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By Dan and Helen S Updated August 2015

It looks like an innocuous set of digits, but your tax code has a critical impact on your finances. It tells your employer how much tax to take, but every year millions of people are hit by errors, and some are due Ј1,000s back.

Thanks to Tony Tesciuba (Tesciuba Ltd ) & Matthew Brown (Chartered Inst of Taxation ) for feedback/suggestions. Every effort's been made to ensure accuracy, yet this guide isn't authorised, tailored tax advice (get help here ). We can't take responsibility nor accept liability for damage or losses; you use the info at your own risk.

What's a tax code?

Before we start explaining what a tax code is, it's important to understand that not everyone has one.

Who has a tax code?

Full or part-time employees

Those receiving a private pension

Fully self-employed or unemployed people

Those ONLY receiving a state pension

On the face of it, a tax code is a dull and harmless series of numbers and letters - 1060L, 965BR and K497 are just some examples.

But these hieroglyphics are used by your employer to calculate the amount of tax that should be deducted from your wages or pension before they hit your bank account.

Therefore if you pay tax through PAYE, the tax code tells your employer or pension provider what it should take - and even small errors can lead to mistakes of Ј100s.

So the aim here is to find your tax code and decipher what it means, to see if it's correct. Don't worry, we'll take you through it simply.

Then you can punch it into our unique tax code calculator which will give you a steer on whether you may have over- or underpaid. Finally, and most importantly, the guide will explain step-by-step what to do about it.

Quick questions

Why are there so many tax code mistakes?

In summer 2010, errors started coming to light and, so far, OVER 25 MILLION mistakes for tax years between 2003/04 and 2013/14 have been uncovered by HMRC. These include the 3.5 million due rebates and 2 million who face shock demands, announced in June 2014. This MSE News story has full details on 2014's tax errors.

People paying the wrong amount of tax is often because they've changed jobs midway through the tax year, or they've retired, or some other change.

Commentators often point the finger at HMRC, though many tax nerds dispute this, saying its reconciliation - that it does at the end of each year - reveals errors, it didn't create them. Current employers can only use the tax code they are told to; the key is having correct info flowing through the system.

How likely am I to be on the wrong tax code?

The errors are indiscriminate but some groups of people are likely to be more affected than others. You should take action quick - if one of the following situations has applied to you in the recent past.

  • Have you changed jobs? The tax system can incorrectly assume you have two jobs if your former employer hasn't let HMRC know you've moved on.
  • Do you have more than one income? If you've been earning money from more than one source (eg, you have a second job), then you could find you've been taxed incorrectly on a chunk of your earnings.
  • Do you get employee benefits? If part of your salary is made up of company benefits such as a company car, healthcare cashplan or medical insurance, it's possible you're being taxed wrongly.
  • Are you over 65? Tax allowances and codes for the over-65s have been particularly troublesome, as personal allowances change if you're in this age group.
  • Just started your first job? Young people embarking on first jobs in the middle of a tax year can easily be shunted onto the wrong code. Never assume the amount you receive in the first few pay packets is correct.
  • Do you have more than one pension/have you recently retired? If you receive money from more than one pension source, have retired in the last couple of years or have recently started to receive the state pension, you could have been taxed incorrectly.

If you've moved house and not told the taxman, any correspondence from HMRC about your tax code may have gone to the wrong address. Your employer can't update this, only you can, so if you haven't, a possible refund could've gone to the wrong address.

You must contact HMRC directly to update your address. The easiest way to do this is online at HMRC's website.

People have used this guide to reclaim Ј5,000+!

Since launching this guide in late 2010, we heard of a blast of successes after MoneySavers used the Tax Code Calculator and realised they were on the wrong code! We'll let some lucky forumites take over the tale. Please tell us about your tax rebate successes .

"Seeing the email, I thought I'd check mine as I had my payslip handy and I was surprised to see my code was BR. Digging out older slips, I saw I'd been on basic rate tax since I started, which seemed odd."

"Quick call to HMRC confirmed I should have been on L - they've refunded just under Ј1,500 for last year and are updating my employer, so I'll be Ј130 better off each month going forward!" Golddustmedia

I got the MSE email, checked my tax code, rang HMRC and it told me I'd get between Ј5,000 and Ј7,000 back. Incredible!

"It's all because it'd been deducting for a company car and medical insurance that I've never had in this job." Chris Kendall

I've rung HMRC and a letter is in the post. I've been on the wrong tax code and paying too much since 2005!

"I've had a cheque for Ј3,698 dating back to

2006 and that's not including this year's return either! I'm very happy indeed and would of been none the wiser had it not been for MSE so thank you very, very much! nat21luv

Step 1. Finding your tax code

Taking on your tax code is not an appealing task for even the most dedicated MoneySavers. But it doesn't have to be that gruelling.

How do I find my tax code?

It's listed on your 'coding notice', payslips or P45s. The most important thing to remember.

Each income source (job, private pension) will have different tax codes. Check them all!

The best source to find your tax code is your PAYE Coding Notice (or P2). A copy of this is sent to both you and your employer around March, just before the start of each tax year. It tells them how to deduct tax, and explain to you how this code was arrived at.

If you can't find your coding notice, then there's other places to look for your tax code.

  • Your payslip: Perhaps the easiest place to look is on your payslip, which you will receive from your employer every time you get paid (whether it's monthly or weekly).
  • Your P45: If you have dumped your payslips, (though it's always best to keep them for records) hunt down a copy of your P45. This is the form given to you by your employer when you stop working for them - and the one you give to your new employer when you change jobs.
  • Your P60: This form is a summary of your salary and the tax that's been deducted. Your employer is required to give you this at the end of each tax year.
  • HM Revenue and Customs: If you can't lay your hands on any of these, contact your tax office with your National Insurance number. After a few basic security questions, they will disclose your tax code (or codes) to you.
  • Tax code for pensions: If you're receiving a private pension, the easiest place to find your code will be on any pension advice slip or on your P60 sent once a year.

What does my code mean?

Tax codes are made up of two main elements, which determine the amount of tax your employer will take. If you work for multiple employers (or work and also draw a pension), you'll have more than one code.

Here's an example of a common tax code from this tax year (similar ones for past years include 944L and 1000L). It will usually be made up of numbers and letters:

What do the numbers show?

It indicates the first three or four digits of your tax-free allowance - the amount you can earn in a year before your employer needs to deduct tax. The size of this layer depends on your age, income and whether there are any deductions (eg, company car) or additions (eg, pension contributions) to this.

You need to add a zero on the end to get the real number, so 1060 means you can earn Ј10,600 a year tax free.

For the 2015/16 tax year (which runs from 6 April 2015 to 5 April 2016):

  • You pay 20% tax. on the portion of your income that is between Ј1 and Ј31,785 above your personal allowance. This is called basic rate tax.
  • You pay 40% tax. on the portion of your income that is between Ј31,785 above your personal allowance and an overall salary of Ј150,000. This is called higher rate tax.
  • You pay 45% tax. on the portion of your income above Ј150,000. This is called additional rate tax.

What does the letter show?

This may relate to a number of different factors, and you should use the ready reckoner to check that the definitions are relevant for you.

It usually refers to your age, at what rate that employment is being taxed, and whether you have any unusual circumstances. Here are a few examples:

  • L - most common code - you're eligible for standard personal allowance (ie, under 65)
  • BR - whole income taxed at 20% - usually for second jobs/pensions
  • NT - no tax to be deducted from this income - often used if you live overseas.

What SHOULD your tax code be?

This is where you need to switch on your brain. The key bit to check it's correct is the number.

  • Find your personal allowance

The first thing that HMRC does to establish your tax code is to tot up all of your tax allowances - in other words how much you can earn before you start to pay tax. In many cases this will be just your personal allowance .

Any income you haven't paid tax on at source is known as your deductions. The usual suspects are taxable employment benefits or extra income, eg, renting out a property or State Pension.

Common taxable benefits include discounted rent or household bills, vehicle usage, medical insurance, healthcare cashplans, some travel costs, payment in vouchers and goods bought on company credit cards.

  • Use these to make the number in your tax code

    These deductions are subtracted from the total amount of tax allowances you get (probably your basic personal allowance), and what's left is the total amount of tax-free income you are permitted in each tax year.

    HMRC then removes the last digit of this number (so 1060 in the case of the 2015/16 standard Ј10,600 personal allowance) - and hey presto! You've established the number part of your tax code.

    In the majority of cases, these numbers will be followed by a letter. And this letter will vary according to your particular circumstances.

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