Death and taxes are the only two certainties in life.
That’s as true in the world of small business as it is anywhere else. Nobody enjoys doing taxes, but it’s an even more unpleasant business here in the UK which is notorious for its kafkaesque bureaucracy.
Although my background is in human resources, I have plenty of hands-on experience helping small businesses manage their payroll and tax deductions.
That’s the sort of thing that happens in a small business. Everyone has to juggle many different coloured balls, and you learn as you go along.
Understanding tax codes in the UK presents some unique - if vexing - challenges for small businesses. The responsibility of knowing how they work and what they mean often falls on someone who doesn’t have the specialised training to deal with them - like the CEO or another senior member of the team. That can lead to confusion, potential legal issues, and costly mistakes.
In this post, I’d like to lend my insight into this important and often headache-inducing business and guide you on UK Tax codes and what they mean.
What are tax codes?
UK tax codes are the alphanumeric codes used by HM Revenue and Customs (HMRC) to calculate how much income tax an individual will have deducted from their wages or pension.
Imagine you’ve just hired a new team member. One of the first things you’ll need to figure out is which tax code applies to them.
Using the correct tax code is important because it helps make sure that the right amount of tax is withheld from someone’s income. For example, the tax code 1257L is used for most people who have one job or pension in the UK.
Tax codes are a combination of numbers and letters. The letters represent the tax-free income, and the letter shows the individual’s tax situation, which will vary depending on the type of employment status.
Tax codes are a central part of the United Kingdom’s tax system. Getting it wrong could mean paying more or less than what you need to, which can lead to legal trouble for you down the line.
You, as an employer, are obligated to assign the right tax codes to your employees to comply with the HMRC's requirements.
List of UK tax codes
Learning what the different UK tax codes mean and why they’re important can easily become overwhelming - especially if you’re a small business CEO who has about 100 better things they’d rather be doing with their time.
I have good news for you, though. I’ve helped founders and CEOs sort out UK tax codes before and I can promise you, they’re not as difficult as they seem.
Let’s break them down in this list of UK tax codes:
- L: This is the standard tax-free personal allowance. Most people will have this in their tax code, including your employees
- M/N: This is the code for marriage allowance. If you see an M, it means your employee has received a transfer of 10% of their partner's allowance. N means they've transferred 10% of their personal allowance to their partner
- T: This one is a bit more tricky. It means other calculations are required to work out your personal allowance
- OT: This is the code you’ll see when there’s no personal allowance left
- BR, D0, D1: These codes are related to different tax rates. BR is the basic rate, D0 is the higher rate, and D1 is the additional rate
- NT: This means that no tax is deducted from your income. Well done, you!
- K: This adjustment to your personal allowance happens when your income not taxed in another way is worth more than your tax-free allowance
There are a few other special cases to keep in mind as well.
If you’re based in Scotland or Wales, you’ll likely see an S or a C prefix, which reflects the tax rates in those different regions.
Then, there are special cases like tax codes W1, M1, and X. This is what you see when the HMRC doesn’t have enough information to assign the correct code. You can think of it as a temporary placeholder until things get sorted out.
Do you see those numbers in your employee's tax codes? They tell you, their employer, how much tax-free income they're allowed in that tax year.
This is calculated based on several factors like your tax-free personal allowance, untaxed interest, part-time earnings, and company benefits.
Examples of UK tax codes
Here, let me give you a few examples of how these work in action.
- 1257L: This is the standard tax code for the 2021/2022 tax year for people who have one job or pension. This will apply to most of your full-time employees. The “1257” represents their tax-free personal allowance. The “L” means that they’re entitled to the standard tax-free personal allowance
- BR: This code here means that all the income from this particular job or pension is taxed at the standard rate of 20%. This is often the case when a person has more than one job or pension
- S1250L: The “S” means the individual pays the tax rates for Scotland. The “1250” represents their personal tax-free allowance, and the letter “L” means they get the standard allowance. This is the code the HMRC would give to someone in Scotland with a standard tax-free personal allowance
You can see from these examples that tax codes are diverse and tailored to individual circumstances, including location or multiple income sources.
The role of employers in managing tax codes
So much for the ins and outs of how UK tax codes work. Now, here’s what that means for you as a small business employer.
When you welcome a new employee onto your team, the excitement of growth is often undercut by the niggling administrative task of processing them with the proper paperwork - including using the correct tax code.
This can mean sifting through a mound of P45 forms and checklists, each with a puzzle of numbers and letters that could apply to your new hire’s tax situation.
UK tax code challenges for small businesses
The labyrinth of tax codes, constant updates, and the sheer brain-fizzing complexity of understanding the UK tax system can be overwhelming - especially if you’re a small business owner who already has enough on.
On top of that, there’s the juggling act of payroll, ensuring compliance, onboarding the new hires, and integrating with your accounting software - all concurrent with the day-to-day of running your business.
It’s a thin line you walk - especially if you don’t have a specialist tax accountant on your team to sort this out for you.
It doesn’t have to be that way though. With tools like CharlieHR, this process can be as easy as teatime. The CharlieHR software can automate your data collection, send automatic emails to new team members, and integrate with Xero as part of your payroll system.
Consequences of incorrect tax codes
Getting your tax codes sorted isn’t just about making your business compliant with the law. For something seemingly so small, an incorrect tax code can lead to some nasty consequences for you if you’re sloppy or careless.
Imagine that your employee discovers they’ve overpaid their taxes due to an incorrect code.
Rectifying this means contacting the HMRC to explain the situation and wait for the correction. On the flip side, underpaying taxes can lead to legal issues and penalties.
Simplify your tax code management with CharlieHR
A lot of mistakes can happen when navigating tax codes that can lead to unpleasant consequences for your small business.
That’s where CharlieHR can help you. The CharlieHR platform integrates seamlessly with Xero, which eliminates the need for manual entry and reduces the odds of human error.
That’s not all either. CharlieHR can automate processes like your data collection, ensuring you stay above board with things like tax codes and Right to Work checks. For a small business owner balancing multiple, equally important responsibilities, this isn’t just convenient - it’s essential.
Sign on with CharlieHR for free today, and take control of your small business tax management.