Tax Codings - a better understanding
Tax codings - a better understanding
In many of our client meetings, the subject of tax codings is discussed. This is only increasing with the rises seen in the State Pension amount coupled with the personal allowance remaining static meaning that more people are having a change in tax coding. In the majority of cases, this is so that tax that is due on their State Pension is being claimed from other sources.
Whilst we are not accountants, we feel it is important that clients understand what their tax codes mean and why they change. As much as anything else, this can give a ‘sense check’ as to whether the tax coding is right or not.
In the UK, a tax code is a series of letters and numbers used by your employer or pension provider to determine how much Income Tax to deduct from your pay or pension. HM Revenue & Customs (HMRC) issues these codes, and they are the only ones who can change them.
How a Tax Code Works
Numbers: The numbers in your tax code indicate how much tax-free income you are entitled to in a given tax year. This is usually based on your Personal Allowance, which is the amount of income you can earn before paying any tax. To get the tax-free amount, you typically multiply the number in your tax code by 10. For example, if your code is 1257L (the most common for 2024/25), it means you can earn £12,570 tax-free.
Letters: The letters in your tax code provide additional information about your specific tax situation and how it affects your Personal Allowance. Common letters include:
L: You are entitled to the standard tax-free Personal Allowance.
BR: All your income from this job or pension is taxed at the basic rate (often used if you have more than one job or pension).
D0/D1: All your income from this job or pension is taxed at the higher or additional rate respectively (also often used for a second job or pension).
K: Your income that isn't being taxed another way (e.g., state benefits or company benefits) is worth more than your tax-free allowance, meaning you'll pay tax on more than your taxable income.
M/N: Relates to the Marriage Allowance, where a portion of one partner's Personal Allowance is transferred to the other.
S/C: Indicates that your income is taxed using the rates applicable in Scotland or Wales, respectively.
0T: Your Personal Allowance has been used up, or it's an emergency code for a new job where details aren't yet available.
W1/M1/X: These are emergency tax codes, usually applied temporarily when HMRC doesn't have your full income details after a change in circumstances (like starting a new job).
Why is a Tax Code Important?
Your tax code is crucial for several reasons:
- Ensuring Correct Tax Deduction: It directly determines how much Income Tax is deducted from your wages or pension throughout the year.
- Avoiding Over or Underpayment: If your tax code is incorrect, you could end up paying too much tax (meaning you'll need to claim a refund from HMRC) or too little tax (which could lead to an unexpected tax bill at the end of the tax year, possibly with penalties).
- Utilising Your Personal Allowance: Your tax code ensures that you receive the correct amount of tax-free income you're entitled to.
- Reflecting Personal Circumstances: Tax codes are adjusted to account for changes in your life, such as getting a second job, receiving certain benefits, claiming the Marriage Allowance, or owing tax from a previous year. Keeping it updated ensures your tax is calculated accurately based on your current situation.
You can usually find your tax code on your payslip, P45 (when you leave a job), P60 (annual statement of earnings and tax paid), or by checking your personal tax account online with HMRC. It's important to regularly check your tax code to make sure it's correct. If you believe it's wrong, you should contact HMRC to get it rectified.
For those people who like an app, I have recently seen the HMRC app in action, and so far it does seem to be quite intuitive and allows you to find relevant information relatively quickly once you have set it up.
Estate Planning, Inheritance Tax Planning, and Tax Planning are not regulated by the Financial Conduct Authority.
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