I get asked a lot about tax codes and how
tax works so we’re going to tackle this topic here and explain it with some quick
examples. Tax in the UK can be a bit tricky to understand
and there are lots of confusing headlines and stories out there to bamboozle you. This
is a basic guide to tax in the UK, check out part 2 if you want to know more about how
taxable benefits such as company cars or medical expenses work.
We are going to discuss personal tax from earnings. Let’s start at the top; HMRC.
HMRC – which stands for Her Majesty’s Revenue & Customs – is the department of the
government responsible for collecting taxes. This is what people mean when they talk about
‘the taxman’. These are some of the types of tax HMRC covers:
VAT Income tax
National Insurance Corporation tax
Capital gains tax Motoring taxes
Inheritance tax Stamp duty
Insurance Premium Tax Air Passenger Duty
PAYE It’s a long list! In this video we are only going to look at
PAYE. PAYE – or Pay as You Earn – is a type
of income tax. It is the amount that is automatically deducted from your salary on your payslip
each month, before you even get a sniff of it.
HMRC gives you a tax code. We’ll discuss tax codes in a minute.
Your tax code determines how you will pay tax and your employer uses your tax code to
deduct the correct amount from your salary each month and give it to HMRC.
PAYE is applied to your normal salary, sick pay, maternity pay, directors’ fees and
pensions. Tax codes. A tax code is usually in the form
of a number followed by a letter and it is a calculation of how much tax you need to
pay in the tax year. You can find your tax code on your payslip or P60 (which we’ll
come back to) and on the letter they write you at the start of each tax year.
Tax codes are calculated as follows: The tax-free allowance for everyone is currently £11,000 This means you can earn £11,000 before you start to pay tax.
This gives you the tax code 1100L which is what most people receive.
Ok, for this example we are going to use this tax code. We will look at how your tax code
can change a bit later. Once you earn over £11,000, you are taxed
at the basic rate. This is currently 20%. So if you earn £20,000 per year, you pay
tax on £9000 at a rate of 20%. This means you pay £1800 tax per year, or £150 per
month. Your employer deducts this automatically from your payslip – hence the term ‘pay
as you earn’. If you earn £30,000 per year, you pay tax
on £19000 at a rate of 20%. This means you pay £3800 tax per year, or £317 per month. Higher rate tax is paid on income above £43,000.
So if you earn £50,000, you will pay: Zero tax on the first £11,000 as above, 20% tax on your income between £11,000 and £43,000, This is £32,000 at 20% which equals
£6400. And you’ll pay 40% tax on your income above £43,000. This is £7,000 in this example which equates to another £2800 in tax. This brings your total tax bill to £9200 or £767 per month. I’ve heard people get this mixed up and think that as soon as you enter the 40% tax
bracket, all your income is taxed at 40%. This is not how it works. The higher rate (40%) tax bracket applies all the way up to £150,000. Above this point
you will pay 45% on your income. Also, if you earn above £100,000, your tax
free allowance diminishes proportionately to zero. If you have any questions about this,
leave them in the comments below but for now, we will assume that most people watching this
channel aren’t worried about this problem. To calculate your tax just remember this; If you earn more than £43,000; the proportion above this amount times 40% and the remaining amount between the two thresholds, – which is £32,000 – times 20% So what if your tax code is not 1100L?
I’m glad you asked. Your tax code may have a different number or a different letter.
We are going to cover this in part 2. Don’t forget to subscribe.
Remember, the figures used in this example are based on the tax year 16-17 and will likely
change from year to year. The basic concept remains the same though. Further information
is available from the HMRC website.