New tax year, new tax code
The role of your tax code
If you receive a salary, bonus or other taxable cash sum from employment, the amount of tax you’ll pay through the PAYE system is worked out according to your tax code number. This isn’t always the final amount of tax payable on that income but the more accurate your tax code the nearer it will be to the right answer. Getting your code right means that you’re less likely to face a tax assessment when HMRC makes its annual review (usually in the autumn), owe tax on your self-assessment or pay too much tax and have to claim a refund.
How many tax codes?
You’ll have a different tax code for each paid employment (or private pension) you receive. The codes allocate how your tax-free allowances and deductions are applied to each source of income. If, for example, you have two paid directorships you need to check your code for each. The allocation of tax-free allowances can make a big difference to the PAYE tax you pay.
Example – Jasmine has two paid jobs, one part time which pays £500 per month, and the other as a director of her own company. The salary from the latter is the greater but varies significantly from month to month, depending on how much business the company generates. Jasmine is entitled to the standard tax-free personal allowance (£12,570 for 2021/22) but no other reliefs. If HMRC allocates all these to her tax code for her part-time job, only £6,000 (£500 x 12) would be used and as a result she would overpay tax on her directorship salary.
Tip – Within reason it’s your decision how to allocate your tax allowances etc. For example, Jasmine knows that her part-time income will only use £6,000 of her allowance so she can ask HMRC to issue a code that only gives her that amount. If her pay exceeds this it just means she’ll pay a little tax on the excess. The balance of her tax allowance can be given in the tax code for her directorship.
Trap – HMRC might not agree to this if the income from each job varies widely as this may result in too much tax being paid at the basic rate when some should be at higher rates.
Tip – Make sure that if you live in Scotland your tax code starts with an S, or if you live in Wales a C. Different income tax rates apply to Scottish taxpayers and may do so in future for Wales. The prefix ensures the correct tax rates are used against your salary, pension, etc.
The ins and outs of tax codes
As well as your tax code reflecting the tax allowances etc. you’re entitled to, HMRC can deduct certain other types of taxable income (investment income) and make reductions to collect tax it thinks you’ve underpaid. The deductions it makes for other income are always estimated, as are some of the tax reliefs etc., e.g. job-related expenses and pension contributions (if you pay tax at higher rates). To be fair to HMRC, you have a better idea of what these amounts will be for the current tax year as it can only make assumptions based on previous years. The onus is on you to check that what’s in your code is correct.