Anyone working in the UK automatically has a tax code. Since they ensure everyone within a company gets paid, they're a basic requirement for running both payroll and a business.
However, with all the numbers and letters included in them, they can seem a little complicated if you're unfamiliar with them. For those who've been a bit confused by tax codes in the past, you'll find everything you need to know about business tax codes below...
What is a tax code?
Part of the PAYE (Pay As You Earn) system, tax codes are applied to every businesses' employees to indicate the amount of income tax HMRC will take. As a result, they do not apply to contractors or freelancers, who take care of their own income tax.
Most payroll software packages will help work out the relevant tax code, though the HMRC site also has information to help you do it manually. If you're planning on hiring, then you have to tell HMRC what the tax code is via a Full Payment Submission on or before your employee's first official payday. In most cases, you'll do this via your first payroll run that includes the new employee.
How do I know if a tax code is correct?
A tax code features both letters and numbers. We'll go into what these mean so you can check if your employees’ tax codes are correct.
What do the letters at the start of a tax code mean?
Scottish and Welsh tax codes
Before we delve into the specifics any further, it's worth noting that if your employee lives in either Scotland or Wales, their tax code will start with an S or a C. This tells HMRC that the employee needs to pay Welsh or Scottish tax rates, which may be different from those in Northern Ireland or England.
The ‘K’ tax code
As well as the above letters, a tax code may begin with tax code K. This means that an employee's income is not being taxed in any other way, and which is worth more than their tax-free personal allowance. This is the same as saying that the total number of deductions from an employee's salary are greater than their personal allowance.
This means the employee is currently paying tax owed from a previous year, or they're receiving state or company benefits.
The numbers following a K tax code show the amount of tax that's owed, rather than their personal allowance. So, as an employer, once this K tax code is applied, you have to take the tax due even if the employee's income comes from a different source. However, there's a limit – you should not take more than 50% of the employee's pre-tax wage.
On the other hand, the numbers of a tax code display the personal allowance the employee is entitled to, minus the sum of any income the employee hasn't paid tax on AND the value of any job benefits, like a company car for instance.
What do the letters following a tax code mean?
The number will be followed by at least one letter. For most employees, this will be tax code L, indicating the employee is entitled to the personal allowance. However, there are other letters which may appear at the end of the tax code, or follow the letter L. These include:
What is an emergency tax code?
Emergency tax codes are used if you're unable to get the required information before you pay the employee's first wage. It's usually the same code that's applied to your other employees, so you assume this employee is entitled to all the personal allowance.
There are other reasons why such tax codes are applied. For instance, if they are receiving company benefits, were self-employed, or they receive a state pension. They may also be applied if an employee has underpaid tax for whatever reason.
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What is a week 1 or month 1 tax code?
Sometimes, you may have to apply a week 1 or month 1 tax code temporarily. These are usually used in the event of an employee changing jobs and their income tax payments do not match their earnings. They may also be used if there is a temporary reduction in hour,s so they don't receive an incorrect tax refund.
Why do tax codes change?
If an employee earns more or less in a second job, or they receive a new taxable benefit like a company car, their tax code might change. It also might change if they owe money to HMRC for unpaid taxes elsewhere, i.e. whilst they were in other employment.
HMRC will send you a P6 form informing you of the new tax code that you should then use immediately.
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