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:

1) 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.
2) If the employee has not given you a P45 in time to be paid, you should use a form P46. The P46 is a 2 page form that can be downloaded from HMRC's website. Depending on whether the employee ticks box A, B or C on page 1, you can then look up the tax code on page 2 of the form. In the rare case when the employee fails to tick a box, or sign the form, there is another rule to follow.

If the employee has a P45

If the form is dated in the current tax year and the information on the form is correct, you will normally use the tax code on the P45, however it is important to follow HMRC's steps. These are explained in part 5 of HMRC helpsheet E13

Once you have determined which tax code to use, you need to notify HMRC of the new employee by sending them details from the P45. From 6th April 2011, these details must be sent electronically, which you do using the Starters/Leavers option on The Payroll Site. We recommend you retain the paper copy of the P45, as proof that these details were supplied by the employee.

If the employee doesn't have a P45 (even if they are expecting one soon)

Print off a P46 from HMRC's website.
The employee should fill out page 1, including ticking box A, B or C in the "Your present circumstances" section, and signing the form.
The employer should complete page 2. In the "Tax code used" section, the employer should tick the same box (A, B or C) that the employee ticked on page 1. The P46 tells you which tax code to use in each case.

The P46 may tell you to use the emergency tax code, which for 2012/13 is 810L.
Contrary to popular belief, the emergency tax code does not cause an employee to pay a higher rate of tax than most employees.

Once you have worked out which tax code to use and paid the employee, you must notify HMRC of the new employee by sending them details of the P46. From 6th April 2011, these forms must be sent electronically, which you do using the Starters/Leavers option on The Payroll Site. We recommend you retain the printed copy of the P46, as proof that these details were signed by the employee.

It is fairly common that an employee will present a P45 after the P46 has been processed. As long as you haven't received a new tax code direct from HMRC, you should process the P45 in time for the next pay date. You should use the new tax code and send the P45 details to HMRC.

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 is 810L then your tax allowance would be £8109. Any amount you earn above this tax allowance is your taxable income. For example, if you earned £20,000 per annum, your taxable income would be £11,891.

Note: If your tax code is a letter 'K' 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 income. For someone earning £20,000 with a tax code of K475, the taxable income would be £24,759.

What the letters mean

The Payroll Site