© Chartered Institute of Taxation 2019

What is PAYE?

PAYE spreads your income tax over the tax year, rather than paying tax in one lump sum. A tax year starts on 6 April of one year and ends on 5 April in the next.

Your employer deducts tax from your wages (in accordance with a ‘tax code’ – see below) before paying you. Your employer is responsible for sending the tax to HM Revenue & Customs (HMRC). Each pay day your employer should give you a payslip setting out your pay and tax.

At the end of the tax year, you should get a form P60 which sets out the total amounts paid to you and deducted from you for the previous tax year (your employer MUST give you this by 31 May following the end of tax year).

PAYE is an estimate, and is not necessarily the exact amount you are required to pay. Indeed, many millions of taxpayers pay the wrong amount during the year.

The Pay As You Earn (PAYE) system is a method of paying income tax on employment income. It can be tricky to understand, however it is the backbone

of employee taxation, so it is very important that you try to do so.

Tax codes – the basics

The starting point for most tax codes is the personal allowance. This is the amount that you can earn each tax year free of tax.

In 2019/20 the main personal allowance is £12,500, although your total amount of tax-free allowances may be higher or lower than this.

HMRC use a tax code to tell your employer what tax-free allowances you are entitled to, so that tax at the appropriate marginal rates may be calculated on the balance.

The code number is the amount of the tax-free allowances you are entitled to, less the last digit. For example, if allowances total £12,500, the code number is 1250.

Most normal codes are four numbers followed by a suffix – L is the most common one. L just means that the full basic personal allowance is included in the code.

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Example

Paul earns £20,000 per year, paid monthly. His tax code is 1250L. What will Paul’s tax be each month?

From the 1250L tax code, his employer knows that Paul will be entitled to £12,500 of tax-free income a year or £1,042 per month.

Each month, tax is calculated on £625 at 20% (that is, his £1,667 salary less £1,042). This gives £124.93 per month PAYE tax.

At the end of the year, we can see this is roughly correct:

Top tip

If, for whatever reason, you don’t end up working for an entire tax year, you may find that you are due a refund, because of unutilised tax-free allowances.

Non-standard tax codes

1250L is the standard tax code for 2019/20. But tax codes can be adjusted up or down. There may be other ‘allowances’ in the code, for example employment expenses such as professional subscriptions.

This essentially ‘increases’ the amount of tax-free pay each month. Note that the 1270L code here gives tax-free pay of £1,058 rather than £1,042: £16 extra tax-free income per month saves £3.20 per month in tax for a 20% taxpayer. Over the course of the year the increased code will provide approximately £40 of tax relief – which is the amount due on the £200 union fee (at 20%).

Tax codes can also be used to collect income tax, for example on untaxed bank interest; or unpaid tax from an earlier year.

This essentially ‘reduces’ the amount of tax-free pay each month. Note, in this example, HMRC are not trying to collect £1,750 of unpaid tax – only £350. But in order to collect £350 of tax, they must tax (at 20%) £1,750 more income.

Salary £20,000

Personal Allowance (£12,500)

Total £7,500

@20% £1,500

PAYE £1,499.16 (£124.93 x 12)

Full basic personal allowance £12,500

Union fee £200

Total allowances £12,700 (Tax code is 1270L)

Full basic personal allowance £12,500

Unpaid tax (£1,750)

Total allowances £10,750 (Tax code is 1075L)

Top tips

Tax codes may change a number of times during the tax year. Common events that give rise to changes are the submission of employment expenses claim forms by employees and HMRC undertaking their annual P800 tax reconciliations. If you get a new tax code, make sure that you check it carefully and understand it!

You should also be aware that tax codes may be ‘wrong’. Consider this: Ruth claims relief for a £200 teaching subscription but in the following year gets a job in a school where they pay it for her. Unless she informs HMRC that her tax code is wrong, she will underpay tax of £40! You can find out how to update your tax code here: www.gov.uk/tax-codes/updating-tax-code

Emergency tax codes

Your tax code is unique to you. It reflects assumptions HMRC make about you, based on information they have been supplied with. This information may come from you, from your employer (who tell HMRC about your income and benefits-in-kind) or from banks and building societies, who submit summaries of interest paid on savings to HMRC.

You will be issued an emergency tax code if HMRC do not have enough information about you to Issue a full tax code.

A ‘true’ emergency code assumes that you are only entitled to the basic personal allowance. It does not take into account any other allowances and reliefs you may be entitled to. So the emergency tax code for 2019/20 is 1250L, which is actually the same as the normal code for the vast majority of people.

Sometimes Basic Rate (BR) codes and Week 1/Month 1 (W1/M1) codes are also referred to as ‘emergency’ tax codes. You most often see these when starting a new job without a P45 or if you have more than one job.

Starting a new job with a P45

PAYE is normally worked out on a cumulative basis.

This means that your previous pay and tax figures are taken into account to calculate what tax to deduct from your pay, so that the amount is correct when figures are considered on a year-to-date basis.

If you leave a job, your employer should complete form P45. The P45 shows total pay, tax-to-date in the tax year, and the tax code that was in use.

Passing the form to your next employer enables them to implement the same code and continue to deduct tax on the correct basis.

Example

Joan leaves her job on the 30 April 2019. Her P45 shows pay-to-date of £1,455 and tax deducted of £82.60. Her tax code is 1250L.

She starts a new job in July after going on holiday. She earns £1,500 a month.

Joan gives her new employer her P45. Joan’s tax is worked out as follows:

July £82.60 refund (this is because her tax-free pay allowed to date is £4,168 (4 x £1,042) compared to the £2,955 she has actually received)

August £0 tax (tax-free pay allowed to date £5,210, compared to the £4,455 she has actually received)

September £0 tax (tax-free pay allowed to date £6,252, compared to the £5,955 she has actually received)

October £32.20 tax (her £7,455 actual earnings have overtaken her tax-free pay amount of £7,294 by £161. £32.20 is £161 x 20%)

November £91.60 tax (by November, all her surplus unused tax-free allowances have been used up and it is just business as usual. That is, £1,500 less £1,042 tax-free pay x 20% = £91.60)

And so it continues…

Starting a new job without a P45

If you cannot produce a P45, your employer may ask you to complete a Starter Checklist and tick whether:

A) this is your first job since 6 April and you have not been receiving any taxable benefits since then either

B) this is your only job but since 6 April you have had another job or have been receiving taxable benefits

C) you have another job

If A is ticked, this enables employers to deduct tax on a cumulative basis straight away (that is, you get the benefit of the basic personal allowance from the beginning of the tax year).

If C is ticked, basic rate tax at 20% will be deducted with no personal allowance available (code BR). (For more on how tax codes work if you have more than one job, see our factsheet: www.litrg.org.uk/sites/default/files/Multiple%20jobholding%202018-19.pdf)

If B is ticked, you will be allocated the basic personal allowance – but on a non-cumulative basis. It should look like this on your payslip – 1250L W1 or 1250L M1 (called Week 1/Month 1 basis) (more on this below).

This factsheet is intended to provide general information only and does not constitute advice. Before taking any action, you should get appropriate immigration, benefit or tax advice from a professional adviser which is based on your particular circumstances. We have done our best to ensure that the information in this factsheet is up to date as of November 2019. You can read our full disclaimer on our website: www.litrg.org.uk/legal. © Chartered Institute of Taxation 2019

This factsheet was written by the Low Incomes

Tax Reform Group. Everything we do is aimed at

improving the tax experience of low income

workers. LITRG do not offer an advice service,

but our website is full of general helpful tax

information, including more on PAYE for

employees and pensioners: www.litrg.org.uk

Non-cumulative (W1/M1) codes

A W1/M1 basis means you will receive some benefit of tax-free allowances each pay period, but the likelihood of there being a significant over or underpayment of tax at the end of the tax year is reduced.

So, for example, normally if someone has not worked since the beginning of a tax year and gets a job on 1 September, they will be allowed £6,252 (6 months x £1,042) of tax-free allowances. But if they are on a non-cumulative tax code, they will only receive one month’s worth – £1,042.

You will generally stay on a non-cumulative tax code until:

HMRC tell your employer the correct tax code to use. Any overpaid tax should be paid to you the first pay day the new tax code is used (for an example, see: https://www.litrg.org.uk/tax-guides/employment/what-if-i-pay-too-much-tax#toc-how-will-i-get-my-emergency-tax-back-) – provided the tax year has not ended in the meantime; or

the following 5 April. Your employer will use the same tax code in the new tax year, but not on a W1/M1 basis.

If the tax year ends and you have overpaid tax through being on a W1/M1 tax code, then HMRC’s P800 tax calculation system should issue a repayment automatically. You can find out more about the P800 process on our website: www.litrg.org.uk/tax-guides/employment/what-if-i-pay-too-much-tax

Top tips

Employers have a legal obligation to issue a P45 but are not allowed to issue duplicate P45s under any circumstances. If you get one, make sure you keep it somewhere safe!

Make sure you ask your employer for a Starter Checklist to complete if you need to – otherwise code 0T will be operated, meaning that you will have no personal allowances allocated to you at all, even if you only have one job.