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Tax codes. How to understand them?

14/02/2018 08:56 pm

If you work in the UK, you must have a tax code. As the tax code is issued by HMRC, not many people take time to check whether their code is correct. And even fewer workers know how to do it. But you should keep in mind that HMRC also makes mistakes and it is not wise to take everything for granted: being assigned with the wrong tax code can cost you hundreds of pounds.

In this blog post we will take a look at what tax codes there are, how they are made up and how to check whether your one is correct.

What is a tax code?

A tax code is a combination of letters and numbers and is usually indicated on your:

You can also find your tax code on the GOV.UK website.

It is created to tell employers and pension providers how much tax-free pay an employee should get for their work and how much tax should be deducted from the payment above the tax-free allowance.

Usually, the tax code starts with a number and ends with a letter. Most of the people who work in one company (and haven‘t recently changed jobs) or get a pension, are issued with a code 1150L.

The number usually demonstrates how much tax-free pay a person can earn in each tax year. You should take the number from the tax code and multiply it by 10 to get the total amount of income that can be earned before being taxed. For example, the mentioned code 1150L would mean that the tax-free amount is £11,500.

How is a tax code made up?

The tax code is made up of:

  • numbers indicating employee‘s tax-free personal allowance
  • a letter or letters which refer to employee‘s situation and how it affects their tax-free personal allowance.

When can a tax code change?

There is a number of situation when your tax code might change. For example:

  • if your personal allowance has increased;
  • if the benefits you receive from your job change;
  • if you have work expenses that you can reclaim tax for;
  • if you receive income that isn't being taxed;
  • if you become entitled to state benefits (including the state pension) that are taxable;
  • you need to pay tax due from previous years.

More than one employment

Most of the time mistakes in tax codes appear when a person has more than one job. This usually happens because different employers use different tax codes. In order to calculate your tax code, HMRC uses information provided by the main employer and automatically apply the left over personal allowance to other jobs.

What the number means

The numbers indicate how much tax-free income an employee gets in that tax year. This is how it is created:

  • HMRC works out tax-free Personal Allowance.
  • Income that you haven’t paid tax on (such as untaxed interest or part-time earnings) and the value of any benefits from your job (such as a company car) are added up.
  • The income that you haven’t paid tax on is taken away from your Personal Allowance. What’s left is the tax-free income you’re allowed in a tax year.
  • The last digit in the tax-free income amount is removed.

What the letter means

Letter What it means
L You’re entitled to the standard tax-free Personal Allowance
M Marriage Allowance: you’ve received a transfer of 10% of your partner’s Personal Allowance
N Marriage Allowance: you’ve transferred 10% of your Personal Allowance to your partner
S Your income or pension is taxed using the rates in Scotland.
T Your tax code includes other calculations to work out your Personal Allowance, for example it’s been reduced because your estimated annual income is more than £100,000
0T Your Personal Allowance has been used up, or you’ve started a new job and your employer doesn’t have the details they need to give you a tax code
BR All your income from this job or pension is taxed at the basic rate (usually used if you’ve got more than one job or pension)
D0 All your income from this job or pension is taxed at the higher rate (usually used if you’ve got more than one job or pension)
D1 All your income from this job or pension is taxed at the additional rate (usually used if you’ve got more than one job or pension)
NT You’re not paying any tax on this income

*HMRC information

What are the 'K code', 'W1' or 'M1' ?

'W1' and 'M1' are emergency codes. They are usually used when an employer or a pension provider have to use an emergency code because HMRC is still working out the correct code.

Tax codes with ‘K’ are intended to tax benefits in kind, state benefits and underpayment of tax. In other words, it means that it is used to tax the income that isn’t being taxed another way and it’s worth more than your tax-free allowance.

For most people, this happens when they are:

  • paying tax that they owe from a previous year through your wages or pension
  • getting benefits they need to pay tax on - these can be state benefits or company benefits

What to do if your tax code is incorrect?

If you think your tax code is incorrect, you should: