Understanding Your Tax Code

Whether you are an employee or pensioner, it is extremely important to understand your tax code. Submitting taxes under an incorrect tax code can mean that you could end up paying too much tax over a period of time or worse- not enough taxes. Following are some general questions which are asked and their corresponding answers.
What is a Tax Code?

A tax code usually contains one letter and several numbers. For instance, two sample tax codes are 117L and K497. You may notice in the first example (117L) this is three numbers followed by a letter. Generally speaking if your tax code is a number followed by a letter, you can multiply the tax code by 10 to get the total amount of income you may earn on a yearly basis before paying any tax. The letter followed by these numbers show how this number should be adjusted following any changes to allowances announced by the Chancellor.

If your tax code is a letter followed by a number, for instance K497, this means that your tax code is K and the number indicates how much must be added to your taxable income. Several letters that are in use under the tax code are K, L, P, V, Y and T, below you will find a brief description of each.

K- This is a tax code used when your total allowances are below the total amount of deductions. You can read more about the K tax code at the following site:
http://www.hmrc.gov.uk/pensioners/understandingyourtax.htm

L- This tax code is used when you are eligible for the basic personal allowance.

P- This tax code is used for individuals that are age 65 to 74 and eligible for the full allowance

V- This tax code is used for individuals age 65 to 74 that are eligible for the full personal allowance and the full married couple’s allowance and which are estimated to be liable at the basic rate of tax.

Y- This tax code is used for individuals age 75 and over eligible for the full personal allowance.

T- T is a tax code used by HMRC when there are other items that require review in your tax code. You can also request that HMRC not to use other tax codes letters listed above, instead using the tax code T.
There are several other tax codes in use including;

Certain tax codes have two letters, but do not have any numbers or can include the letter “D” followed only by a zero. These tax codes usually indicate that you have two or more sources of income and that these sources of income have been applied to both the tax code and the income that corresponds with your primary job.

BR- This tax code is used when your income is taxed at the basic rate. Currently the basic rate most commonly used for a second source of income is 22%.

D0- This tax code is used when your income is taxed at a higher rate. Currently the higher rate most commonly used for a second source of income is 40%.

NT- This tax code stands for “No Tax” and literally means no tax is to be taken from either your income or pension.

Please note; if you have more than one source of income, all other income will usually be taxed at the basic or higher rate. This amount depends on how much you earn overall.
How Your Tax Codes are instituted

The process of how your tax codes are instituted usually consists of four steps.

* Step 1. Your tax allowances are added up. Typically this will consist of your personal allowance.
* Step 2. Income that you have paid tax on and any taxable employment benefits are added up.
* Step 3. The third step is the total amount of income you have not paid any tax on is taken away from the total amount of tax allowances. This total amount is usually called deductions. After this calculation you will have the total amount that you are left with that is tax free income you are allowed in a period of a year’s time.
* Step 4. The fourth step is to create your tax code. Your tax code is created by taking your tax free income and dividing it by 10. Once the calculation is performed, you will receive a number. This number will be added to a letter that fits your situation.

Where to Find Your Tax Code

Finding your tax code is usually a simple process, but does depend on the circumstance of the individual. For those individuals that are currently employed or between jobs, you can locate your tax code on your P45 Form. Your P45 Form can be requested from your employer or your tax office. It is usually given to the individual when he or she stops working for the employer. This is why it is extremely important to ensure that your new employer receives your P45 Form when you change jobs.

If you are starting your first job, you tax code will need to be created. You employer will issue you a P46 form to complete and sign. From this point, your employer will be given the task to allocate a tax code to you, as well as work out the amount of tax due. If the tax code is incorrect and too much tax has been taken out, your employer will make the necessary repayment, if too little taxes have been collected, your tax code will be amended to collect any unpaid taxes due.

For those that have a company or personal pension, you can request your tax code on your notice of coding. This notice is sent to you by your tax office at the beginning of each year and if your tax code changes. For more information regarding your tax code, you can easily request more information by contacting your local tax office.

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Source: http://www.hmrc.gov.uk/pensioners/understandingyourtax.htm