Tax codes - how important are they?

Incorrect codes

Despite what the general media might have you believe, for many taxpayers your PAYE tax code doesn’t determine how much tax you’ll ultimately have to pay, instead it merely determines how much you’ll pay on account. Your final tax bill is decided by your self-assessment (SA) tax return. Nevertheless, it’s sensible to get your code right so you don’t overpay and have to claim a refund, or underpay and face a large tax bill out of the blue.

For taxpayers who aren’t required to complete SA returns, tax codes are more important. HMRC often includes estimated or incorrect deductions in the codes. Unless these are corrected you might pay the wrong amount of tax permanently.

Coding adjustments

You’ll often see figures for savings, dividends, property rental income, pensions, freelance earnings and benefits in kind. Less often you’ll see adjustments for tax you owe and some types of NI debt and tax credit overpayment.

While you must accept adjustments for pensions, benefits in kind, tax, NI and tax credit debts, as long as they are accurately calculated, you can insist HMRC removes those relating to other income, e.g. savings income and dividends.

Accepting an adjustment

Accepting a deduction for other income in your code might work well for you as it means you’ll pay tax over the course of the year rather than all at once either through SA or, if not in the SA system, as a result of an HMRC review. However, there’s a problem in the latter situation.

If HMRC has included an adjustment in your tax code which is an estimate, when it reviews your tax position it assumes its estimates are accurate unless you tell it otherwise. This means you can pay the wrong tax year after year without HMRC doing anything to correct it.

Example. John works for Acom Associates. At one time he received free gym membership as a perk of his job. John also receives interest from various savings accounts. HMRC includes adjustments in John’s code to collect the tax on these incomes and increases them year on year for assumed rises. However, John opted out of the gym membership a while ago and until the current tax year his interest from savings has reduced not increased. HMRC’s estimated adjustments have cost John over £400 in tax over the last three tax years. Unless John intervenes it’s virtually certain that HMRC will never correct this. Worse still, the error is likely to continue.

Check your code! Also, don’t forget that if you’re a basic rate taxpayer the first £1,000 of savings income, e.g bank interest, is tax free (the figure is £500 if you’re a higher rate taxpayer). Similarly, the first £1,000 of dividends is tax free (£2,000 for 2021/22 and 2022/23). Therefore, even if you decide to accept an adjustment to your code for this type of income, make sure that it takes these tax-free amounts into account.