What Must Employers Do with Tax Codes?
As a rule, employers use a P45 to work out a new employee’s tax code. P45s contain several numbers and a letter (e.g. 1257L).
In most cases, you also need to update the tax code of each employee at the beginning of each new tax year.
You will get an email from HMRC if any of your employees’ tax codes change during the year (so you can update your payroll records).
Note: Check a list of tax codes and what they mean if you are an employee. A guide explaining what employees’ tax codes mean is also available in Welsh language (Cymraeg) via the GOV.UK website.
Most Common Tax Code
Employee tax codes change on a regular basis. But, 1257L is the most common tax code used in the current tax year (6th of April 2022 to the 5th of April 2023).
In general, HM Revenue and Customs (HMRC) use tax code 1257L for people with only one job and no untaxed income, unpaid tax or taxable benefits (e.g. a company car).
Important: HMRC use emergency codes for any new employees who do not have a P45. But, 1257L would need to be followed by ‘W1’, ‘M1’, or the letter ‘X’ to be used as an emergency tax code.
Numbers in Employee Tax Codes
So, what do the numbers in an employee’s tax code mean? In short, the digits show how much tax-free income the employee can get in that particular tax year.
Multiplying the actual number in the tax code by ten (10) gives the total amount of income that the employee can earn before they get taxed.
An Example:
After starting a new employee, you determine their tax code as being 1257L. As a result, the numbers and letters mean they can earn up to £12,570 before being taxed.
In this example, and based on earnings of £27,000 per year, the employee’s taxable income would be £14,430. Even so, the process differs if their tax code contains the letter ‘K’ (see below).
Letters in an Employee’s Tax Code
There are two parts to understand about the letters in employee tax codes. One part relates to the situation (e.g. how many jobs they have) and the other refers to the affect it has on their Personal Allowance.
What Tax Code Letters Mean
| Letter(s) | How HMRC is Deducting Tax | When HMRC Usually Uses this Tax Code |
|---|---|---|
| OT | From all sources of income (hence, there is no Personal Allowance). | If an employee cannot provide a P45 or enough personal details to work out their tax code. It can also apply for employees who have used up all their Personal Allowance. |
| BR | From all income sources at the basic rate of Income Tax. | If the employee has a second job or is getting a pension. |
| C | From income in the Welsh tax bands (see Income Tax in Wales). | When an employee’s main home is in Wales. |
| COT | From all sources of income (hence, there is no Personal Allowance). | When an employee’s main home is in Wales and they cannot provide a P45 or enough personal details to work out their tax code. It can also apply for employees who have used up all their Personal Allowance. |
| CBR | From all sources of income at the basic rate in Wales. | If the employee has a second job or is getting a pension. |
| CDO | From all sources of income at the higher rate in Wales. | If the employee has a second job or is getting a pension. |
| CD1 | From all sources of income at the additional rate in Wales. | If the employee has a second job or is getting a pension. |
| DO | From all sources of income at the higher rate of Income Tax. | If the employee has a second job or is getting a pension. |
| D1 | From all sources of income at the additional rate of Income Tax. | If the employee has a second job or is getting a pension. |
| L | At basic, higher, and additional rates (depending on taxable income). | If an employee is entitled to the standard tax-free Personal Allowance. |
| M | At basic, higher, and additional rates (depending on taxable income). | For employees whose spouse or civil partner transferred some of their Personal Allowance. |
| N | At basic, higher, and additional rates (depending on taxable income). | For employees who transferred some of their Personal Allowance to their spouse or civil partner. |
| NT | No tax deducted. | Specific cases that use code NT (e.g. musicians regarded as self-employed and not subject to PAYE). |
| S | From income in the Scottish tax bands (see Income Tax in Scotland). | When an employee’s main home is in Scotland. |
| SOT | From all sources of income (hence, there is no Personal Allowance). | When an employee’s main home is in Scotland and they cannot provide a P45 or enough personal details to work out their tax code. It can also apply for employees who have used up all their Personal Allowance. |
| SBR | From all sources of income at the basic rate in Scotland. | If the employee has a second job or is getting a pension. |
| SDO | From all sources of income at the intermediate rate in Scotland. | If the employee has a second job or is getting a pension. |
| SD1 | From all sources of income at the higher rate in Scotland. | If the employee has a second job or is getting a pension. |
| SD2 | From all sources of income at the top rate in Scotland. | If the employee has a second job or is getting a pension. |
| T | At basic, higher, and additional rates (depending on taxable income). | When a review of certain items with the employee is necessary. |
Employee Tax Codes Ending in ‘W1’ or ‘M1’
HMRC uses ‘W1’ (meaning week 1) and ‘M1’ (meaning month 1) as emergency tax codes. You will only see them appear at the end of your employee’s tax code (e.g. ‘577L W1’).
As a result, employee tax calculations should only be made on what they get paid for the current pay period (not for the whole tax year).
Tax Codes with Letter ‘K’
Often, deductions due for company benefits, state pension, or tax owed from previous years will be greater than an employee’s Personal Allowance. In this case, HMRC will use the letter ‘K’ as part of employee tax codes.
Multiplying the tax code number by ten (10) shows the amount that needs adding to their taxable income before calculating any deductions.
An Example:
Supposing your employee has K475 tax code and a salary of £27,000. In this example, their taxable income would be £31,750 (£27,000 plus £4,750).
Changes to Employee Tax Codes
It is not uncommon for your employee’s tax code to change during the tax year. This usually occurs if their tax-free income (Personal Allowance) goes up or goes down (e.g. they start receiving a taxable benefit).
As an employer, if any of your employees’ tax codes changes during the tax year, you will:
- Receive an email alert about the adjustment from HM Revenue and Customs (HMRC).
- Be able to access the new tax code in PAYE Online (found in ‘tax code notices’), the PAYE Desktop Viewer application, or your payroll software. Note the figures if the new tax code includes your employee’s previous pay and tax.
- Need to update the employee’s payroll record with their new tax code (no later than when you next pay them) and add their previous pay and tax (if you received the figures).
Note: HMRC may refer to a tax code notice as a P6 form. You should use an employee’s new tax code in the new tax year if you do not get it in time to use in the current one.
How to Update the New Tax Year
HM Revenue and Customs (HMRC) will not contact you if your employee’s tax code remains unchanged. Hence, you should carry forward your existing employee tax codes for use in the new tax year.
But, employers may need to use new tax codes for their employees at certain times in the new tax year (from April 6th). If so, you will receive notification from HMRC between January and March.
Important: There is no need for employers to carry the end part of an employee’s tax code ‘M1’ or ‘W1’ into the new tax year.