Guide to Tax Codes
How do I work out which tax code to use?
A lot of small employers make the mistake of asking their new employee which tax code to use. For new employees, there are two ways to determine the tax code and they are, as follows:
- If the employee gives you a P45, you should follow HMRC's rules for checking it and then, assuming it is in the correct tax year, use the tax code from the P45.
- If the employee has not given you a P45 in time to be paid, you should find out the employee's circumstances using a 'starter checklist', or similar form. Depending on whether the employee ticks box A, B or C, you can then look up the tax code to use.
If the employee has a P45
Within The Payroll Site, click 'Add Employee', then choose the option for an employee who has supplied a P45 and enter information where prompted. The system will automatically follow HMRC's rules to choose the correct tax code and create the starter information, which will be sent with your next RTI return.
Before Real Time Information (RTI) was introduced, employers had to send a separate notification to HMRC to tell them that a P45 had been received. Now this has changed and the notification is included as part of your next normal RTI return.
If the employee doesn't have a P45 (even if they are expecting one soon)
Print off HMRC's starter checklist.
The employee should fill out the form, including ticking box A, B or C in the
'Employee Statement' section, and signing the form.
Depending on which box the employee ticked, HMRC's rules dictate which tax code should be used in each case. The Payroll Site will choose the correct tax code when you use the 'Add Employee' option. For cases 'A' and 'B', the emergency tax code (1257L for the tax years 2022/23 and 2023/24) is used. Contrary to popular belief, the emergency tax code does not cause an employee to pay a higher rate of tax than most employees.
As with the P45 case, HMRC now learns about new starters from information contained in your next RTI return. We recommend you retain the original printed starter checklist, as evidence that these details were signed by the employee.
It is fairly common that an employee will present a P45 after they have been paid for the first time. As long as you haven't received a new tax code directly from HMRC, you should follow HMRC's rules for dealing with the P45 in time for the next pay date - see the HMRC website for the latest guidance.
Tax code notices
HMRC may send you a P6 tax code notice for one of your employees, either electronically or through the post. If this happens, you should check which tax year it is for. If it is for the current year, apply the details to the employee's Tax Details tab and they will automatically be used for your next pay run. If the notice is for the next year, don't apply them until after you have clicked Finish Tax Year.
Scottish and Welsh rate tax codes
HMRC decides who is a Scottish rate tax payer. Employers should not use a Scottish rate tax code unless they receive one on a P45 or a tax code notice. Scottish rate tax codes have an extra S at the start.
Similarly, Welsh rate tax codes start with the letter C.
What the number part of the code means
The number in the tax code indicates the tax allowance as follows:
Tax allowance = Number x £10 + £9
For example, if your tax code were 1257L then your tax allowance would be £12,579. Any amount you earn above this tax allowance is your taxable pay. For example, if you earned £20,000 per annum, your taxable pay would be £7,421.
Note: If your tax code is a letter 'K' (or 'SK' or 'CK') followed by a number, it means that the total allowances in your code are effectively negative. In this case the number is added rather than deducted to determine the taxable pay. For someone earning £20,000 with a tax code of K475, the taxable pay would be £24,759.
What the letters mean
Tax codes starting with C mean HMRC has determined you are a Welsh rate tax payer.
Tax codes starting with S mean HMRC has determined you are a Scottish rate tax payer.
Tax codes ending in L indicate a basic personal allowance.
Tax codes ending in M and N indicate that part of the personal allowance has been transferred from one person to their partner using the Marriage Allowance.
Tax codes ending in T indicate there are items requiring review by your Inspector of Taxes.
Tax codes starting with K indicate allowances are less than the total deductions. An example could be if you have a company car, private medical benefit and other taxable expenses and benefits in kind which exceed the amount of the personal allowance.
Tax code BR stands for 'Basic Rate' and indicates that all of your pay is to be subjected to the basic rate of tax at the current rate. You will therefore receive no personal allowances but you will not be subjected to higher rates of tax.
Tax codes starting with D indicate that your pay is taxed in one band. D0 (or SD0 or CD0) is used for the band above the basic rate, and D1 (or SD1 or CD1) is for the band above that. SD2 is used for the top rate of Scottish tax.
Tax code 0T indicates that you have no personal allowances and all pay is subject to tax.
Tax code NT indicates that no tax is to be deducted on your pay.