Pay As You Earn (PAYE) is an integral part of the UK income tax system. But what do the PAYE codes issued by HMRC to you and your employees actually mean?

Here’s our lowdown on PAYE codes and how they help you understand your tax allowance and the amount deducted in tax on your monthly salary and income.

PAYE codes and what they tell you about taxable pay

When individuals are paid in whole or in part through a payroll, income tax is deducted from each payment part and that tax then paid to HM Revenue & Customs (HMRC).

Generally, some of the income is tax free, and HMRC tells you (the employer) how much is tax-free by issuing a tax code. The tax code is in two parts:

A number which usually indicates the tax-free amount that can be paid – The numerical part indicates the individual’s personal allowance, and is one-tenth of the annual tax-free amount.

And an alphabetical suffix which provides further information – the most common code is 1257L where the 1257 is one-tenth of the normal annual tax-free personal allowance of £12,570. The ‘L’ simply means that it’s the standard allowance.

The £12,570 equals £1,047 per month for an employee. So, ignoring National Insurance (NI) and any other factors, this employee earning £2,500 would pay tax of (£2,500 – £1,047 @ 20% =) £290 per month.

Other alphabetical suffixes and what they mean

‘0T’ – A code of ‘0T’ means there is no tax-free amount to be taken into account. All earnings are subject to basic, higher and additional rate tax, depending on the total earned by the employee.

‘BR’ – A ‘BR’ code means that all earnings are taxed at the basic 20% rate.

‘D0’ – A ‘D0’ code means that all earnings are taxed at the 40% higher rate.

‘D1’ – A ‘D1’ code means that all earnings are taxed at the 45% additional rate.

‘M’ – ‘M’ denotes that the employee is in receipt of the marriage allowance from their partner.

‘N’ – ‘N’ denotes that the employee has transferred the marriage allowance to their partner.

‘NT’ – ‘NT’ denotes that no tax is to be deducted.

‘C’ & ‘S’ – Suffixes beginning with ‘C’ are for employees who live in Wales, and ‘S’ for those who live in Scotland.

How does HMRC work out what tax is payable?

Generally, tax is calculated on a cumulative basis throughout the year.

For each pay period, the entire earnings and allowances for the year to date are used to calculate the total tax due. Then the tax that’s been deducted up to the previous pay period is subtracted to work out the amount to deduct in the current period.

A few other suffixes to be aware of:

• Sometimes HMRC requires each period to be calculated in isolation, in which case an additional suffix of ‘W1’ or ‘M1’ will be added.
• There are some occasions where tax on the payroll is calculated on a higher amount than the employee’s total pay, and in those cases a ‘K’ prefix is used in front of the numerical value.
• ‘T’ arises where there is unpaid tax from previous years or where the employee has other income which is not taxed at source.

Talk to us about your PAYE codes

It’s not just your employees’ tax codes that you must keep an eye on. If you’re paid a salary as a director through the business, then you will also have a PAYE tax code.

If you receive a coding notice from HMRC, you should ask us to check if it’s correct. It’s always best practice to ensure you have the right code and that the right tax deductions will be made.

If there are any additional questions about PAYE codes, please do get in touch. We’d be happy to explain your codes, tax allowances and what any specific suffixes may mean.