Do you know what your tax code is?

Your employer or pension provider uses a tax code to calculate the amount of tax to deduct from your pay or pension.  If you have the wrong tax code you could end up paying too much or too little tax.

There are a number of things that affect your tax code.  Here are the top five.

1. Personal Allowances that you receive

Personal Allowances are the amount of money that you are allowed to earn every tax year before you start paying tax.  For example, the basic personal allowance for the 2010/11 tax year is £6,475.

You may also receive other personal allowances such as age related allowances.

Your tax code is often a number followed by a letter.  Assuming this is the case, if you multiply the number in your tax code by ten, you will get the total amount of income you can earn in a year before paying tax.

2. Whether you have more than one job

If you have two jobs or pensions, it is likely that all of your second income will be taxed at the basic or higher rate – depending on how much you earn. This is because all of your allowances will have been used against the income from your main job or pension.

So, if all of the income from your second job or pension is taxed at the basic rate, your tax code may be ‘BR’.  If your income from your second job/pension is all taxed at the 40 per cent rate of tax, your tax code may be ‘D0’.

You may have different tax codes for your various incomes.

3. Your previous income and tax for the year from a previous job

There are occasions where HM Revenue and Customs (HMRC) don’t know enough about your income or tax payments for the tax year to allocate a tax code.  This may be because you have changed jobs or if you have taken up a salaried job after being self employed.

In these situations, you may be put on an ‘emergency’ tax code.  Your employer or pension provider uses this emergency code is a code until HMRC has enough information about your income to enable them to send your employer (and you) your correct tax code.

The emergency tax code is set each year and is a number followed by the letter L. The number is the basic Personal Allowance (£6,475 for the tax year 2010-11) divided by ten. The emergency code for 2010-11 is therefore 647L.

4. Company benefits

If your employer provides you with company benefits – such as a car or medical insurance – you may have to pay tax on them.  HMRC will usually include the value of the benefit in your tax code so that they can collect the tax due through the Pay As You Earn (PAYE) system.

HMRC adds the value of the benefit to any other untaxed income you have.  They then take away the total amount of income you’ve not paid tax on from the total value of your allowances and reliefs.  The amount you’re left with is the tax-free income you are allowed to receive in the current tax year.

For example, you may receive medical insurance benefits worth £1,000.  HMRC will deduct this from your personal allowance (currently £6,475) and so the total amount you can earn tax-free will be £5,475.  Your tax code will be 547L.

HMRC will usually send you a ‘PAYE Coding Notice’ that explains exactly how they have dealt with the benefit in your tax code.

5. Whether you have underpaid tax

If your employer or pension provider uses the wrong tax code, or if your income increases but HMRC do not know about it straight away, you may end up paying insufficient tax.

In these situations, HMRC can often alter your tax code to collect underpaid tax through the PAYE system.