You should give it to your next employer so they know what tax you’ve paid so far in the tax year. It’ll help them make sure you won’t pay too much tax in the future.

What if I’ve lost my P45?

If you’ve lost your P45, your employer may ask you to complete a Starter Checklist, which in turn he will forward to HMRC. It’s really important to make sure you provide your employer with a completed Starter Checklist or provide the relevant information your employer has asked you before your first payday! If you don’t, you could end up paying too much tax. The Starter Checklist contains important details that affect the tax you’ll pay. It will ask you relevant information before your first payday to tell HMRC about you, help your employer to allocate a tax code and work out the tax due on your first payday. HMRC will process the information you have provided on the Starter Checklist and where necessary, revise your tax code. Provided you follow this procedure, any tax that you may have overpaid should be refunded to you through your wages – this normally can take up to 6 weeks.

I’ve been on BR or ‘emergency’ tax code for months and I didn’t receive a refund

Unfortunately, this is quite a common and financially painful situation to be in. If this is your case, it might indicate that HMRC are unable to work out your personal allowance and allocate the correct tax code to your employer so you would pay the correct amount of income tax. If your tax code is BR, it means that HMRC will charge the basic rate of income tax (currently 20%) on every pound you earn. This usually happens because HMRC is unclear about the tax you paid or/and the income you earned from a particular employment (especially if you changed jobs often) or/and if they don’t know how much taxable benefits you received if you claimed JSA/ESA at some point. If you think you’ve paid too much tax because you’ve been taxed on an ’emergency’ code you should claim a refund. You can do this by contacting HMRC directly (they only accept telephone enquiries) or by contacting us so we can assess your situation free of charge.

What to do if you think your tax code is wrong

If you think your tax code is wrong you must tell HMRC as soon as possible so they can correct it. You may get some tax back – or you might have to pay a bit more.

Am I due a tax refund for last year?

The Pay As You Earn (PAYE) system works out if you have paid too much or too little tax, and HMRC will send you a P800 calculation if you have. However, this isn’t always automatic, bear in mind that HMRC can only work out your tax position if they hold full and correct records about you in the first place, so there is always a margin for error. According to HMRC, 1 in 3 tax payers pays too much income tax. This means that most people pay the right amount of tax but it also means that up to a third pay too much tax. As a rule of thumb, if your employment history has been stable (say, you have been with the same employer for over 12 months), then the chances are you would be paying the correct amount of income tax. However, you may actually be due a tax refund if one or several of the following scenarios apply to your situation:

  • You changed jobs frequently in the last 4 tax years
  • You had multiple claims for JSA/ESA
  • You applied for tax relief for job expenses (i.e. You’re an employed mechanic and you have to buy your own tools with no reimbursement from your employer)
  • You were employed and left the UK in the last 4 tax years

You can also use our tax calculator to check if you paid the correct amount of tax or not. If you realise you have overpaid tax and never got a refund, contact HMRC or get in touch.

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