Hidden cost of the tax code

Anthony Bailey explains how to ensure you do not pay the Inland Revenue more than you should

IT IS called an income tax code, and code is the mot-juste. Taxpayers who have not learned to decipher the code will not know whether they are paying the right amount of tax.

And that could be a lot of people. Even the Inland Revenue acknowledges that about 7 per cent of codes could be wrong- meaning perhaps 1.5 million people could be paying the wrong amount of tax. Some accountants reckon the error rate is much higher. But in its defence, the Revenue says many codes are wrong because taxpayers have not supplied it with up-to-date information.

Everyone who has tax deducted at source under the pay-as-you-earn (PAYE) system has a customised code. This accounts for the great majority of taxpayers. And it is worth taking time out to make sure the code is right.

The code is given to employers and companies paying pensions by the Inland Revenue. It shows the employer how much of your pay (or pension) is tax- free, and by implication how much tax needs to be deducted. It will also be on many people's payslips.

Codes typically have a three- digit number. You simply add on a "9" to find out how much tax-free money you get. For example, if your code is 352L, you get pounds 3,529 tax-free. It means you have just the basic personal allowance of pounds 3,525 plus a little extra because of the way a 9 is added to codes. The letters can show various things. L means you are on the basic personal allowance.

But if you want to know where the figures come from, ask your tax office (not your employer) for a Notice of Your Income Tax Code. In many cases, you will receive one automatically anyway, normally every year.

The notice has two columns. On the left-hand side are tax-free allowances. On the right-hand side are things that need to be taxed (other than your basic pay). Deduct taxable items from your allowances. Knock off the last number from the answer, and that is your code.

Either side of the sum could be wrong. Here are common errors on the allowances side:

q You have got married and are now entitled to the married couple's allowance of pounds 1,720, but are not getting it. The married couple's allowance is on top of your personal allowance. But there is only one allowance between two of you.

q You have separated or divorced and are no longer entitled to the married couple's allowance. If you are still getting it, the Revenue is likely to catch up with you eventually.

q You are a single person with children and should be getting the additional personal allowance (pounds l,720).

q Your husband has died and you are entitled to the widow's bereavment allowance (pounds 1,720).

q The Inland Revenue does not realise that your 65th birthday falls in the tax year (or that you are already 65 or over) and are entitled to a higher personal and married couple's allowance.

q If you are entitled to these age-related allowances, they can be reduced once your total income exceeds pounds l4,600. Your tax office may have over- estimated your total income.

q You may be entitled to set certain work expenses against tax.

q You may have PAYE income from more than one job or pension and may accidentally get too much tax-free pay - because the same notice of tax code is used twice - or not enough.

q Higher-rate taxpayers should check that they are getting higher-rate tax relief for contributions to personal pension plans and for donations under the gift aid scheme.

Here is what to watch out for on the taxable items side:

q The allowance restriction could be wrong. This restriction brings back into tax part of your income taken out of tax by the married couple's allowance, additional personal allowance or widow's bereavement allowance. It can be a difficult concept to grasp. Whereas tax-free allowances are normally worth more to higher-rate taxpayers, the allowances named above are worth the same amount to any taxpayer: 15p in the pound or pounds 258 a year. Basically, if your tax office has wrongly estimated your income and highest rate of tax, the allowance restriction will be wrong.

q The value of your taxable benefits from work - such as a company car, luncheon vouchers, membership of a sports club, private medical insurance - may have changed. Your employer is duty-bound to report taxable benefits to the Inland Revenue on form P11D. But there can be a delay before this works its way through to your tax code. And, of course, your employer may have made a error.

q There may be an estimate of tax payable on income from investments through PAYE. It could be wrong.

q Tax on state pensions and other taxable benefits can be collected through the PAYE system. Check the figures are right.

q A figure for taxable main- tainance payments should be scrutinised.

Those who think their codes are wrong should contact their tax offices. In addition, you can rectify mistakes such as allowances you forgot to claim during the last six tax years.

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

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