Tax codes: what employers need to know
When you employ someone, you will need to collect income tax from their wages in accordance with their tax code. As an employer, your main role in relation to tax codes is to operate the code that HMRC give you and change the code when HMRC tell you to change it. However, it is helpful to understand how tax codes work.
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What a tax code is
A tax code is used by an employer to calculate the amount of tax to deduct from an employee’s pay. A tax code is normally made up of numbers and letters for example 1257L or K396.
HMRC uses the tax code to tell an employer what tax-free earnings an employee is entitled to in a particular pay period, so that tax at the appropriate rates may be calculated on the balance. The more a person earns, the higher the amount of income tax they pay. You can see the key rates of income tax and personal allowances on GOV.UK.
How a tax code works
Most people who pay tax in the UK are entitled to a personal allowance.
If your employee has no other income, they can have employment earnings up to the amount of the personal allowance without having to pay any tax. This is the starting point for most tax codes.
The basic tax code can be changed up and down. There may be other amounts to add to the basic personal allowance which will increase the amount an individual can earn before paying any tax – and therefore reduce the amount of tax they have to pay on their wages. There can also be deductions, such as tax underpayments, that reduce the amount the person can earn before paying any tax and therefore increase the amount of tax they have to pay on their wages.
The tax-free amount, reduced or increased as necessary, is turned into a tax code. HMRC do this, but the easiest way to understand how it works is to take off the last number and add on a letter. For example, in 2023/24, someone whose tax-free amount is just the personal allowance of £12,570 will have a tax code of 1257L. This code means that your employee is entitled to £1,048 tax free pay per month or £242 per week.
The letters used in tax codes often do not mean much to anybody. However, they are there for HMRC to communicate with employers about changes to tax codes. Every year, for example, HMRC will issue guidance to employers telling them to uprate all ‘L’ codes for the new personal allowance amount so that they can be carried forward into the new tax year. We talk about this annual process below under the heading: Changes to tax codes.
Please note that since 6 April 2017, Scottish taxpayers pay Scottish Income Tax. HMRC will tell employers whether to treat an individual employee as a Scottish taxpayer by issuing tax codes prefixed with an ‘S’ for Scottish taxpayers. Operating an S code should make sure the correct tax is deducted at the correct rate.
Since 6 April 2019, there is also a Welsh tax code (prefixed with a ‘C’) – but for 2023/24, the Welsh tax rates and thresholds are the same as the rest of the UK (that is, England and Northern Ireland).
Cumulative tax codes
Most of the time, PAYE is calculated on a cumulative (i.e. ongoing) basis over a tax year. So, if your employee starts on 1 September 2023 having not worked at all since the start of the tax year (6 April 2023), in September they will be allowed £6,288 (6 months x £1,048) of pay free of tax, to use against that month’s wages. The tax-free amount increases by £1,048 each month thereafter and it is only when the employee finally earns more than the tax-free limit that will they start to pay tax.
Dealing with in-year employee tax refunds
A cumulative tax code can also mean that you might need to pay a tax refund to an employee through the payroll. For example, an employee starts with you on 1 September 2023, with pay and tax from a previous job ended on 30 April 2023 of £1,000 and £20 respectively. In September they earn £500 with you. As they are allowed £6,288 of tax-free pay at this point in the tax year, but have only actually earned £1,500, they have overpaid £20 in tax.
Typically, you would refund this to them in their September pay packet on behalf of HMRC and fund the £20 by reducing any other amounts you need to pay over to HMRC for that same period (for example tax and NIC for any other employees). If your payment to HMRC for the same period isn’t sufficient to cover the tax refund, you can do either of the following:
- reduce your subsequent monthly or quarterly payments to make up the balance, or
- apply to HMRC for funding to cover the balance.
For more information on reducing your subsequent monthly or quarterly payments to HMRC to recoup your employee’s tax refund, see Paying PAYE to HMRC.
You can apply for financial help for an employee tax refund on GOV.UK.
We understand that HMRC treat tax refund funding for employees as a priority and aim to issue funds within 6 days. If an employer supplies bank details, HMRC will issue funds by bank transfer, but if you choose to receive a cheque this will delay receipt by several days.
Where to find your employee’s tax code
When you first take an employee on, you will usually be able to work out their initial tax code from their form P45 or from the 'Starter Checklist' explained in our guidance on the starter procedure.
Once your new employee’s information has been sent to HMRC and processed by them, they may issue you with an updated tax code. This will be either:
- sent by post,
- viewed online if you use HMRC’s PAYE Online for employers service, or
- received electronically if you use payroll software.
Changes to tax codes
Most tax codes change at the beginning of each new tax year to take account of any increases in the personal allowance and HMRC will advise you on what you need to do prior to the start of the new tax year. This will either be on form P9X or if your employee has a specific tax code, on P9(T).
Your employee’s tax code may also change during the year, if the employee's circumstances change, for example if they notify HMRC that they have a new source of untaxed income. HMRC will let you know if it changes. Once a code number is issued it remains in force from year to year until HMRC notify a change. You must not, under any circumstances, use another code unless advised to do so by HMRC.
During the year, any changes to an employee’s code will be notified to you on form P6. This will be either:
- sent by post,
- be viewed online if you use HMRC’s PAYE Online for employers service, or
- received electronically if you use payroll software.
It should be used on the first pay day after it is received, unless you are notified otherwise.
At the same time, HMRC will notify any changes of tax code to your employee and will give them a breakdown of the allowances that HMRC think they are due, and an explanation of how the code number is worked out. The P6 that you receive as the employer tells you what your employee’s tax code is, but does not explain how the code is worked out for reasons of confidentiality.
It is always a good idea to make sure you understand generally how your employee’s tax works, so that you can answer any queries from them if they do not understand their coding notice or think it is wrong.
Please be aware that HMRC have started to use information provided by third parties to update employees’ PAYE tax codes more frequently. This can affect their take home pay. You should tell employees to contact HMRC if they think the changes are wrong.
Emergency tax codes
You may have heard people talk about an emergency tax code. Sometimes you may see something that looks like 1257L W1 or 1257L M1. This is an emergency tax code and means that only one week’s or one month’s proportion of the allowances due for the tax year is given against each week’s or month’s pay so that the pay period is dealt with in isolation and not on a cumulative basis. If you see an X rather than a W/M, this indicates the person's pay period is not weekly/monthly – they could be paid four-weekly for example.
As explained above under the heading Cumulative tax codes, normally if someone has not worked since the beginning of a tax year and gets a job on 1 September, they will be allowed £6,288 (6 months x £1,048) of tax-free pay to use against that month’s wages. This is because PAYE is calculated on a cumulative basis. But if they are on an emergency tax code, they will only receive one month’s worth – £1,048 – of personal allowance to use against that month’s wages. In these situations, PAYE is operated non-cumulatively, which means the person does not get the benefit of their unused allowance since the start of the year. This will generally happen until a proper code is received from HMRC. Then the cumulative basis may come into play.
It is likely that you would operate PAYE non-cumulatively like this where, for example, your employee’s pay and tax details for an earlier part of the tax year are not known. Using an emergency code means they will be getting some benefit of the personal allowance each pay period, but the likelihood of them having paid significantly too much or too little tax at the end of the tax year is reduced. You can find out more about when to use these codes in the context of a new employee, in our guidance on the starter procedure.
There are other situations where an emergency code may be used. HMRC will tell you when you need to use one.
Other tax codes you might see
Other codes you may see include:
- BR, which means basic rate tax applies.
- NT, which means no tax is to be deducted.
- 0T, which means there are no allowances left for that employment but tax will be deducted at the appropriate rates.
You can find a list of common tax code letters on our PAYE codes page.
Employees with another job
You may be employing someone on a part-time basis, so your employee may well have another job. If they do have another job, you may be told to use a BR code against the wages that you pay them. This is because HMRC assume all of their tax-free amount will be used against the other job and so tax any wages from you at 20% (BR, or basic rate) to help ensure there is no underpayment at the end of the year. You can see an example of how this works in Jenny under the NIC heading on our page about the PAYE system.
Note, however, that there are other reasons why your employee may have a code of BR and as such, you must not assume they have another job if code BR is issued to them.
If your employee is earning only a small amount in the other job, which when added together with the earnings from your employment does not exceed the personal allowance, then they can contact HMRC and ask them to split the allowances so that they do not have tax deducted by either employer. If they wish to do this, they should contact HMRC.
PAYE usually works best when an employee has a single, stable job that lasts a complete tax year. In any other situation, an employee could end up paying too much or too little tax by the end of the year. In these circumstances, HMRC will normally send out a tax calculation – form P800 – at some time after the end of the tax year when they put all the employee’s records together. The P800 will tell the person that there is either an underpayment of tax (which will probably be ‘coded in’ and collected later via PAYE) or an overpayment of tax (in which case HMRC should issue them with a refund).
There is nothing you need to do with regard to this, but it is important to be aware of it as it is a routine part of the PAYE lifecycle.
Using the wrong tax code
It is possible that an underpayment will arise if you do not operate PAYE correctly, for example, if you do not apply a tax code that HMRC sends to you.
Consider also the following situation: Your employee starts a new job in 2023/24 and gives you a starter checklist that indicates that code BR should be used (as it is a second job). However, you do not use the code – you just put them on a standard 1257L code. This means that your employee will be given the benefit of extra personal allowances and will not pay enough tax, leading to an underpayment for the tax year.
If this is the case, HMRC should first seek the tax from you, not from your employee. See our further guidance on this issue in our page on getting things wrong. If HMRC recover this from you, our understanding is that you may then have a right of recovery against the employee, however you would need to seek legal advice on this.
If you have any questions about the tax code HMRC have asked you to operate you should contact the Employer Helpline.