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How is my tax code adjusted to collect any tax I owe in an earlier tax year?

H M Revenue & Customs will collect the tax due by including a restriction in your code which will increase the amount of tax you pay over the year via your salary or pension.

For example:

If you owe £500 from an earlier tax year and this is to be collected via your salary/pension in the current tax year.

Assuming you pay tax at basic rate, your personal allowances will be reduced by £2500 to collect the £500, (£2500 x 20%= £500). If you are paid monthly, this means you will pay an additional £41.66 per month (£41.66 x 12 = £500).

If you pay tax at the higher rate of 40%, the restriction would be £1250 (£1250 x 40% = £500).

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How does my tax code work? Something like "816L" does not tell me much.

Your tax code is made up of allowances and deductions. First of all you add up your allowances, then you take away all your deductions. Assuming the result is a positive number, it is taken away from your total taxable income before tax is calculated.

For example, a code 816L may comprise Personal Allowance of £8105, plus business expenses of £740, giving a total of £8845. From this you may have medical insurance benefit of £680. Taking this away from your allowances gives a net amount of £8165. This is the amount of your tax-free allowances. The code is simply this number with a letter substituting the final digit.

Each time you are paid, a proportion of that amount is taken away from your salary. For instance, if your salary is £1000 per month, you will only pay tax on £320. Each month £680 is paid to you tax free. (£8165 divided by twelve equals £680 approximately.)

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How does my tax code work if it has a K in it? I've heard that this is different than usual.

A tax code including a 'K' indicates that your deductions exceed your personal allowances and reliefs available.

Whereas a normal tax code gives you a tax free amount over the year, with a 'K' code you have no tax free amount and instead are charged additional tax to cover the shortfall.

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My tax code has an explanation that it is done "on a special basis" and I will be taxed as though it is the first week of the tax year. I do not understand this.

Your tax free allowances are spread equally throughout the tax year and tax is calculated on your income. However, where the tax code is amended part way through the year to reduce the tax free allowances available, the code is usually issued on a 'week 1' basis.This is because you will have had too many tax free allowances up to the date the code was changed.

To avoid H M Revenue & Customs collecting any tax owed in one lump sum from one week's / month's salary, the tax code is operated on a 'special basis' and any tax due arising from the 6th April to the date the code was changed will be reviewed after the end of the tax year.

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I have just had a new code that mentions a potential underpayment. Can you explain this?

A potential underpayment will arise when your tax free allowances have been reduced during the year. As a result, you may not have paid enough tax from the 6th April to the date your tax code was amended. To avoid this being collected in one lump sum through your salary or pension, your code is operated on a 'special basis' known as 'week 1'

The potential underpayment is the amount the Revenue has estimated that you owe. It will be reviewed after the end of the tax year.

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Can I question my Tax Code? I do not think it is right.

It is your responsibility to ensure that the information shown on your tax code is correct. If there are any amendments to the code you should either contact your professional advisor or H M Revenue & Customs direct and provide them with up to date information.

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