Understanding your employees’ tax codes

If you pay employees through the PAYE system, it’s essential to use the latest information from HMRC on tax codes. This ensures that your employees receive the correct payment and that you deduct the correct amount of Income Tax.

This article explains the different tax codes and identifies the situations when an employee’s tax code might change.

Basis of tax codes

Tax codes consist of numbers and letters and these are set out in the government website.

Numbers

The numbers in a tax code indicate the amount of income an employee can earn before paying Income Tax. For most individuals, this number is based on the national Personal Allowance; for the current tax year that allowance is £12,570 and this is shown in the tax code as 1257.

Any income or taxable benefits above that allowance are taxed at the appropriate rate of Income Tax.

Letters

The most common code is 1257L, which applies to employees with one job, no untaxed income, unpaid tax or taxable benefits.

If the number is followed by a different letter, you must deduct a different amount of Income Tax.

BR - The employee has additional income from a second job or a pension. If total income falls into the basic rate tax band, Income Tax is deducted at the basic rate.

D0 – The employee has additional income from a second job or a pension. If total income falls into a higher tax band, Income Tax is deducted at the higher rate.

D1 - The employee has additional income from a second job or a pension. If total income falls into the highest tax band, Income Tax is deducted at the highest rate.

K – An employee has income that is not being taxed another way and is worth more than the tax-free allowance. They may be paying Income Tax owed from a previous year or they may be receiving state benefits or company benefits. Income Tax Is deducted on the income that has not been taxed at the basic, higher or highest rate. The number that follows K is multiplied by 10, added to the employee’s income and Income Tax Is deducted on the total amount at the basic, higher or highest rate.

L – The employee has the standard Personal Allowance and no other source of income. Income Tax is deducted at the basic, higher or additional rate.

LW1, LM1, LX – These are emergency codes, which can be used to calculate taxable income if a new employee does not have a P45. M1 is for monthly paid staff and W1 is for weekly paid staff. Income Tax is deducted on all taxable income at the basic, higher or additional rate. These codes are only applied to the current period of pay, not the whole tax year.

M – The employee’s spouse or civil partner has transferred some of their Personal Allowance. The tax-free allowance will be higher and Income Tax is deducted at the basic, higher or additional rate.

N – The employee has transferred some of their Personal Allowance to their spouse or civil partner. The tax-free allowance will be lower and Income Tax is deducted at the basic, higher or additional rate.

NT – This code generally applies to individuals who are treated as self-employed. They will pay Income Tax through their Self-Assessment account, rather than PAYE. No Income Tax should be deducted.

OT – A new employee has not given you a P45, or an existing employee has used up all their Personal Allowance. Income Tax is deducted on all taxable income at the basic, higher or additional rate.

T – The tax code includes other calculations to work out the employee’s Personal Allowance. Income Tax is deducted on all taxable income at the basic, higher or additional rate.

Scottish and Welsh tax payers

Tax payers in these countries receive different tax codes. The codes described above are preceded by the letters S (Scotland) or C (Wales).

Changes to an employee’s tax code

HMRC issues new tax codes if an employee’s circumstances change in a way that affects their Income Tax liability. These circumstances include:

• A new employee joins, but you have not received their P45 notice.

• An employee has notified HMRC of an additional source of income.

• An employee’s income has increased, taking them into a higher tax band.

• An employee has changes in any state benefits or pensions they receive.

• An employee has new company benefits that are treated as taxable.

The tax code changes are issued by email and should be applied to the next pay period.

Income Tax underpaid or overpaid

HMRC or the employee will notify you if Income Tax has been overpaid or underpaid for a previous tax year. HMRC will issue a revised code that takes into account increases or decreases the employee’s tax-free allowance.

Support from Accounts and Legal

These tax codes are important to correct payment and Income Tax deduction. If you have any queries about tax codes or need help to deal with HMRC, our team of experienced small business accountants will be glad to help.

To find out more about employee tax codes, or to speak to one of our team about any other tax advice please contact us at info@accountsandlegal.co.uk.