What is a tax code?

Definition of a tax code

A tax code is a mechanism that HMRC use to deduct tax from wages, or pension income, under the PAYE scheme.

HMRC tell your employer, or pension provider, what tax code to use when they work out how much tax to keep back from your wages or pension income.

The tax code means your employer should take into account your Personal Allowance, and also any benefits you receive from your employer that you have to pay tax on.

If your tax code is correct, you will pay the right amount of tax on your earnings for your circumstances. If you think your tax code is wrong, you should contact HMRC straight away. Your employer cannot start using a different tax code without HMRC's approval.

How tax codes work:

In 2019/20, if you only have one job and don't receive any taxable benefits, your tax code is likely to be 1250L, because you are entitled to a Personal Allowance of £12,500 and it all goes against your salary.

Different letters at the end of the tax code mean different things, for example if you are aged between 65 and 74, your tax code will end in a P to show that you are entitled to a slightly higher Personal Allowance.

Will my tax code change when I start a new business?

If you’ve just set up a new business, you might be worried that this will change the tax code for your day job. Don’t worry, HMRC won’t do this unless you specifically ask them to. You’ll still pay the same tax on your wages, you’ll just have more to pay separately on anything you make from your new business.

Got questions? Ask Emily!

FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.

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