If you have income taxed at source, such as from an employment or pension then you will receive a tax code (notice of coding) from HMRC.
Tax codes look at your tax position and aim to collect the right amount of tax each month, so that the liability is correct at the year-end.
There are of course limitations, such as where your additional annual income or expenses vary each year. The tax code will have been based on the last tax return submitted so there will be an adjustment required at the end of the year after your actual figures are known and the next tax return submitted.
The tax code number is the result of a simple equation: allowances – deductions = code number (after removing a zero from the end of the number to make it simpler)
For example, a basic tax code might be Allowances 12,500 – deductions 0 = code 1250.
There are various letters added to the end of the code number to signify different situations, a general example would be the letter L giving the tax code 1250L for a basic rate taxpayer in 2019/20.
The tax codes assume your income will be the same, so if you leave employment part way through a year you may have overpaid tax if there isn’t another employment source before the end of the tax year. This overpayment can be refunded in the next tax return, or set against the tax due on other new income sources.
HMRC normally issue the annual tax codes each year around February, so you know your tax code before the start of the new tax year on 6th April. Tax codes are also issued following the submission of a tax return if necessary.
It is important to review any tax code notices when issued to check that they are correct, as your situation may have changed since the last tax return.
One key area to watch out for is if you are close to £100,000 income for a year – above that the personal allowance is reduced, eventually to nil. Unless you update your tax code based on projected future earnings mid-year you could find that a significant underpayment arises by the year end.