Tax Codes – Understanding Them In Order To Avoid Paying The Wrong Taxes

When you part with your hard-earned savings to pay your taxes, are you convinced that you are paying the right amounts? Or do you suspect that you may be paying more than what you should? Understanding your tax code and knowing what it means give you a sigh of relief that you are indeed paying what is due the government.

What is a tax code?

The computation of income tax may seem complicated if you do not have a clear understanding of your assigned code. Your code is composed of numbers and letters issued by the HM Revenue and Customs (HMRC) to your employer. It is used to determine the right amount of income tax that your employer will deduct from your salary each month. Some tax codes would look like these: 434L, 323P, 456V, K345, DO, NT, BR, and OT.

What do the numbers mean?

The numbers represent your tax allowance or the total amount allowed to be deducted from your total income for the year. Your tax allowance is derived by using the following formula:

Tax allowance = Number X 10 + 9

To illustrate, a code of 434L means that you are entitled to a tax allowance of 4,349 that can be deducted from your income for the year to arrive at your taxable income. Thus, if you have earned 30,000 for the year, your income that is subject to tax would be 25,651.

What do the letters mean?

The letters indicate certain conditions why you have to pay certain amounts that are different from what others are paying. Let’s take a look at some of the letters and what they mean:

L – This is the most common code that refers to basic personal allowances.

P – This applies to people with ages between 65 and 74 who are eligible for full personal allowances.

Y – This is for people who are more than 75 years old and eligible for full personal allowances.

K – This means that the amount of allowances is less than the amount of deductions.

T – This indicates that there are things that need to be reviewed by the appropriate Inspector of Taxes.

BR – This stands for basic rate and this means that your total income will be subject to the basic tax rate for the current year but you will not be entitled to personal allowances.

NT – This is used when no amount is to be deducted from your income or pension.

D0 – This indicates that you have to pay at a higher rate like 40% because of a second job or pension.

D1 – This means that you have to pay at a higher rate like 50% for multiple income or pension.

Virtually every citizen in the UK is eligible for a personal allowance, which entitles them to a corresponding tax free income. Earnings above the tax free income are subject to the basic tax rate up to a certain limit while higher earnings are subject to higher taxes according to the income brackets set by the HMRC. Thus, knowing how your tax code as determined by HMRC is important to be able to know if the government is imposing the right amount of assessment on you.

Source by Donald Milton

Diana McCalpin is an accountant who manages a Certified Public Accounting Practice in Laurel, Maryland which performs audit, accounting and tax services to customers. She loves to share information with clients to help them grow their businesses and be profitable.

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