There are 30.4 million payrolled employees in the UK, paying tax through the pay as you earn (PAYE) system.
The PAYE scheme was introduced in 1944 following the Second World War. It’s designed to deduct tax at each pay date (weekly or monthly), so tax is paid evenly throughout the year – avoiding you having to make large tax payments long after income is earned.
PAYE works by spreading out your allowances and tax bands through the tax year so you pay roughly the same tax each week or month. This works well for someone earning the same amount each month from one job for the whole year, but there are some scenarios that the PAYE system either cannot handle or takes a while to catch up on.
Here are a few examples:
Example 1: Emergency Tax
If you move jobs or change from self-employed to employed, HMRC sometimes issues a Month 1 or Week 1 ‘emergency tax’ code (M1 or W1). This is non-cumulative, so it does not smooth out your income and tax over the year – effectively, it gives you 1/12th of the allowances and tax bands in the month of payment, regardless of income earned in the rest of the year.
HMRC could also issue a 0T code, which gives you no personal allowance. With these codes, you’ll either underpay or overpay tax each week or month until it’s fixed.
Example 2: Multiple Jobs
If you have two or more jobs, the PAYE scheme cannot split allowances across all the employers. HMRC will usually tell one employer to deduct basic rate tax (BR code) or higher rate tax (D0 code) on everything and allocate the normal code to your other employer.
This can also happen if you have a job and receive pension income. It works provided HMRC can clearly predict your income for the full year, but the more jobs and the more variation in income, the higher the chance of the PAYE scheme collecting the wrong amount of tax.
Example 3: Going Over £100,000
Suppose you get a one-off March bonus pushing your annual earnings over £100,000. The PAYE scheme does not automatically adjust to restrict your personal allowance, meaning that you’ll be undertaxed. As this happened in March, the PAYE scheme cannot catch up, so you’ll owe tax at the end of the tax year.
The following year, HMRC may assume you’re earning over £100,000 and reduce or remove your allowance for the whole year, meaning that you overpay tax through PAYE.
Example 4: Receiving Benefits-In-Kind
HMRC may amend your PAYE code to collect tax on benefits-in-kind (BIKs) such as private health insurance. It typically amends your PAYE code when it receives the form P11D in July, resulting in a mid-year change. But the value of BIKs can change each year, so the PAYE code allocated may collect too much or too little tax.
The move to payrolling BIKs should alleviate this problem.
If you find yourself in these situations, you should get your code corrected quickly to avoid running up a big bill or repayment.
Do not forget that PAYE is not a final tax, just a payment on account, so you might still owe tax at the end of the year or qualify for a rebate. Sometimes, HMRC will automatically correct this, but the onus is on you as a taxpayer to make sure you pay enough tax.
Practical Tip
Check your payslips regularly and understand your PAYE code to make sure it is collecting enough (and not too much) tax. If it’s wrong, call HMRC as soon as possible to correct it. The earlier in the tax year you call, the easier it is to correct and for any under or overpayment to be corrected in the remainder of the year. Watch out for the emergency tax codes – W1 or M1, and the non-standard codes (BR, 0T, D0 and D1).