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What is Pay As You Earn (PAYE)?

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The Pay As You Earn (PAYE) system is a method of paying income tax and national insurance. Your employer deducts tax from your wages or occupational pension before paying you your net salary.

Wages includes sick pay and maternity pay. This means that you pay tax over the whole year, each time you are paid. Your employer is responsible for sending the tax on to HM Revenue and Customs (HMRC).

If you pay tax on your wages or occupational pension under PAYE, the PAYE system can also be used to collect the income tax of any other taxable income you have. For example, if you pay tax under PAYE on an occupational pension, the tax due on your state retirement pension is collected through PAYE by deducting tax from your occupational pension.

How is PAYE calculated?

The tax office will tell your employer how much tax to deduct from your wages/occupational pension, but will not give details about how your code has been decided. If the tax office does not have enough information to issue a full tax code, it will use an emergency tax code until more information is received and the tax can be adjusted (see under heading Emergency tax codes).

Most PAYE codes are made up of a number followed by a letter:-

  • The letter relates to the type of allowance(s) you are getting (see below)
  • The number shows the amount of income you have as allowances which may be set against tax (see below).

The letter in the tax code

The letter in the tax code, which shows which tax allowances you are receiving, will be one of the following:-

L if you are aged under 65 and getting the personal allowance. You will be given this code if you are a single person, the person in a married couple or civil partnership who is not claiming the married couple's allowance, or, if you are a person who is being taxed on the emergency code.

P if you are single person, or a married woman, aged 65-74 who is entitled to the full age related allowance.

V if you are a married man aged 65-74; and

  • your wife is aged 74 or less; and
  • you are entitled to the full age related allowance; and
  • HM Revenue and Customs estimate that tax will be paid at the basic rate.

T may be allocated for a number of reasons. These include:-

  • Where you request it, because you do not want to reveal your actual code; or
  • Where you are eligible for Child Tax Credit but pay tax at the higher rate; or
  • You or your partner is aged 75 or over; or
  • There is a reduced age-related allowance in the code.

K if you are someone whose untaxed income adds up to more than your personal tax allowances. If your untaxed income is from fringe benefits and/or pensions, interest or social security benefits you may be given a K code.

Y if you are aged 75 or over and have the full personal allowance.

NT if you do not have to pay tax. This code does not include a number.

BR if you have not been given any allowances and tax will be deducted at the basic rate. This code may be given where you have more than one job.

DO if you have tax deducted at the higher rate.

OT no allowances have been given or remain after other adjustments have been made. Tax will be paid at the lower, basic or higher rate, depending on the level of income.

The number in the tax code

The number in the tax code represents the total of all available allowances, less any amount to be deducted to cover other income or benefits.

If you are given a PAYE tax code it will be shown on:-

  • A notice of coding sent by the tax office (see under heading Notice of coding); or
  • Your payslip; or
  • Your pension statement if you are getting an occupational pension.

Emergency tax codes

The tax office may not be able to give your employer a tax code to allow them to deduct the right amount of tax over the whole year. In this case, the tax office gives your employer an emergency code with which to tax you. An emergency code assumes that you are only entitled to the basic personal allowance and your PAYE tax code will include the letter L, which shows that you are only receiving this personal allowance. It does not take into account any other allowances and reliefs you may be entitled to.

You will stop being taxed on an emergency code:-

  • When the tax office sends your employer (and you) a PAYE tax code, and details of previous earnings and tax paid for that tax year. This enables your employer to deduct the correct tax in future and refund any overpaid tax caused by the emergency code; or
  • At the end of the tax year. Your employer will usually start deducting tax cumulatively, that is, when deducting tax your employer will take into account the amount of tax you have already paid. If, at the end of the tax year, you think you have paid too much tax because you have been taxed on an emergency code, you should claim a rebate by writing to the tax office.

Notice of coding

A notice of coding shows your tax code if you are going to pay through the PAYE system. The notice is usually sent out in January or February for the tax year beginning on the following 6 April. The code shown in the notice is given for that tax year only. The notes that come with the notice of coding explain how the code is worked out.

Not everyone gets a notice of coding each year. It depends on what allowances and reliefs you are claiming and whether these tend to change from year to year. It is important to check that the notice of coding gives the correct allowances and reliefs, because if it is wrong you will be paying the wrong amount of tax.

Self Assessment

Under the system of Self Assessment, you have to assess how much tax you have to pay on any income which you receive which is not taxed through PAYE, for example:-

You must tell the local tax office if you receive taxable income in addition to that which you pay through PAYE. You will then have to complete a tax return form and either ask HM Revenue and Customs (HMRC) to calculate how much tax is due (Revenue calculation) or do the calculation yourself (taxpayer calculation).

If you owe £2,000 or less in tax on sources of income which are not taxed through PAYE, and you send your completed tax return form back by the 30 September following the end of the tax year, you can pay all your tax through PAYE. If you owe more than this amount, or if you prefer, you can pay the tax due on the other sources of income directly to HMRC. To check the current amounts, contact your local tax office.

If you want to check that you are paying the right amount of tax, or, for example, if you think you may have over or underpaid tax, you should contact your local tax office and ask if you can complete a tax return form. Once you have completed the form you can either ask HMRC to calculate the amount of tax due, or do the calculation yourself.

Citizen Advice Bureau
December 2008

© 2008 All rights reserved. Reproduction in whole or in part without permission is prohibited.
Image: Tax by definition by alancleaver_2000

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