Tax codes are used by HMRC to notify employers on how much tax is to be deducted from an employee's pay, through the PAYE (pay as you earn) system.
A tax code is made up of numbers followed by a letter. The most common example is 1257L .
The first part of the tax code refers to a person’s personal allowance, which is the amount a person can earn in a tax year before tax is deducted. In the example above, 1257 means that a person can earn £12,570 in the current tax year before tax is deducted.
The letter in the tax code refers to the person's situation and how that will affect the personal income allowance. The ‘L’ shows that a person is entitled to the standard tax-free personal allowance.
Example
A person earns £27,000 a year and has the tax code 1257L. Then they will have a tax-free personal allowance of £12,570.
£27,000 - £12,570 = £14,430
This means that they will only pay tax on £14,430 of their income.
Do everyone have a tax code?
If you have money coming in from a job or a pension, then you will have a tax code, as this means that your tax is being deducted through the PAYE system.
If a person is self-employed and doesn’t have money coming from another source, then they won’t have received a tax code. This means that every year a Self-Assessment must be completed so that tax can be deducted from the self-employed income over the tax year.
Can tax codes change?
Yes, depending on a person’s situation or employment status a tax code can change.
The most common scenario where people will have a change is when they change jobs. When a person starts a new job, the new employer should give the new employee a ‘starter checklist’ that allows the new employer to calculate a tax code.
If a starter checklist has not been filled out then an emergency tax code will be given to the new employee. This could be 1257L Week 1/Month 1 (depending on how frequently they are paid) or 1257X (unknown tax code). These are all temporary tax codes and will be updated by HMRC