What is a tax code and how is it calculated?
Answered 11 March 2026
What is a Tax Code and How is it Calculated?
What the law says
A tax code is used within the PAYE (Pay As You Earn) system to determine how much income tax an employer deducts from an employee's wages or pension. The Income Tax (Pay As You Earn) Regulations provide for several types of code, including:
- Suffix codes (e.g. a number followed by a letter): the standard type used for most employees
- The 0T code: which, without allowing for personal allowances, effects deductions of tax so that amounts subject to deductions are in accordance with the basic, higher and additional rates
- The emergency code: which, after allowing for the personal allowance, effects deductions at the basic rate, or basic and higher rates, or basic, higher and additional rates
- The nil tax (NT) code: which requires no deductions of tax
- The BR code: used to charge all payments at the basic rate only
- D prefix codes: used to charge tax at the higher or additional rate
- K prefix codes: for cases where coding deductions exceed allowances
An employee who objects to the determination of their code must state the grounds of objection. HMRC may amend the code by agreement; if not, the employee may appeal to the First-tier Tribunal, which must determine the code in accordance with the Regulations. HMRC may also amend a code if it is found to be inappropriate because actual circumstances differ from those by reference to which it was determined.
HMRC guidance / practice
What a tax code is:
PAYE is a provisional system of deducting tax from employment income such as wages and salaries by the use of code numbers and tax tables. Where PAYE does not get things right in the tax year, matters are sorted out at year-end either by informal calculation or assessment.
In plain terms, a PAYE code is issued to employers to tell them what HMRC estimate to be the tax-free earnings the employee is entitled to at any particular point. The employer does not know how it is calculated; they simply apply the code. In every payroll run the employer deducts tax on the basis of that code and reports it to HMRC via RTI data.
How the code number is structured:
Most tax codes are made up of a number followed by a letter (suffix codes), for example 747L. The main special codes are:
- D prefix – charges tax at the higher or additional rate
- K prefix – where coding deductions exceed allowances
- S prefix – Scottish resident (Scottish income tax rates apply)
- C prefix – Welsh resident (Welsh income tax rates apply)
- BR – all payments taxed at basic rate (20%)
- NT – no tax deducted
- 0T – no tax-free allowance available
- D0 – all income taxed at 40% higher rate
- D1 – all income taxed at 45% additional rate
How the code is calculated:
The tax code is built up from an individual's allowances (which increase the tax-free amount) and deductions/adjustments (which reduce it). The key components include:
- Personal Allowance – the starting point for most people
- Other allowances – e.g. blind person's allowance, married couple's allowance
- Deductions – e.g. benefits in kind from an employer, unpaid tax from previous years, non-PAYE income (such as rental income or self-employment income)
For age-related allowances, the system calculates Adjusted Net Income (ANI) as follows:
- Start with net income (chargeable income less deductions)
- Deduct gross Gift Aid payments
- Deduct grossed-up pension contributions paid under relief at source
- Add back any life assurance payments made
Where ANI exceeds the income limit for age-related allowances, the Personal Allowance is gradually reduced by £1 for every £2 of excess income.
The Notice of Coding (Form P2):
The employee is sent a Notice of Coding (Form P2), which shows the code and explains how and why it is calculated. It is for the taxpayer to check whether it is correct and appeal if appropriate. The P2:
- Is personalised to each customer's circumstances
- Displays an arithmetical breakdown of how the code is made up
- Shows the Personal Allowance entitlement and anything that reduces the tax-free amount (e.g. benefits in kind)
- Explains how much the customer can earn before paying tax and shows how much will be taxed at each rate band
Automatic calculation:
Tax codes can be automatically calculated by HMRC's systems (e.g. at Annual Coding, Budget Coding, or when a new employment record is created), or manually generated by an HMRC operator.
Citation sources
When calculating the age-related levels of Personal Allowance and Married Couple’s allowance the system will calculate the individual’s adjusted net income (previously known as net statutory income). Adjusted net income is calculated as follows Stage 1 - start with Net Income (Chargeable income less deductions - for example job expenses, professional subscriptions, losses and loan interest) Stage 2 - deduct gross Gift Aid Stage 3 - deduct grossed up pension contributions paid under relief at sou
PAYE is a provisional system of deducting tax from employment income such as wages and salaries by the use of code numbers and tax tables. Where PAYE does not get things right in the tax year matters are sorted out at the year-end either by informal calculation or assessment (see EIM71405). Because PAYE is a provisional system it makes sense to deal with taxpayer enquiries about code numbers as informally as possible. That is why the PAYE regulations give taxpayers initial rights to object to co
The list below gives the ‘Circumstance’ and the ‘P2X explanatory note’- If tax code BR is present, Tax code BR shows that all your income from your job or pension is taxed at the 20% basic rate. If tax code 0T is present, Tax code 0T shows there is no tax-free allowance available for this job or pension. If tax code D0 is present, Tax code D0 shows all your income from this job or pension is taxed at the 40% higher rate. If tax code D1 is present, Tax code D1 shows all your income from this job
The main differences from normal PAYE are Department for Work and Pensions (DWP) only use a small number of tax codes, based on the most common personal allowances Basic personal allowance (100 per cent amount) Basic personal allowance (100 per cent amount) plus blind person’s allowance Basic personal allowance plus wife’s married couple’s allowance (100 per cent amount) Basic personal allowance plus wife’s married couple’s allowance (100 per cent amount) plus blind person’s allowance Basic pers
1. Wherever possible, coding should be carried out at the point of capture in order to avoid actions on the following day 2. Coding should be based on the latest return but, where available, you should take into account any information which is more up to date 3. Return information about non-PAYE income must only be included in a PAYE tax code where there is no entry in box 3 of the Finishing your Tax Return section on page TR 5 4. If the income is to be coded, the system will calculate any codi
the following types - Automatic Code Change - The system has automatically calculated the tax code - Manual Code Change - An operator has generated a tax code calculation - Annual Coding - The code has been calculated in the automatic annual coding process - Budget Coding - The code has been calculated in the automatic Budget coding process - Budget Coding (Not yet issued) - The code has been calculated in the automatic Budget coding process but has not yet been issued. The code will be finalise
The P2 Is personalised to fit each customer’s circumstances Includes the customers employments / pensions and National Insurance number and gives their HM Revenue and Customs phone number Explains why customers need a tax code, why they need to check that their code is correct and confirms what their tax code will be for the year, or remainder of the year Displays an arithmetical breakdown of how their code is made up, by showing what their Personal Allowance entitlement is, anything that reduce
d by the SARs team indicated that it was £59,739.01. 61. HMRC’s submissions simply identified that there were three estimates of Mr Bird’s pay in that information and one of them appeared to be a duplicate. There was no explanation as to why there were estimates. The submission went on to refer to and rely on the form P14 which is the end of year summary produced by the employer(s). 62. No-one referred Mr Bird to it but I understand that HMRC’s PAYE Manual at PAYE130010 states that IABD “is used
t 2007 ; or ii in the tax tables; c the employee’s PAYE income is not chargeable to tax; or d the employee does not have a liability to tax in respect of any PAYE income. Appeals and amendment Objections and appeals against employee’s code 18 1 An employee who objects to the determination of a code must state the grounds of objection. 2 On receiving the notice of objection the Inland Revenue may amend the determination of the code by agreement with the employee. 3 If the Inland Revenue and emplo
e additional rate; bb the appropriate Scottish upper rate code, which effects deductions of tax wholly at a Scottish upper rate for a Scottish taxpayer; c the nil tax code, which requires no deductions of tax; ca the 0T code, which without allowing for personal allowances, effects deductions of tax so that during the tax year the amounts subject to deductions are in accordance with section 10 of ITA (income charged at the basic, higher and additional rates: individuals) or section 11A of ITA (in
Most tax codes are made up of a number followed by a letter, for example 747L. We call these suffix codes. There are other tax codes for special cases. The main ones are Prefix D code - used to charge tax at the higher rate and the additional rate Prefix K code - for cases where coding deductions exceed allowances Prefix S code – indicates the individual is a Scottish resident and tax is deducted at the Scottish income tax rates Prefix C code – indicates the individual is a Welsh resident and ta