The letters in an employee’s tax code signify their entitlement (or not) to the annual tax-free personal allowance. The tax codes are updated annually and help employers work out how much tax to deduct from an employee’s pay packet.
The basic personal allowance for the tax year starting 6 April 2021 is £12,570 and the tax code for an employee entitled to the standard tax-free Personal Allowance is 1257L. This is the most common tax code and is used for most people with one job and no untaxed income, unpaid tax, or taxable benefits (for example a company car).
There are also emergency tax codes that may be used if a new employee doesn’t have a P45. These codes mean that an employee’s tax calculation is based only on what they are paid in the current pay period.
A ‘K’ tax code is seen less often and is used when deductions due for company benefits, state pension, or tax owed from previous years are greater than an employee’s personal allowance. Employees need to multiply the number in the employee’s tax code by 10 to show how much should be added to their taxable income before deductions are calculated. The tax deduction for each pay period can’t be more than half an employee’s pre-tax pay or pension. For example, an employee with tax code K475 and a salary of £27,000 has a taxable income of £31,750 (£27,000 plus £4,750).
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