If you are registered as an employer with HMRC, then it is your responsibility to ensure you deduct tax correctly from each person on your payroll, including yourself if you are a Director Only Company taking full advantage of incorporation.
Table of contents
1. What is a Tax Code?
A tax code is a numerical number, followed by a letter, that is issued by HMRC to an employer so they know how much income tax to deduct from employees gross salaries. It’s issued by HMRC because they are the only people that have all the information on an employees total income, earnings or outstanding debts that can be deducted from gross pay. That means an employee can keep things confidential from their employers.
2. What a Tax Code Means
Each code tells an employer how much tax to deduct with the most common tax code being 1257L for the tax year 2021/2022 (and 1250L for the tax year 2020/2021).
Every year, all UK residents are entitled to earn an amount tax-free known as a personal allowance. For 2021/2022, this is £12,570 and for the previous tax year, it was £12,500. After use up this tax free amount, individuals will begin to pay income tax depending on how much they earn.
| 2021/2022 | 2020/2021 | |
|---|---|---|
| Personal allowance 0% | £12,570 | £12,500 |
| Basic rate 20% | £12,570 to £50,270 | £12,501 to £50,000 |
| Higher rate 40% | £50,271 to £150,000 | £50,001 to £150,000 |
| Additional rate 45% | over £150,000 | over £150,000 |
For the purposes of tax coding, HMRC removes the last digit and replaces it with a letter. In this case, the letter “L” has been used which means you’re entitled to the standard tax-free Personal Allowance.
3. How Does HMRC Work Out a Tax Code
HMRC uses the information it has on an individual to decide which tax code they should be on. They take three steps to work this out:
- HMRC works out how much personal allowance an individual is entitled to (common adjustments are made for marriage allowance and blind person allowance);
- HMRC then deducts income you receive (that they know about) which you have not paid tax on from your personal allowance. Such as bank interest or taxable benefits in kind like medical insurance;
- Once deducted, the last digit in the tax-free amount is removed and replaced with a letter.
4. Tax Code Letters
Tax code letters give more information about how an individual is being taxed. Here is a list of the most common letters used by HMRC:
| Code | Type of Code | How Income is Taxed | Example of When the Tax Code is Used |
|---|---|---|---|
| 0T | Emergency tax code | All income is taxed with no personal allowance deducted | An employee has a second job, has used up their personal tax elsewhere or hasn’t provided a P45 |
| BR | Emergency tax code | All income is taxed at the basic rate (20%) | An employee has a second job or receives a pension |
| C | Welsh tax code | Income taxed as normal, with full personal allowance entitlement | Employee lives in Wales |
| D0 | All income taxed at the higher rate (40%) | An employee has a second job, is self-employed or receives a pension | |
| D1 | All income taxed at the additional rate (45%) | An employee has a second job, is self-employed or receives a pension | |
| K | Untaxed income is added to gross pay | An employee who owes tax from previous a tax year, receives untaxed income such as a pension or company benefits | |
| L | Income taxed as normal, at the basic rate, higher rate and additional rate, depending on how much they earn. | An employee who is entitled to the standard personal allowance | |
| M | Income taxed as normal, at the basic rate, higher rate and additional rate, depending on how much they earn but the employee has additional personal allowance entitlement due to marriage allowance scheme | An employee who has received an additional amount of personal allowance from their partner (up to 10%) | |
| N | Income taxed as normal, at the basic rate, higher rate and additional rate, depending on how much they earn but the employee has less personal allowance entitlement due to marriage allowance scheme | An employee who has transferred an additional amount of personal allowance to their partner (up to 10%) | |
| NT | No tax deducted | Where an individual is on the payroll but is self-employed and responsible for their own tax | |
| S | Scottish tax codes | Income taxed in accordance with Scottish laws | Employee lives in Scotland |
| T | Income taxed as normal, at the basic rate, higher rate and additional rate, depending on how much they earn but HMRC needs to review some items with the employee | HMRC needs to review items with the employee to confirm their tax code |
5. Emergency Tax Codes
An emergency tax code is used by an employer when they do not have sufficient information to put you on a standard tax code such as 1257l for 2021/2022 or 1250l for 2020/2021.
In some circumstances an employee will pay more tax, that’s because they will not be receiving any personal allowance. But the impact of being on an emergency tax code will depend on which one they have been put on. The main emergency tax codes in use are:
6. HMRC Coding Notices
A tax code lasts for one tax year so both the employee and employer will receive (either by post or email) a coding notice before the start of every new tax year.
HMRC may also issue a coding notice during a tax year if an employees circumstances change and a change to a tax code needs to be made. Common reasons changes are made include:
- you are claiming the marriage allowance tax rebate or other taxable state rebates.
- need to pay the £50,000 high-income tax charge
- are self-employed and want to pay any tax you owe through your PAYE tax code
Once a change has been made, the employees’ payslip will be updated to show the new tax code and new adjustments being made.
7. How to Contact HMRC About a Tax Code
Employers only receive coding notices, with very limited information on why HMRC have made a change to a tax code. If an employee believes that they are on the wrong tax code, then they should contact HMRC on 0300 200 3300. Alternatively, HMRC has an online service that lets individuals check their income tax and tax code online, click here to access this service.
