A tax code is calculated by HM Revenue & Customs for each individual to inform an employer or pension provider how much tax to deduct from income. An incorrect tax code will result in a person paying too little or too much income tax during the year. Tax codes typically consist of numbers and a letter so that an employer or pension provider knows how many personal allowances an individual is entitled to and how to make an alteration to the tax code followed by any changes announced by the Chancellor.
The basic personal allowance is allowable to people aged 16 to 64 and for the 2012-13 tax year is £8105. If a person is due to receive the basic personal allowance the tax code will be 810L, which signifies the yearly allowances due. The letter L indicates the basic personal allowance and may also be used for an emergency tax code. An emergency tax code will be operated by an employer or pension provider if they aren’t sure what the correct tax code should be. The tax code will be shown as 810L followed by either W1 or M1, which stands for week 1 or month 1. In this case the individual would receive personal allowances for the week or month that they are being paid for. This would occur for each week or month until HMRC notifies the employer or pension provider of the correct tax code. The emergency tax code allows a person to receive a limited amount of personal allowance although any additional allowances or deductions won’t be taken into consideration. The use of an emergency tax code will restrict any potential overpayment or underpayment of tax during a specified period.
A person who is entitled to full personal allowances and is aged between 65 and 74 years of age will have the letter P after the numbers, while people entitled to full allowances aged over 74 have the letter Y after the numbers. If the amount of personal allowances that a person is entitled to is affected by circumstances like income being over £100,000 or a reduction due to amount of income, letter T will be the suffix so that the tax code will be reviewed annually. There are times when deductions from a tax code can be more than the personal allowances due, which results in a K code.
There are other tax codes which are used, usually for a second job or pension. BR stands for Basic Rate and will result in all the income being taxed at the current tax rate without any tax free amount. This typically occurs when all the personal allowances have been allocated against the main income or pension, leaving tax due on all other sources at the basic rate of tax. If no tax is to be deducted from income, code NT is operated. This may occur if a person leaves the UK but still receives a source of income from there. If a double taxation agreement is in place with the country of residence, no tax will be deducted from that source in the UK as tax will be paid in the country of residence.
There are additional allowances that may be claimed in certain circumstances, like Blind Person’s Allowance or fixed rate expenses that will increase the amount of personal allowances due. This will result in less tax being paid during the year. Any taxable benefits, state pension, untaxed interest or taxable employer benefits will be deducted from the personal allowances, leaving a person with fewer allowances and paying more tax. It is important to retain Notices of Coding which are issued by HMRC and check tax paid at the end of each tax year.
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