When your employer or pension provider deducts income tax from your salary or pension each month, the amount deducted is calculated by reference to your PAYE tax code which is sent to your employer or pension provider by HMRC.
The PAYE code may include allowances (which reduce the amount of tax you pay) and restrictions (which increase the amount of tax you pay). Examples of allowances are the tax-free personal allowance (currently £11,850, reduced for those earning over £100,000) or an extra allowance to give you tax relief on gifts to charity or pension contributions. The PAYE code may be restricted to collect tax on employment benefits such as private medical insurance or to collect tax on other sources of income you may have, for example rents or savings income.
Some of the allowances and restrictions in your PAYE code will be estimates which HMRC calculate using figures reported to them either by your employer or on your tax return. Sometimes, HMRC adjust these estimates part way through a tax year when they receive updated information. Unfortunately, HMRC don’t always interpret this information correctly, so the estimates they use in arriving at the allowances and restrictions in your tax code can be wrong by quite a big margin. This could result in you paying too much tax, which you will have to reclaim, or too little tax, which can be an unpleasant shock.
HMRC don’t notify your tax adviser when they make changes to your PAYE code, so it’s important that you keep an eye on how much tax is being deducted from your salary or pension and let us know straight away if the net amount you receive changes significantly (up or down!) from one month to another. We will then contact HMRC and check that the allowances and restrictions included in your PAYE code are correct.
Similarly, if you receive a copy of a new PAYE code from HMRC in the post, please let us know. The sooner we can check it and, if necessary, get it changed, the better; every month that your employer or pension provider uses an incorrect code is a month in which you will have paid too much or too little tax.