Tax codes are used to work out how much tax an employee should pay over the course of a tax year. This guide gives an insight into how tax codes are applied to payroll and how it is worked out.
The number in a tax code if it ends with a L, M, N, or T relates to the amount of personal tax-free allowance an employee is entitled to throughout the tax year.
There is usually some confusion around this as it is assumed that it means an employee will only pay tax after the have reached a tax free allowance but tax codes are normally cumulative and so the tax free allowance is spread throughout the year.
Different rates around the UK
There are different tax rates for England, Wales, Scotland and Northern Ireland and how much you pay will be dependent on where you live and how much you earn. A standard tax code in England is 1257L, Scotland will be S1257L and Wales will be C1257L.
England and Northern Ireland
The standard employee personal allowance for the 2023 to 2024 tax year is:
£242 per week
£1,048 per month
£12,570 per year
PAYE tax rate | Rate of tax | Annual earnings the rate applies to (above the PAYE threshold) |
|---|---|---|
Basic tax rate | 20% | Up to £37,700 |
Higher tax rate | 40% | From £37,701 to £125,140 |
Additional tax rate | 45% | Above £125,140 |
Scotland
The standard employee personal allowance for the 2023 to 2024 tax year is:
£242 per week
£1,048 per month
£12,570 per year
PAYE tax rate | Rate of tax | Annual earnings the rate applies to (above the PAYE threshold) |
|---|---|---|
Starter tax rate | 19% | Up to £2,162 |
Basic tax rate | 20% | From £2,163 to £13,118 |
Intermediate tax rate | 21% | From £13,119 to £31,092 |
Higher tax rate | 42% | From £31,093 to £125,140 |
Top tax rate | 47% | Above £125,140 |
Wales
The standard employee personal allowance for the 2023 to 2024 tax year is:
£242 per week
£1,048 per month
£12,570 per year
PAYE tax rate | Rate of tax | Annual earnings the rate applies to (above the PAYE threshold) |
|---|---|---|
Basic tax rate | 20% | Up to £37,700 |
Higher tax rate | 40% | From £37,701 to £125,140 |
Additional tax rate | 45% | Above £125,140 |
Tax thresholds
When an employee has tax code 1257L (most common tax code for people who have one job or pension) it means the employee can earn £12570 per year tax free. To make sure that employees pay any tax over this allowance throughout the year, each pay period has a tax free amount. This is so that employees pay tax evenly throughout the year and helps avoid unpleasant tax surprises at the end.
How does a standard 1257L tax code work?
Depending on how often the employee is paid determines how the tax free allowance is broken down.
For weekly pay - the tax free allowance of £12570 is divided by 52. Each week, any earnings above £242 will be taxed.
For monthly pay - the tax free allowance is divided by 12. Each month, any earnings above £1,048 will be taxed.
However, there will be a little adjustment throughout the year as £242 x 52 does not add up to £12570. This is where software comes in and makes sure that the correct amount of tax is paid without having to be manually adjusted.
What does this mean over the tax year?
If the tax code is cumulative, then each payment the employee receives, is added together and compared to how much much tax free allowance they should receive.
Let's look at a simple calculation based on an employee that lives in England.
Example - Monthly Paid Employee with a 1257L tax code.
The employee starts a new job in April and hasn't worked anywhere else since the 6th April. They are paid on the last working day every month.
Month 1 - because the employee starts mid month, they are only paid £500. This is below the tax free allowance of £1048 and so no tax is paid.
Month 2 - employee is paid £2000. Because the tax code is cumulative, the £500 and £2000 are added together meaning they have earned £2500.
For Month 1 and Month 2, they have a total of £2096 tax free allowance. £1048 for each month.
£2500 is more than the tax free allowance and so they will pay some tax on £404.
What happens if the tax code has a W1, M1 or X?
If the employee had a W1, M1 or X after their tax code or it is shown on their P45 that they are on a week 1 / month 1, it means that the tax code is no longer cumulative.
Let's see what happens to the above monthly employee who has been given a week 1 / month 1 tax code, 1257LX.
Month 1 - Employee earns £500. This is still below the monthly tax free allowance and so no tax is paid.
Month 2 - Employee earns £2000. But this time because the employee's tax code is not cumulative, the earnings in the previous month are not taken into account, nor is any tax free allowance not used in the previous month. This means that the calculation is £2000 - £1048 (month 2 tax free allowance only) = £952.
They will pay tax on £952, which is a lot more than if the employee had a cumulative tax code.
What do the other letters or tax codes mean?
Letters in an employee’s tax code refer to their situation and how it affects their Personal Allowance.
Code | How tax is deducted | When this code is usually used |
|---|---|---|
0T | From all income - there is no Personal Allowance | When an employee has not given you a P45 or enough details to work out their tax code, or when their Personal Allowance has been used up |
BR | From all income at the basic rate | For a second job or pension |
C | From income in the Welsh tax bands | For an employee whose main home is in Wales |
C0T | From all income - there is no Personal Allowance | When an employee whose main home is in Wales has not given you a P45 or enough details to work out their tax code, or when their Personal Allowance has been used up |
CBR | From all income at the basic rate in Wales | For a second job or pension |
CD0 | From all income at the higher rate in Wales | For a second job or pension |
CD1 | From all income at the additional rate in Wales | For a second job or pension |
D0 | From all income at the higher rate | For a second job or pension |
D1 | From all income at the additional rate | For a second job or pension |
L | At basic, higher and additional rates depending on the amount of taxable income | For an employee entitled to the standard tax-free Personal Allowance |
M | At basic, higher and additional rates depending on the amount of taxable income | For an employee whose spouse or civil partner has transferred some of their Personal Allowance |
N | At basic, higher and additional rates depending on the amount of taxable income | For an employee who has transferred some of their Personal Allowance to their spouse or civil partner |
NT | No tax is deducted | Very specific cases, for example musicians who are regarded as self-employed and not subject to PAYE |
S | From income in the Scottish tax bands | For an employee whose main home is in Scotland |
S0T | From all income - there is no Personal Allowance | When an employee whose main home is in Scotland has not given you a P45 or enough details to work out their tax code, or when their Personal Allowance has been used up |
SBR | From all income at the basic rate in Scotland | For a second job or pension |
SD0 | From all income at the intermediate rate in Scotland | For a second job or pension |
SD1 | From all income at the higher rate in Scotland | For a second job or pension |
SD2 | From all income at the top rate in Scotland | For a second job or pension |
T | At basic, higher and additional rates depending on the amount of taxable income | When HMRC needs to review some items with the employee |
The employee has a K at the front of the tax code
This means that the employee has no tax-free allowance and may pay higher tax in this employment. No more than 50% of pre-tax earnings or pension can be deducted.
For more information on the different codes for employees, HMRC have a helpful guide under Income tax - Tax codes.