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How is my tax code worked out?
Your tax code is used by your employer to work out how much Income Tax to take from your pay through the pay-as-you-earn scheme (PAYE). In calculating your tax code, HM Revenue and Customs will consider firstly the tax-free allowances you are entitled to, and from this deduct any amounts to cover any income that hasn't already had tax deducted at source (such as income from letting a property).
If the un-taxed income is under £2,500, HMRC may be able to collect the tax through the PAYE system (if you already pay tax in this way). You must fill in a Self Assessment tax return if your untaxed income is over £2,500, but GOV.UK advice is to contact the Income Tax helpline if it's less than £2,500.
For those working beyond state retirement age, a deduction will also be made to collect the tax due on any State Pension. This is because the State Pension is taxable but isn't taxed before receipt. Your State Pension is not subject to the £2,500 limit. Any tax underpaid in previous years can also be collected by reducing the amount of your tax-free allowances.
Your tax code can be adjusted to recover tax of up to 50% of your total taxable pay in any pay period (before taking off any allowances or other reliefs). If your wages and/or pension are too small to recover the tax due, you will need to complete a Self Assessment tax return.
Once any necessary deductions are subtracted from your total allowances, the amount left is the figure available to be set against your pay. This is then converted to a code by dividing by ten, giving the number part of your code, such as 1150L. The letter is used to tell your employer the type of taxpayer you are so that any general Budget changes can be easily implemented.
In some cases, the deductions from your allowances required to collect the correct amount of tax will be more than the total of your tax-free allowances. This situation gives rise to a 'K' code. K codes are described in detail along with more information on tax codes on the GOV.UK website.