What do those tax codes actually mean?

Tax codesNo one wants to pay more than their fair share of tax and National Insurance. For contractors in particular, guaranteeing the correct tax payments and avoiding unnecessary costs comes down to more than just checking their employment status. Understanding the tax code issued by HM Revenue and Customs (HMRC) is the key to managing your finances.

Having the incorrect code could mean you paying more with every tax year. By using the guidance below, you can identify any tax code errors, and potentially reclaim overpaid tax. Read on to find out more about what your tax code means, whether it’s the right code for you and what steps you can take if you think your tax code is incorrect.

What is a tax code and where does it come from?

Tax codes are issued by HMRC to employers paying their workers using the PAYE or Pay As You Earn system. Using this tax code, a certain amount of income tax can be deducted from a salary each and every month.

Most tax codes use a format that is a mixture of letters and numbers, the number representing the tax allowance that has been specified for you. The number in the tax code is multiplied by 10 to give the total tax allowance amount. The letter part of the tax code is a little more complicated to understand.

Although the code issued to most taxpayers includes the letter ‘L’, which relates to the taxpayer being under the age of 65 and eligible for the basic Personal Allowance, there are many more tax code letters pointing to other circumstances and unlocking tax breaks such as the Marriage Allowance. LoveMoney.com offers an excellent breakdown of what each and every tax code letter for 2018/19 means.

Where can I find my tax code for 2018/19?

Finding out your personal tax code is easy. The code is usually displayed on your payslip, or you can check your P45 for details if you’ve recently changed employment. Your P60 will provide information on your tax code, including the payments you have made in tax and National Insurance during the previous tax year. A coding notice is also generally provided at the start of your calendar year. This notice will inform you of any changes in your tax code and the subsequent tax amounts due for the coming tax year.

What should I do if I have the wrong tax code?

Keeping HMRC and/or your employer informed about any changes that could affect your tax code is important. When starting a new role, your employer will retrieve the details needed to generate the most appropriate tax code from your P45. If you think you have the wrong tax code, you can use HMRC’s online service to inform them of any changes or contact HMRC direct to discuss your current circumstances.

The use of emergency tax codes is common, particularly for contractors using umbrella companies. Contractor Calculator offers some great advice for contractors, currently using emergency tax codes:

“Umbrella company contractors who have suddenly changed umbrella company service provider or perhaps changed providers rapidly, may find that they do not have a P45 to hand to their new employer. The umbrella company hiring the contractor uses as emergency tax code that automatically deducts 20% income from the contractor’s salary. This is most likely too much tax for the contractor to be paying, but eventually HMRC will issue a new tax code which will be adjusted to allow for the overpayment.”

You can find out if you are using the right tax code for this tax year by working with your accountant. Want to know now? Use MoneySavingExpert’s Tax Code Calculator.

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