What your PAYE code means – continued

Changes to codes

The number part of the code can be changed (adjusted) to collect the tax due on other income you have. This can be done to avoid a tax bill at the end of the year. HM Revenue and Customs uses code adjustments to collect tax due on other untaxed income (on, for example, employment benefits, state pension, taxable state benefits and small amounts of rental income), by taxing your earnings or non-state pension at a higher rate.

The starting point for the code will be your tax free personal allowance (747L for under-65s).  This will then be adjusted to the extent that you have other earnings from employments or pensions against which tax is not deducted.

For example, your employer provides you with medical insurance costing £1,000. As you are not receiving cash it is not physically possible for your employer to withhold tax from that benefit, despite it being considered taxable income.  If HMRC reduce the tax free pay allowed against your pay by £1,000 for the year (changing your code from 747 to 674), then the extra tax that would be due on the medical insurance will be collected from your pay instead.

If your code has been adjusted and you do not know why, you should contact HMRC to check the tax code.

K codes

K codes are different from all other codes, in that they tell the employer to use a negative tax free allowance. If your code is adjusted (as described above) but you do not have enough tax free personal allowance to cover all your additional untaxed income then you will be issued with a K code.  Where other codes show an amount of tax free pay, K codes show an amount of additional income to be added to your pay when calculating the tax to be taken. A ‘K’ code means that the employment or pension is being used to pay tax due on other income as well. It is essential to check K codes individually as they usually result from a number of adjustments to your personal allowance

For example, your employer provides you with various benefits in kind £10,000.  This is £2,525 more than your tax free personal allowance of £7,475.  If HMRC issue you with a K252 tax code, then you will be taxed on an extra £2525 of salary which you don’t actually receive. This is done to prevent the need for a tax bill for the untaxed income at the end of the tax year.

Unlike the other codes (where the letter is at the end of the code), the ‘K’ in the K code is placed in front of the numbers.  This helps the employer easily identify this special type of code.

Letter only codes

There are some codes that are just letters. For example:

• The NT code means that no tax should be deducted.  It is rare and used only in exceptional circumstances.  This may be because the employee lives overseas or was made bankrupt during the year.
• The BR code is more common and means that you will be taxed at the basic rate (20% for 2011/12) on your total pay from this employment or pension. It is usually used for a second job. It assumes that your main job will have used up all the tax free pay to which you are entitled (your personal allowance) and so none remains to claim against this second employment or pension. However it is not appropriate if, for example:
  • Your earnings from your main job are less that your basic tax free pay (£7,475 for someone aged under 65 in 2011/12)
  • You are a higher rate tax payer and should be paying 40% tax (or more) on your second job (rather than 20%).
  • The DO code means that you will pay higher rate (40%)  tax against all the income from this employment
  • The D1 code means that you will pay additional rate (50%) tax against all the income from this employment

Week 1 or month 1 codes

Week 1 and month 1 codes are described in detail above in so far as they apply to the emergency code that may be issued to a new employer. All week 1 and month 1 codes operate on the same basis as that described in that section. However, HMRC may also issue you with a week 1 or month 1 code if they make a very large change to your code for the current year. HMRC will have amended your code because they identified income or employment benefits that were not otherwise being taxed.  You would not therefore have paid enough tax over the first part of the year.

If HMRC simply issue you with a new code, the normal PAYE process will mean that the shortfall in tax will be collected in full from your next pay.  But, where there has been a large tax underpayment the adjustment to your next pay may be so large that you would receive little or no pay that week/month.

In these circumstances HMRC may instead issue an adjusted code on a week 1 or month 1 basis.  This is to ensure that the problem does not continue and the correct tax is taken for the rest of the tax year, but there will have been no claw back of underpaid taxes from the start of the year.  Instead, this tax will normally be collected by an adjustment to the following year’s tax code, or through the self assessment system.