23 July 2020
Everyone on payroll in the UK has them, but what are they and how are they important?
In this guide, we will go through everything you need to know about those pesky little letters on your payslip. Should they be incorrect, you may be paying more tax or less even, so looking to see if they are correctly applied is essential.
What are they for?
Your employer uses a tax code to work out how much tax they have to deduct from you. HMRC will send them a notice of which code to use, and your employer will apply it when running their payroll, so that the appropriate deductions can be collected through the PAYE (Pay as You Earn) system.
How do HMRC work out the code?
HMRC works out your tax code based on your income, mainly using previous years’s data. There may be adjustments for current year declarations your employer(s) make about your payroll, such as taxable benefits you may be receiving.
What do the numbers and letters mean?
The numbers show how much tax-free allowance you get in the tax year, so 1250 would mean that your tax-free allowance is the standard £12,500 (you get taxed on your earnings over this amount).
The letters refer to your circumstances, as in do you have two jobs, lost your P45, or perhaps your income falls into the higher rate tax band.
Here are examples of the most common tax codes umbrella employees will come across:
1250L – Standard tax code – £12,500 tax allowance, icome above this amount taxed at 20%
0T – Temporary tax code – all income taxed at 20% – employers apply this code when they have not received a P45 from the new employee, typically corrected within a month or two based on advice from HMRC.
BR – all income taxed at basic rate (20%) – typical for second jobs where the standard allowance has been used up by the first job where the total income is below £50,000
D0 – tax is deducted from all income at the higher rate (40%), no tax allowance applied, typical for a second job where the total income is above £50,001
W1M1 – W1 (week 1) and M1 (month 1) are emergency tax codes and appear at the end of an employee’s tax code. Tax is deducted only on what you are paid in the current pay period, not the whole year.
K – Tax codes with the letter K refer to tax owed for company benefits, pension income or tax owed from previous years that are more than the personal tax allowance. K675 for example means that your income plus £6,750 is being taxed.
What tax code should I be on?
As an umbrella worker with one employment, no taxable company benefits and no additional income (like pension income) you should be on the standard 1250L.
Sometimes, when the personal allowance changes, like when someone stops receiving a company car, HMRC will send out a notice of tax code change (known as the P6 form). When this happens, have a look and see if it is correct. If you think there is a mistake (it happens often) contact your umbrella employer or even HMRC if you know where the problem might be.
What are emergency tax codes?
When you leave employment, you get issued with a leaver’s form (P45) to give to your new employer. The from helps them to put you on the right tax code. Umbrella workers, however, often change firms too quickly for the form to be issued in time.
In this case, the new employer will issue an emergency tax code so that the payroll can commence. They typically have the above mentioned W1 M1 or an X next to the numbers.
On this tax code, employees are likely to be paying too much tax as there will be no tax allowance applied. Once the first monthly payroll submission is made, HMRC issues a tax code correction and any over/underpaid tax will be adjusted over the following months.
What to do when your tax code is incorrect?
There are a couple of ways you can have your tax code amended if you think it’s incorrect and non of them are very complicated.
HMRC introduced an online tax service for which you can sign up for here. Signing up, the service allows you to check if there is anything affecting your tax code, in addition to seeing and amending employer or pension provider data. Most importantly you can tell them about changes like amending your tax code.
You can, of course, call HMRC on the general income tax enquiry line (0300 200 3300) and have your tax code changes. Make sure you have your NI number handy and be prepared to answer a few questions about your annual income.