Tax codes

25 September 2018

This article was featured in the October 2018 issue of the magazine.

Jill Smith MCIPPdip, CIPP policy manager, provides basic explanation of tax codes which will be useful to anyone carrying out basic payroll processing.

What is a tax code?

A tax code determines the amount of PAYE (pay as you earn) income tax a UK taxpayer is charged. The tax code describes to employers how much tax to directly deduct from an employee’s earnings before they receive any money.

What is a Tax Allowances?

All individuals are entitled to allowances that serve to reduce the income on which they pay tax. The standard amounts of tax allowance vary according to the circumstances of the individual. The table below shows the allowances for 2018–19.

The marriage allowance was introduced in April 2015 and is available to spouses and civil partners born after 5 April 1935. (Its formal name is the transferable tax allowance.) A spouse or civil partner who is a basic rate taxpayer can apply to HM Revenue & Customs (HMRC) to transfer £1,190 from his or her personal allowance to the other partner, who must also be a basic rate taxpayer. Following a successful application, HMRC notifies the employers about the revised personal allowances.

How are Tax Codes Initially Assigned?

There are several ways in which an employer can receive a tax code allocation for an employee. A common way is through the form P45 on joining. Another is for HMRC to issue an official ‘notice of coding’ to the employer (with a copy to the employee on form P2). This notice of coding is usually referred to as a ‘P6 notice’ but can sometimes be issued as a ‘P9 notice’. If more than one coding is received in the pay period, then use the one with the latest date of issue.

HMRC normally issues an annual ‘blanket’ code change via form P9X. It is not uncommon for further tax code changes to be notified to employers after the annual Budget. Form P7X is used for this purpose. Forms P9X and P7X will typically require the numeric part of certain tax codes (determined by the suffix letter) to be increased (or, exceptionally, decreased).

Breakdown of the Letters & Numbers in Tax Codes

In the UK, every person paid under a PAYE scheme is allocated a tax code usually in the form of a number followed by a letter suffix (though other 'non-standard' codes are also used). Most tax codes are a combination of numbers and letters (e.g. 1185L, 384T, K384).

The number is used to work out how much tax-free pay someone is allowed to earn in each tax year before they pay tax (https://bit.ly/2MocSAZ). It works as follows: the annual tax allowance equals the number × 10. For example, if someone earns £20,000 per annum and their tax code is 1185L their annual tax allowance would be £11,850 which is deducted from their annual salary to determine taxable income: £20,000 minus £11,850 = £8,150. 

Note that if the tax code is a letter ‘K’ followed by a number, it means that the total allowances in the code are less than the total deductions to be taken away from the allowances. In this case the number is added rather than deducted to determine the taxable income. For someone earning £20,000 with a tax code of, say, K1185 the taxable income would be £31,850 (£20,000 + £11,850). 

The letter (suffix) in the tax code helps an employer to work out how much tax to take from the employee’s salary. Most tax codes will have a suffix, signifying some aspect of the employee’s tax status.

In 2018–19, the most common tax code is 1185L, used for most people with one job and no untaxed income, unpaid tax or taxable benefits. This reflects that the personal allowance is £11,850.

List of Tax Codes by Letter Prefix & Suffix

  • M suffix – The individual is benefiting from the marriage allowance, receiving 10% of their spouse’s or civil partner’s personal allowance.

  • N suffix – The individual has transferred 10% of their 'unused' personal allowance to their spouse or civil partner (i.e. marriage allowance).

  • T suffix – This is used if the tax office needs to review a tax code – for example, because the tax affairs are complex, or estimated annual income is more than £100,000, which would affect the amount of personal allowance. An individual can also ask for a T code to keep their personal details confidential.

  • K prefix – The total deductions exceed the allowances. If the untaxed income on which tax is still due is greater than the annual allowances, an individual will be given a K code, to ensure they pay tax on the excess. For more details, see www.gov.uk/tax-codes.

  • S prefix – In operation since April 2016 to identify Scottish rate taxpayers, it can be used with any tax code, including those with a K prefix. It must only be used when notified to do so by HMRC or when the tax code on a new starter’s form P45 already includes this prefix. On leaving employment, the tax code for processing a payment after leaving will only be S0T if it had previously had an S prefix.

(When Welsh income tax is devolved from April 2019, tax codings for Welsh taxpayers will be prefixed with ‘C’.) 

List of Other Key Tax Codes

  • 0T – An individual is given no personal allowance to offset against income. The various rates of income tax and earnings bands will still be applicable (the basic and higher rates, and so on). It is used if an employee fails to provide an employer with a P45 or answer the employee declaration in the Starter Checklist or when the personal allowance has been used up by previous income. This code is the default code for payments after leaving. 

  • BR – All pay from this source is taxed at the basic rate (20%) and there are no allowances applicable. This is because the personal allowances have been used up, such as where the individual has a second job or receives a pension whilst working. 

  • D0 and D1 – All pay from this source is taxed at higher rate (40% D0) or the additional rate (45% D1). There are no personal allowances applicable, which may happen where, for instance, the individual has more than one income. 

  • NT – This stands for ‘no tax’ (or ‘nil tax’), meaning no tax is to be deducted. This code must only be used if advised by HMRC in specific cases. It would never be used with S prefix for Scottish taxpayers.

  • Emergency tax code – HMRC prescribes an emergency tax code for each tax year. It is the code that, in practice, provides the basic personal tax allowance. The emergency code is often, but not always, applied on the non-cumulative basis (see below). It is commonly used for new starters who have not provided a form P45 bearing a valid tax code. 

Basis of Tax Code Operation

A person’s tax liability is based on their total taxable income during the whole tax year. For that reason, PAYE normally operates on a cumulative basis, which means that in each pay period:

  • tax due is calculated on the total taxable earnings in the tax year to date

  • any personal tax allowances are apportioned over the tax year

  • tax charged that period is the difference between the total tax due and the tax paid to date.

Such a system is, to some extent, self-regulating. An under-deduction in one period will be collected, or a refund due will be generated, in a later period. This is useful when a change in tax code is processed, particularly if it has retrospective effect. The cumulative nature of the calculation will ensure that full retrospection to the beginning of the tax year applies automatically as soon as the new code is used.

HMRC may however, sometimes issue a notice of coding to be applied on a ‘week/month 1’ basis (i.e. non-cumulatively). In this case, the employee’s tax is calculated by reference to the current tax period only. Previous earnings and tax paid in the current tax year are ignored.

The following tax codes can be operated on either the cumulative or non-cumulative basis: the emergency tax code; BR; prefix D codes; NT prefix K codes; all tax codes with a suffix letter of L, M, N or T; and S prefix codes. (It’s presumed C prefix codes will operate similarly.) 

How to Get Advice on a Tax Code

If you are responsible for payroll, becoming a member of the CIPP gives you access to advice from our payroll advisory service. So if you have a have a tax code query, join us and get in touch!

 

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