Last reviewed 5 March 2018

Employers are required to calculate the tax to be deducted for their employees. As John Davison explains, it can be difficult to understand the reasons for the tax that is being deducted for both the employer and employee.

While there were only minor changes to the rates and thresholds for the year 2018–2019, the amount of tax payable by an individual taxpayer is becoming increasingly complex. The tax liability for an individual will depend upon the amount of income and the way that income is made up, whether it is salary, profits, rent, interest or dividends.

While the increase in thresholds will mean a reduction in tax for most tax payers, the increases in National Insurance may offset this to a degree.

Tax codes

The basis for deductions is the tax code. This made up of several numbers and letters. The most common code for 2017/18 is 1150L. It is used for employees that have only one job, no other untaxed income, unpaid tax or taxable benefits (such as a company car). The numbers show how much tax-free income the employee is entitled to in that year. If this number is multiplied by 10 it shows the income that is tax-free; in this instance, it is the amount of the personal allowance. In 2018/19 the personal allowance will increase to £11,850, so the code number will increase to 1185 in that year. This process is different for an employee with a letter K in their tax code.

The letters in the tax code relates to the individual taxpayer's situation and how their position impacts their tax.

Code

How tax is deducted

When this code is used

OT

All income is taxed, no personal allowance

This is used when the employee has not provided a P45 or sufficient details to calculate the tax code.

BR

All income is taxed at the basic rate

Where there is a second job or pension

D0

All income is taxed at the higher rate

Where there is a second job or pension

D1

All income is taxed at the additional rate

Where there is a second job or pension

L

Taxed at the basic, higher and additional rates depending on the amount of the taxable income

The employee is entitled to the personal allowance

M

Taxed at the basic, higher and additional rates depending on the amount of the taxable income

For an employee whose spouse of civil partner has transferred some of their personal allowance

N

Taxed at the basic, higher and additional rates depending on the amount of the taxable income

For an employee that has transferred some of their personal allowance to their spouse of civil partner

NT

No tax deducted

For rare occasions, for example, where the employee is regarded as self-employed

S

Scottish rates apply

If the employee’s main home is in Scotland

T

Taxed at the basic, higher and additional rates depending on the amount of the taxable income

Where HMRC is to review the tax position of the employee

Emergency codes are sometimes used such as Week 1 (W1) or Month 1 (M1). The employee’s tax is calculated on what they are paid in the current period. A non-emergency tax code will be issued for the employee at a later date. An employee with a K code has extra tax to pay (either because there is back tax to pay or there are benefits that have used up all the personal allowance). This is used by multiplying the number by 10 and adding this to their taxable income to show what their taxable income is.

Tax code examples for 2018/19

Tax code 1185L. Salary £25,850. Basic rate tax applied to £25,850 - £11,850 = £14,000.

£11,850 is the personal allowance for this year.

Tax code 850L. Salary £25,850. Basic rate tax applied to £25,850 - £8,500 = £17,350.

£11,850 is the personal allowance for this year, but this has been reduced by £3350 due to back tax, other untaxed income or benefits received.

Tax code 850K. Salary £25,850. Basic rate tax applied to £25,850 + £8500 = £34,350.

No personal allowance is available for this year and further tax has to be collected due to back tax, other untaxed income or benefits received.

Assuming a taxpayer is not living in Scotland. If the amount of taxable income exceeds £34,500 the higher rate applies.

Main thresholds 2018/19

The main thresholds that apply are the following.

For the UK excluding taxpayers with their main home in Scotland:

Taxable income

Band

Rate

From

To

Personal allowance

0%

£0

£11,850

Basic rate

20%

£11,851

£46,350

Higher rate

40%

£46,351

£150,000

Additional rate 4

5%

£150,001

For taxpayers with their main home in Scotland:

Taxable income

Band

Rate

From

To

Personal allowance

0%

£0

£11,850

Starter rate

19%

£11,851

£13,850

Basic rate

20%

£13,851

£26,000

Intermediate rate

21%

£26,001

£57,580

Higher rate

41%

£57,581

£150,000

Top rate

46%

£150,001

Scottish income tax and rate bands apply to earned, pension and property income. UK rates apply to other income such as savings and dividend income.

The basic personal allowance reduces once taxable income reaches £100,000. The reduction is £1 for every £2 income above the £100,000 threshold. Once taxable income reaches £123,700 the taxpayer will have no personal allowance.

Non-residents may not be eligible to receive the personal allowance.

Other thresholds and allowances

Non-dividend savings income — 0% for income up to £5000 when taxable non-savings income does not exceed £5000.

Dividend allowance of £2000 effectively taxed at 0%. Above this threshold they are taxed at 7.5% for basic and standard rate taxpayers and 32.5% for higher rate taxpayers and 38.1% for additional and trust rate taxpayers.

The basic rate band is increased by the gross Gift Aid donation and most personal pension contributions to give basic rate tax relief for these payments.

Blind person’s allowance — £2390

Rent a room relief — £7500

Trading income — £1000

Property income — £1000

If trading or property income is in excess of the £1000 threshold a deduction of £1000 instead of the actual expenses is permitted.

Personal savings allowance — £1000 — this is £500 for higher rate taxpayers and nil for additional rate taxpayers.

Married persons/civil partners allowance — £8695 is available to persons born before 6 April 1935. This allowance is reduced by £1 for every £2 earned over the income limit of £28,900. This reduces to a minimum of £3360. Up to £1185 can be transferred to a spouse or civil partner if this provides a benefit.

Pension contributions

Pension contributions are made from untaxed income. The annual allowance for contributions is £40,000. This annual allowance is reduced by £1 for every £2 of income over £150,000 to a minimum of £10,000 and to a £4000 maximum when pension drawings are made. The lifetime allowance is £1,030,000. Contributions can be made up to the lower of 100% of earnings of the maximum contribution. The maximum contribution is the annual allowance plus any unutilised allowances from the previous three years. £3600 can be contributed irrespective of actual earnings.

National Insurance

The class of National Insurance (NI) will depend on whether the taxpayer is an employer, an employee or self-employed. The thresholds for 2018/19 are the following.

Employees and employers

Class 1

Earnings per week

Employer

Employee

£0.01–£162.00

Nil

Nil

£162.01–£892.00

13.8%

12%

Over £892.00

13.8%

2%

Class 1A and 1B

13.8%

Self-employed

Class 2

£2–£95 per week (small profits threshold of £6,205)

Class 4

Profits up to £8,424

0%

Profits from £8,424–£46,350

9%

Profits above £46,350 per annum

2%

Voluntary NI contributions

Class 3

£14–£65 per week

Voluntary contributions are paid to ensure sufficient contributions have been made to obtain pension entitlements or other benefits.

Actions for employers

  • To claim allowances it is necessary to complete a tax return.

  • Ensure all allowances and thresholds are claimed, for example, determine if the £1000 threshold for property or savings income provides a better deduction than actual expenses, it is necessary to make the correct election to gain the best tax outcome.

  • Consider the level of pension contributions that can be made to obtain the best tax advantage without exceeding the thresholds, including utilising past years’ allowances if not already fully utilised.

  • Ensure that the new codes for 2018/19 are entered into payroll software.

  • Consider if a person is employed or self-employed to ensure that the correct PAYE and NI deductions are made.