Oh, tax codes! How I hated them when I first started training as a tax advisor. It can be tricky little things. If you misunderstand them, the consequences can be quite serious. Your customer could end up paying too much or, worse, too little tax and be left with a huge tax bill at the end of the year. As you can probably imagine, that customer is not going to be a happy bunny.
I am a tax advisor in training and work at a small tax consultancy near London. When I arrived in London from Germany on a gap year adventure 8 years ago, little could I have imagined that one day I would become a tax consultant in the UK. These days I can’t imagine a better job for myself.
For most of us, having an incorrect tax code means we end up paying too much tax. You’ve probably heard or been warned about the dangers of having an emergency tax code. Guess? The emergency tax code – 1000L in 2014/15 – is the code most of us have to make sure we pay the correct amount of tax.
A tax code tells your employer how much money you can earn tax-free each year so they can withhold the correct amount of tax from your wages. For most of us, this will only be our basic personal allowance, which is £10,000 for the 2014/15 tax year. The tax code itself is your tax-free earnings divided by ten and followed by a letter (usually “L”) – hence the tax code 1000L. Unless you have additional earnings or untaxed income, this code ensures that you receive your full personal allowance and that approximately the correct amount of tax is withheld from your wages.
So what are the “dangerous codes” to watch out for? In short, any code that is not 1000L requires a good check. Below I have listed a number of common ones:
W1/ M1 means week 1/ month 1. Normally, your tax position is recalculated with each payout, taking into account your aggregate income for the year, so that you receive your full personal allowance over a tax year. However, if your employer uses a W1/M1 code, it will not have enough information about your income before you entered employment to calculate your personal allowance for the remaining tax year. Instead, you will receive 1/12 or 1/52 of your personal allowance (depending on whether you are paid monthly or weekly). However, you may not get your full personal allowance if, for example, you had no or less income before you started your job and you may be paying too much tax.
The W1/M1 code is intended as a temporary code and must be changed by HMRC. However, if this does not happen, you can call HMRC on the tax helpline (tel: 0300 200 3300) and request an amendment.
If your tax code is 0T, alarm bells should be ringing. Your employer uses this fiscal code if you do not complete a starter’s statement before you start working.
When you start a new job, your employer may, in certain circumstances, ask you to provide a start-up declaration to verify whether you had any wage or benefit income prior to your employment or whether you have a different job.
With the 0T code you do not receive a personal allowance and you withhold tax at the relevant tax rates. If you have such a code you will almost inevitably pay too much tax and you should call HMRC and request that it be changed as soon as possible.
BR, D0 or D1
Chances are you will come across a BR code. This code withholds tax at a rate of 20% (D0 withholds tax at 40% and D1 at 45%). If you have a second job, this job is likely to have a BR code where the 1000L code is mapped to your main job. However, if you earn less than £10,000 a year in your main job, the 1000L code will not give you your full personal allowance. You must transfer the unused part of the surcharge to your second tax code, otherwise you will pay too much tax.
Sometimes tax codes are more complicated, for example if you have other untaxed income, are entitled to a higher personal allowance, receive a benefit from your employer (for example, private health insurance or a company car) or incur work costs. Your tax code must list all of your untaxed income and allowances in order to deduct the correct amount of tax. If you are unsure whether your tax code is correct, seek advice from HMRC on the tax helpline.
Where can you find your tax code?
You may have received a tax code notice from HMRC before the start of the tax year. However, not everyone receives such a notification. If you recently retired from work and received a Form P45 from your employer, that form lists your tax code. (An employer must provide a P45 to each employee who no longer works for them). You can also call the HMRC tax helpline to find out.
If you had a wrong tax code in the past
The default tax codes in the past 4 tax years were as follows:
If you are concerned that you have paid too much tax in the past due to an incorrect tax code, you can request a tax refund for up to the past 4 years.
It’s been a year since I started working in the IRS and I’m still not a big fan of those tax codes. Fortunately for most of us, our tax codes are probably pretty straightforward. However, they are worth checking because if they are wrong you could end up paying the wrong amount of tax. And who knows, you may discover that you have paid too much tax and you can claim a refund.