Pay As You Earn is a means of taxing monthly or weekly income by deducting a percentage of earnings based on a proportion of the annual tax bracket into which you fall.
Most employees pay most of their tax though the PAYE system. Calculating the correct amount is outlined in this beginner's guide.
What is PAYE?
PAYE is the name for the way tax is collected from employees. It spreads your income tax over the tax year, which starts on 6 April of one year and ends on 5 April in the next.
It is a payment on account, and is not necessarily the exact amount you are required to pay. The final amount may be more, or often less, than is taken into account during the year.
Indeed one in four taxpayers pay too much tax during the year through PAYE. This is why it is important to check your PAYE bill carefully as you may be entitled to a rebate (or you may need to pay more tax).
How does PAYE work?
Under PAYE, your employer takes tax from your weekly or monthly earnings and pays it to the Inland Revenue.
How does my employer know how much tax to pay?
You don't pay tax on all your income. Everybody can earn or receive a certain amount in each tax year free of tax. This amount is called a 'personal allowance'.
The Chancellor of the Exchequer sets the amounts of the allowances each year in the Budget. The amount of tax to be paid then increases in bands, starting at 10 per cent and rising to a top rate of 40 per cent. You can check for current rates and allowances here.
These rates may seem high, but they are a lot lower than they used to be. In the 1970s it started at 33 per cent, and the top rate was 83 per cent.
Your Tax Office gives your employer a PAYE code. This instructs your employer how much tax they should pay on your behalf. There are strict rules, which the payroll staff must follow on receipt of this coding.
If it is wrong the employer must still deduct tax per the wrong instructions or they will be in trouble with the Inland Revenue, so check the Tax Coding yourself.
The PAYE coding is crucial to how PAYE operates. It is important that this is right, so we will explain this in more detail.
What does a PAYE code look like?
Your PAYE code is unique to you. It reflects assumptions the Inland Revenue makes, based on information it has been supplied with.
The code is normally a number followed by a letter, but can be a letter followed by a number e.g. K438. The number is simply your total allowances, without the last figure. For example, if your total allowance is £4,385 your code will be 438 followed or preceded by a letter.
The letters show which allowances are included in the number. These are the most common:
- L includes the basic personal allowance for a person under 65
- H includes the basic personal allowance and the married couple's allowance for a person under 65, or the additional personal allowance and also shows that the taxman estimates you are liable at the basic rate of tax.
- K (followed by a number) is used where your state pension or benefits in kind from your employment (for example, the value of a company car) are greater than your allowances.
Please note that other factors can be taken into account. For full details read the Inland Revenue's leaflet How to Understand Your Tax Code downloadable in .PDF format here.
Check that the details on your coding notice are correct. Make sure nothing is missing. If your Tax Code is wrong, you could pay too much or too little tax.
My tax code is wrong. What does this mean? What do I do?
The tax code is used by your employer to deduct the right amount of tax from your pay. So if you think it is wrong you should tell your Inland Revenue office straight away.
Ask your payroll department for the address and phone number of the Inland Revenue office that deals with your company. If you contact your Inland Revenue office you will need to tell them your tax reference and your National Insurance number. These should be shown on your payslip.
Tell your Inland Revenue office about any changes which could affect your Tax Code. For example if:
- There is a big change in your income
- You receive any income that is not taxed
How do I find out my PAYE code?
Before the beginning of the tax year, you may receive a notice of coding from your Tax Office. You will normally only get such a notice if your code changes. This shows the amount of your allowances and your PAYE code. There are some notes with it to help you. Otherwise, check with your payroll department.
What if I only worked for part of the tax year?
In this case you could well be entitled to a tax rebate, as in working out your tax code the Inland Revenue assume you work the whole year.
If you notify the tax office during the tax year, they can adjust future payments via your PAYE to compensate for this. Otherwise you can submit a tax return after the end of the tax year to claim your rebate.
How can I check my employer's calculations?
Most employers use sophisticated software to calculate the tax, and rarely make mistakes. Errors usually arise because the coding is wrong. However, to make a quick check whether your employer's calculations are accurate, try www.digita.com.
This allows you to enter information from your payslip and will calculate the amount of tax your employer should be deducting from your pay. It is free and easy to use. All you will need is a copy of your latest payslip.
You now have an idea as to whether you are paying the right amount of tax. If you think you are owed tax then you need to raise this with the Inland Revenue.
If you have never completed a tax return, then call your payroll department and ask them for the address of the Inland Revenue Office which handles your employers PAYE affairs. Contact the tax office and explain that you want to revise your Tax Coding, then follow their guidance.
If you have completed a tax return in the past, you will now have a tax reference and tax office, so contact them directly and explain your position.
In either case you should allow a few weeks for this to be changed, but any tax adjustment will be made in the next salary payment after the new tax coding has been issued.
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