Do you understand Tax codes?

INTRODUCTION

In the 2015-16 tax year, the applicable tax code for all the tax-payers was 1060L. This tax code applied to all the individuals who received the entire tax free Personal Allowance and at the same time 1060L was even the applicable ‘emergency tax code’ for 2015-16. Tax code 1060L means an individual could earn £10600.00 before having to pay the UK Government tax. Tax codes are issued by HM Revenue and Customs (HMRC) each tax year and reflect an individual’s personal tax-free allowance. A tax code is used by employers or pension providers to calculate the amount of tax deductible from an employee’s pay or pension. It is imperative to have the correct tax code and it should be updated each year. If the tax code is incorrect, an employee may end up paying too much or too little tax.

What does the letter ‘L’ represents?

In the UK, each individual is permitted to earn a certain amount without paying any income tax. This threshold is referred to as ‘personal allowance’. In April 2015, the Personal Allowance was increased from £10,000.00 (as applicable for tax year 2014-15) to £10,600.00. If the tax code features numbers and then the letter ‘L’, for example 1060L, it means that an individual was born after 5 April 1938 and is eligible for the basic Personal Allowance in that specific tax year.

If the tax code ends with the letter ‘Y’ it means that an individual was born before 6 April 1938 and is eligible for the entire Personal Allowance. Additionally, if the tax code ends with ‘M’ or ‘N’ it means that an individual has either transferred or received 10% of the Personal Allowance to/from their partner.

Letters in the tax code and their meaning

Letters in the tax code refer to an individual’s situation and provide details on how it can affect the Personal Allowance

Letter	What it means
L	An individual is entitled to the usual tax-free Personal Allowance
M	Marriage Allowance: An individual is eligible to receive a transfer of 10% of their partner’s Personal Allowance
N	Marriage Allowance: An individual is eligible to transfer 10% of their Personal Allowance to their partner
S	An individual’s income or pension is taxed according to the Scottish rate of Income Tax
T	Tax code includes additional calculations to compute the Personal Allowance, for example it has been abridged as the projected annual income is in excess of £100,000
0T	Applicable Personal Allowance has been used up / an individual has started a new job and does not have form P45 / appropriate details were not provided to the new employer (the details they need to assign a tax code)
BR	The entire income of an individual is taxed at the basic rate
D0	The entire income of an individual is taxed at a higher rate
D1	The entire income of an individual is taxed at an additional rate
NT	No tax is being paid on this income

If a tax code has letter ‘K’ as a prefix

A tax code with letter ‘K’ at the commencement mean an individual’s income has not been taxed in any different way and it’s worth more than the tax-free allowance. This usually happens if any individual:

• Is paying tax from a previous year through their wages or pension
• Is getting state benefits (state pensions) on which tax is payable
• Is getting benefits (like a company car or health insurance) from work that an individual must pay tax on

Tax code ending with ‘W1’ or ‘M1’

W1 (referring to week 1) and M1 (referring to month 1) are emergency tax codes. This means the payable tax is based only on what an individual is paid in the current pay period, and not the whole year. Codes ending with W1 or M1 are known as ‘non-cumulative’ and appear as ‘587L W1’ or ‘587L M1’. Emergency tax codes are generally updated automatically after an individual provides new employer with P45. A new tax year always begins with a normal tax code, not an emergency one.

Working out the tax code

To work out a tax code, firstly, an individual must add up all the tax allowances.  For most individuals, this will be the basic Personal Allowance; although some might also have age related allowances or a Sightless Person’s Allowance. Secondly, an individual needs to add up the income on which tax hasn’t been paid. This may comprise of untaxed savings interest, untaxed company benefits or income from a second job.  These deductions are then reduced from the allowances. The remaining amount is the earnings for a tax year on which income tax is payable. This number should be divided by ‘10’ and add the letter which best fits an individual’s personal circumstances. For example: steps would be:

1. Allowances – Basic personal allowance of £10,600
2. Deductions – NIL
3. Personal allowance for 2015-16 = £10,600 divided by 10 i.e. 1,060
4. If an individual was born after 5 April 1938 and qualifies for full Personal Allowance = letter L
5. Therefore, Tax code = 1060L

1060L as ‘emergency’ tax code

If an individual has recently changed their job, or has multiple jobs at one time or haven’t sent the current employer a copy of your P45 – in such cases HMRC may not have adequate information about the income of an individual to send an employer or pension contributor a correct tax code. In such a scenario, they will issue an ‘emergency tax code’ which is used on a provisional basis while HMRC arrives at the correct tax code. If an individual has an emergency tax code it will ensure that they receive the basic tax free Personal Allowance (£10,600 in tax year 2015-16 or £11,000 in tax year 2016-17). HMRC sets the emergency tax code each year and is a number followed by the letter ‘L’.

DNS ACCOUNTANTS – EXPERT ADVISORS IN THE UK

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