Tax codes can be confusing at the best of times and can be especially so where a person receives multiple sources of income. However, a K code is a bit different from its cohorts in that it increases the tax you pay, understanding why is even more important.
Codes are made up of numbers and letters. The numbers represent the amount of tax free allowance you have to set off against your income and the letters are the system that Her Majesty’s Revenue and Customs (HMRC) use to communicate with the employer or pension provider. The letters follow the numbers and are generally based on your age;
- L – under 65
- P – 65 to 74 (born before 6th April 1948)
- Y – 75 and over (born before 6th April 1938)
- T – any age but affairs more complicated and code should be reviewed annually
This is all fine provided you have tax free allowance left, but what happens if you don’t? Some people receive income that is not taxed at source, such as a state pension or savings interest. If a person’s untaxed income is higher than their personal allowance (PA), they will not have any tax free allowance but tax will be due on the difference, a K code that instructs a provider to take more tax is needed.
An example will better explain;
Mr Kitton is 66 years old, still working and intends to continue doing so for a few years yet. His state pension is £12,500 a year which cannot be taxed at source, but it is higher than his PA of £10,500. He will be due to pay tax on the difference of £2,000 (£12500 – £10,500). To achieve this, HMRC will issue a K code, calculated as so; take his state pension figure away from his PA (£10,500 – £12500) leaving him a negative figure of £2000 and knock of the last number and reduce it by 1 to give the number -199. The minus is then swapped for a K. Notice the K prefixes the number, different to the other tax codes. Mr Kitton will be given code K199 which is sent to his employer. The K code instructs the employer to add £1,999 to his income before they calculate the tax to deduct. Mr Kitton will pay the tax due on his state pension from his employment earnings, in this case £166 a month.
But beware! The source of income carrying the K code must be large enough to take the tax due. If Mr Kitton’s employment income had only been £3000 a year, the K code would have failed. Why? Because the employer can only deduct up to 50% of a person’s income in tax. In this case, they would have taken £1,500, leaving an underpayment of £500.
Unfortunately HMRC does issue out K codes that don’t work, and providers do operate the 50% rule, and because HMRC are not informed, underpayments of tax can occur.
Underpayments are usually picked up during HMRC’s annual reconciliation process. Sometimes there is an explanation, but not always. Sometimes it is caused by HMRC or Employer error. A taxpayer has the right to ask HMRC to explore the reason why an underpayment has occurred and can ask HMRC to consider a concession called ESC A19 or Employer error. The criteria can be quite restrictive so it may be worth seeking guidance on how to proceed.
This article is by Tax Help for Older People registered charity no 1102276, offering free tax advice to older people on incomes below £17,000 a year. The Helpline number is 0845 601 3321 or geographical 01308 488066.