PAYE Coding Notice
Written by Ray Coman
A tax code is an instruction sent from HMRC to the employer, to instruct the employer on how much tax to deduct at source for each employee. The tax code is based on the historical circumstances and income of the employee.
The employee receives a PAYE Coding Notice as well, referred to as a P2. The P2 version will show how components that comprise the tax code. These documents are posted by HMRC if there has been a change of code, or will be available online for those with a personal tax account. The employer receives a P9 version of the tax code. For confidentiality reasons, this notice states only what the code is an not how it was worked out.
If the taxpayer has an allowance, the last digit of the allowance is removed and replaced with the letter L. For instance in 2023/24, the personal allowance is £12,570. A tax code of 1257L entitles the taxpayer to the full personal allowance, of £12,570. If the tax code goes down, it means an entitled to less personal allowance. For instance, a code has reduce to 623, will mean an allowance of £6,230 will be used each month to calculate tax to deduct at source.
If the allowance has already been reduced to zero and tax still needs to be collected at source, the letter K is added to the start of the tax code. A code K100 means that the equivalent of £1,000 is added to income in calculating tax to deduct at source. For instance, if the taxpayer had no entitlement to personal allowance, but received £1,000 in private medical insurance, a K code is added to the start
The tax code is 0T means that no personal allowance is available.
An X at the end of a tax code indicates that the non-cumulative basis has been used. This is sometimes referred to as emergency tax code. An emergency tax code means that pay and tax for previous months (since the most recent April) is not taken into account in calculating tax to deduct at source for a given month.
If a P45 issued since the most recently passed April is not available, the employee is required to complete a starter checklist for PAYE. The starter checklist for employees includes an employee statement. An employee that select box A will be on a cumulative tax code, an employee that selects box B will be on a non-cumulative tax code and an employee that selects box C will be on a BR or basic rate tax code.
Each month a twelfth of rates and allowances are used to calculated the amount of tax to deduct at source. On a cumulative tax code, the pay to date and tax to date are taken into account. The remaining months of the tax year are then factored in and lastly this is applied to that month’s pay to find the tax to deduct at source. Where there is a non-cumulative tax code, it is just
A tax code will effect that amount of tax deducted at source and will therefore effect the taken home pay. However, after the end of the tax year (which is the following 5 April), HMRC will calculate if too much or too little tax has been deducted at source. If too little tax has been deducted at source, tax is usually collected via adjustment to the tax code for a future year. This means that HMRC will collect the extra tax by making the employer increase the amount deducted at source. A refund is usually paid to the taxpayer. If a Tax Return is calculated, tax deducted at source contributes to the calculation of any overall tax payable or repayable via self-assessment.
If too much tax is being deducted at source, HMRC benefits from holding on to the tax sooner. With interest rates high, the taxpayer could be sufficiently incentivised to request a change to the PAYE code before the end of the tax year. For an X code, this could be achieved by passing the P45 to the employer. It is not necessarily the case that a change from emergency tax code to cumulative tax code will result in less tax being deducted at source. If too little tax was deducted at source by previous employer/s, a switch to a cumulative tax code will increase tax deducted at source.
The reason for a decrease in tax code is likely due to an increase in employment earnings. For every £2 that total income is over £100,000, £1 of personal allowance is abated. The personal allowance is £12,570, so an allowance is fully abated when income reaches (£100,000 = (£12,570 x 2)), or £125,140.
To the extent that it is affordable, consider additional voluntary pension contributions to bring total to below £125,140, and closer to £100,000.
The reason that a change in PAYE code is not yet reflected in a payslip is likely due to a lag in communication between HMRC and the employer.
HMRC provide a PAYE Coding Notice Query form online. The taxpayer (or the taxpayer’s agent) will complete the form and provide a reason that the PAYE code needs to be updated. If HMRC agree with the reason, a new tax code will be issued.
A tax code has a cash flow implication only. It is preferable to take action to correct a tax code that is wrong. However, it is not necessary. If too much tax, or too little tax, has been deducted at source, this will be established by HMRC after the end of the tax year. Too little tax deducted at source is collected via adjustment to the tax code of a future tax year. Too much tax deducted at source should be repaid after the end of the tax year in question. If a Tax return is completed, any tax payable to or repayable from HMRC will be addressed via self-assessment.