Crack your tax code and get to know yourself better

Most people have absolutely no idea what their Inland Revenue coding notice is all about.

If you are an employee or a pensioner you get one of these every year, and many of us ignore it because it is so hard to understand.

Despite its daunting appearance, all it does is tell you how much tax will be deducted from your salary during the year - and why.

Spending a little time trying to crack the Inland Revenue code is worthwhile, because if it is wrong you may end up paying too much tax.

n Most codes are a number followed by a letter, for example 220L. The number represents the tax allowances to which you are entitled, meaning the amount of money you can earn each year before you have to pay any tax on it. Confusingly, the last number is left out (this is a code, after all!). So if your allowances total pounds 2,203 then your code would begin with 220.

n The letter indicates what sort of tax allowance you receive:

L is the single person's allowance, worth pounds 4,335 in the current tax year.

H is the married couple's allowance, worth pounds 5,125. This is also given to single parents.

P is the age allowance for a single person, worth pounds 5,980.

V is the age allowance for a married couple, worth pounds 5,195.

So a single person might have 433L as their tax code this year, and a pensioner 598P.

n However, your code may not be this straightforward.

Codes are also used to collect tax on benefits provided by your employer, such as company cars, cheap loans and health insurance. These amounts are deducted from your tax allowances and are shown on the right hand side of your coding notice.

Small amounts of tax overpaid or underpaid from previous years may also be taken into account. Deductions are shown on the right hand side of the coding notice and repayments on the left.

Some allowances reduce the amount of tax you pay on the top slice of your income. So, if you are a higher-rate taxpayer, they reduce the amount of tax you pay at 40 per cent.

But other allowances only give relief at a reduced rate. For 1999/2000 the rate for mortgage interest relief at source (Miras) and the married person's allowance is only 10 per cent.

The Inland Revenue's system deals with this by giving you the full allowance on the left hand side of the coding notice, and then reducing its value on the other side. This is called an allowance restriction.

Age allowances are tapered, which means they are withdrawn gradually, depending on a person's income. So a single pensioner aged 70 with an income of pounds 5,720 or less will receive the full age allowance. But one of the same age with income of pounds 16,800 or more will receive only the single person's allowance of pounds 4,335.

Pensioners with an income between pounds 5,720 and pounds 16,800 will be given part of the allowance.

n There are also a few special code letters. These are:

BR: all your income will be taxed at the basic rate of tax, without any allowances. This might happen if you have more than one employment, so that allowances are given against your earnings from the other job.

D: all your income will be taxed at the higher rate. This is only likely to happen if your basic-rate band and allowances are absorbed by other earnings.

NT: no tax is deducted from your earnings. This will apply, for example, if you go overseas but are still being paid by your UK employer.

K: this means that your taxable amounts exceed your allowances, so that instead of deducting the total from your earnings, it has to be added back, thus increasing your taxable income. Employees with large company cars commonly have K codes.

If you think your code is wrong, you should contact your tax office (ask the payroll department where to call, or if you are a pensioner speak to the local tax office in the phone book). The tax office will investigate and, if necessary, amend the code and tell your employer. The amount of tax you pay will be adjusted so it is correct before the end of the tax year.

When you look at this year's coding notice, which you probably received in April, you should see an increase in your personal allowance, whether you are single, married or a pensioner. However, the married couple's allowance has fallen to 10 per cent from 15 per cent. Thus the overall effect of this year's changes may be negative rather than positive.

There is some good news. The Chancellor surprised everyone in this year's March Budget by introducing a starting 10 per cent rate of tax, and he also abolished tax on mobile phones. You are likely to receive a second revised notice taking account of these changes, and this would be a good opportunity to check that the other parts of your coding notice are correct. You might save yourself some unnecessary tax!

n Anne Redston is a Chartered Tax Adviser with Ernst & Young.