The importance of your tax code

Written by Paul Windsor on 18 November 2014

I was reminded recently by my eldest son about the importance of the tax code – the code indicating what level of personal allowances an employer should give each month to those in receipt of a weekly or monthly income. It is used for all earners that are taxed at source, including those in receipt of pensions.

Of the 30m people who pay income tax in the UK, approximately 24m are basic rate taxpayers, most of whom do not submit a tax return. This means that the annual coding is the single most important tax document as it determines how much tax they pay each week or month.

It is easy to ignore the small piece of A5 paper that often comes through the letterbox early in the year when depression over the long winter months has already set in and a letter from HMRC simply adds to the low. The young seem to have an implicit trust that their employers will deduct the correct amount of tax from their pay. With on-line payslips and direct bank transfers the tax and NI deducted at source is already invisible and it takes time and effort to examine the details of the calculation.

So back to my son. After a number of requests, he finally produced a P60 summarising his income for last year; his first year of full time income since finishing his masters degree. On it was a small easily missed box headed 'Final Tax Code' and in it was some very good news. 944LM1. He had been taxed on a Month 1 basis and he had started work, like many new graduates, in September.

The penny dropped. He had only been give half of the full annual allowance to which he was entitled and the consequence of this was that he had been substantially over taxed on his income for the last tax year. The outcome was a joyous refund of tax, which arrived in his bank account within 10 days of submitting an online tax return and claim.

A lesson for all earners – check your tax code. It really does make a difference.