Most people in the UK are entitled to a ‘personal allowance’.  This is the amount of money that you can earn every year before you start to pay tax.

If you are employed or you have a pension, you will generally pay your tax through the Pay as you Earn (PAYE) system.  Here, you will be given a tax code which is used by your employer or pension provider 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. Our guide looks at how your tax code deals with your Personal Allowance.

Your Personal Allowance

Your Personal Allowance is the amount of money you can earn before you start paying tax.  In the 2011/12 tax year, the personal allowance amounts are:

• Standard Personal Allowance – £7,475
• Personal Allowance for people aged 65 to 74 – £9,940
• Personal Allowance for people aged 75 and over – £10,090

Your tax code

To work out your tax code, the total amounts of your allowances are added up.  This will normally just be your Personal Allowance as above, although you may qualify for other allowances (such as Blind Person’s Allowance or Married Couples Allowance).

Then, any income you have not paid tax on already – company benefits, untaxed interest, part-time earnings etc – are added up and deducted from your allowances.

Broadly speaking, to arrive at your tax code the amount of tax-free income you are left with is then divided by ten and added to the letter which fits your circumstances.

Tax code letters relating to your Personal Allowance

If you replace the letter in your tax code with ‘9’ you will get the total amount of income you can earn in a year before paying tax.  For example, tax code 347L would mean you had income of £3,479 before paying tax.

The letter in your tax code shows how the number should be adjusted.  The tax code letters that relate to your Personal Allowance are:

• L -  if you are eligible for the basic Personal Allowance – 747L for the 2011-12 tax year
• P -  if you are aged 65 to 74 and eligible for the full Personal Allowance
• Y -  if you are aged 75 or over and eligible for the full Personal Allowance