Person doing paperworkYour tax code may not be the most fascinating of issues, but it is important. If you're on an incorrect code, you could find yourself underpaying throughout the year and being hit with a huge bill, or being overcharged and left out of pocket each month.

If you've recently changed jobs or gained a new source of income, you should be especially vigilant about being placed on the correct code.


Here's what you need to know...

The L code: for most people

Tax codes are usually made up of a series of numbers and a letter. The most common letter is L. This means that you are under 65 and eligible for the basic personal allowance – this is the amount you can earn before income tax kicks in. The basic personal allowance for 2012-13, applicable to low and middle earners with an annual income of less than £100,000, is £8,105.

However, this is jumping sharply next year to £9,440.

This exact allowance figure (divided by ten) will precede the letter in your code. So for the 2013-14 financial year, 944L will be one of the most common codes – indicating that you are aged under 65 and earn less than £100,000, and are hence entitled to a £9,440 personal allowance before income tax kicks in.

The K code: for untaxed income

Another code that many people may have is the K code. This is essentially the reverse of an L code and is used when your level of untaxed additional income exceeds your personal allowance.

To take a step back: the taxman wants to know about any additional income you get from your employer – often this will be in the form of employee benefits. This income eats away and reduces your personal allowance.

Consider this example: your employer provides you with a brand new BMW company car to use both on the job and at home. All your petrol is paid for, as is the licensing and tax associated with the vehicle. The taxman will come up with a figure for the income you're receiving from this (for personal journeys), and cut it from your personal allowance. This will give you a tax code that still ends in L, but has a smaller figure preceding it. So if the taxman decided that you were getting £5,000 of income from your company car, you will see a code of 310L on your new tax code (£8,105 - £5,000 = £3,105 or 310).

However if this additional income exceeds your personal allowance, wiping it out completely, you'll be shunted onto a K code.

To continue our example – if the taxman decides that you're receiving £15,000 of additional income from the company BMW, you'll see 689K as your tax code. This means that you need to pay income tax on all of your earnings plus the £6,895 additional income from the company car that exceeds your personal allowance.

For £100,000+ income

If you're a high-earner, the situation starts to get a little more complex. For every £2 you earn over £100,000, you'll lose £1 of your personal allowance. At this point you should be put on a T code, preceded by a figure showing the level of allowance you have left, providing any company benefits aren't forcing you onto a K code.

For example, someone with an income of £110,000 with no untaxed benefits or other relief will see a 310T code – indicating £3,105 of personal allowance.

When your income reaches £116,210, you'll lose all of your allowance and your whole income will be subject to the appropriate rates of income tax. At the point you'll be put on a 0T code.

P and Y codes: for pensioners

If you have a low or middle income and are aged between 65 and 74 you'll be placed on a P code, enabling you to have an income (after certain allowances such as donations or pension contributions) of £10,500 across the 2012-13 year before you pay any tax.

If you're 75 or over, this allowance increases to £10,660 – signified by a Y code.

However there is also a cut-off point applicable to pensioners on the upper end of the income spectrum.

For every £2 you earn over £25,400, you'll lose £1 of your personal allowance until it reaches the basic rate. Providing your income does not exceed £100,000, you'll keep this allowance. If it does, your basic personal allowance will begin eroding away again at the same rate (£2 earned = £1 loss) as those aged under 65.

It's also worth pointing out that the basic state pension is paid untaxed – though it is taxable. Most people opt to have this fall under their personal allowance.

Second jobs and pensions

You'll usually receive a tax code for each source of income you receive. If you have more than one income, you'll be asked to state which is your main source, and this will have the appropriate level of personal allowance applied to it.

All other income will all be taxed without any allowance. If you pay at basic rate, additional income sources will receive a BR code, higher rate payers will get a D0 code and those liable for the additional rate will get the D1 code.

An NT code will come through if no tax is to be taken. This could be because your total income is less than your personal allowance, or you're a self-employed contractor who is liable to pay National Insurance but not income tax.



Emergency Codes

An emergency tax code is issued if HMRC does not have enough information about you to send your employer the correct code. This usually happens if you start your first job and get your first source of income part of the way into the financial year, or you haven't got a P45 from a previous employer.

The emergency tax code for 2012-13 is 810L – the same as the basic personal allowance code. This normally ensures you receive the basic amount of monthly tax-free pay. But it doesn't take into account any other relief or allowances.

You may also see W1 (for weekly pay) or M1 (for monthly pay). This signifies that you are being taxed as if it is the first week or month of the financial year. However if you start work part of the way into the year, a W1 or M1 code could see you overpay in tax – as it is spreading your person allowance over too many months.

For example, if you start your first job five months into the financial year, you should receive a seventh of your personal allowance in each monthly wage packet. A W1 or M1 code will only give you a twelfth – meaning that you will be overpaying. However when you hand over your P45 or P46 to your new employer, your tax code should change – and you should be reimbursed with any losses. If you get to the end of the financial year and still haven't been reimbursed with the overpaid tax, you should get it back in a refund.

If your tax code is wrong

If you think your tax code is wrong you need to tell HMRC as soon as possible so it can be corrected. You'll need to have your tax reference and National Insurance number to hand – these can be found on your payslips or any letters from HMRC.

You can get hold of all of the contact details for HMRC by heading to its website.



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