How tax codes work
The letters in an employee’s tax code signify their entitlement (or not) to the annual tax-free personal allowance. Tax codes are updated annually, or when an employee’s circumstances change, and help employers work out how much tax to deduct from their pay packet.
The basic personal allowance for the tax years starting 6 April 2021 and 6 April 2022 are both £12,570. This is used to create the PAYE tax code for an employee, entitled to the standard tax-free Personal Allowance of 1257L. This is the most common tax code and is used for most people with one job and no untaxed income, unpaid tax or taxable benefits (e.g. company car).
This is also used as the emergency tax code when a new employee doesn’t have a P45. This code is usually applied on a ‘Week 1/Month 1’ basis, meaning that an employee’s tax calculation is based solely on what they are paid in the current pay period and disregards their earnings in the year to date. If this is not corrected by the end of the tax year, the employee is unlikely to have paid the correct amount of tax for the year.
What is a K code?
A K tax code is seen less often and is used when total deductions due for company benefits, state pension, or tax owed from previous years are greater than an employee’s personal allowance. This typically arises when an employee is provided with an expensive company car. Employees need to multiply the number in the tax code by 10 to work out how much will be added to their taxable income, before tax is calculated. For example, a code K600 will result in £6,000 being added to taxable income over the year, at a rate of £500 per month.
K code example
You have previously been on tax code 1257L, but have now received a company car from your employer, on which the benefit in kind will be £20,000 (lucky you!). HMRC deducts £20,000 from £12,570 which effectively gives you negative tax allowances of £7430 and converts this into a new tax code K743.
In future, instead of having £12,570 / 12 or £1047.50 deducted from your taxable pay every month, you will have £7,430 / 12 or £619.17 ADDED to you taxable pay each month.
Your tax code does not affect the calculation of National Insurance contributions, which are based on your actual gross salary.
What does X or W1/M1 mean?
This means your new K code will be applied on a Week1/Month 1 basis, rather than cumulatively. It won’t be used to recalculate the tax paid for previous months, which is usually what happens when your tax code changes. This is correct if the extra income that is being taxed only started part-way through the year. The X or W1/M1 should disappear from your code after the next 5th April.
I think my K code is wrong (or I don’t know why I have received a K code)
This is a common query.
When HMRC send details of a new tax code to your employer, they should also send you a detailed calculation, explaining how they have calculated the code. The snag is, if they don’t have your current address, you won’t receive this and even if they do, it seems these letters don’t always get sent. So, ask HMRC using one of the contact methods below to explain the new code. If it’s wrong, they can correct it pretty quickly over the phone, or online.
In order to cap HMRC’s enthusiasm for restricting allowances, to recover large amounts of unpaid tax, an employee’s PAYE tax deduction for any pay period can’t be more than half their gross pay. Bear in mind that any adjustment to a tax code, whether K code or another, represents HMRC’s estimate of other income, or tax due and is unlikely to be exactly right. If you believe they have over-estimated the adjustment, you are entitled to contact them and ask for the code to be amended. You don’t need to over-pay tax all year and then claim back the excess later (although you can if you wish).
To contact HMRC, go to this page.
Likewise, if you normally file a Self-Assessment Tax Return after the end of the tax year you can ask HMRC not to adjust your tax code for other income (gross interest, rental income, etc.) and simply pay any tax due under Self-Assessment on 31 January, after the end of the tax year. You are not obliged to have tax on other income sources collected through your PAYE code.
Would you like one of our team of professionals to help you with your Personal Tax return?
There will be many reasons why you might need to submit a Self-Assessment Tax return. Find out more about the requirements you must meet and the services we offer here and get in contact with our Small Business & Tax Manager, Alison Tideswell, who can guide you through the process.
Check your code now
Thankfully, you don’t have to accept a tax code change without any explanation. HMRC have a simple online service where you can check your current tax code and tell them if you think it’s wrong. Find your tax code now…
Even better, register for an online Personal Tax account, which will give you instant online access to your tax code calculation, as well as a quick and easy way to query it or ask for it to be amended.
For a general explanation of tax codes, how they work and what to do if you think your code is wrong, check out ‘What does my tax code mean?’