A new tax year begins on April 6. And in the run-up to that date, millions of people will receive their new tax codes.

Your tax code may not be the most exciting topic, but it is important. If you have the wrong code, you could end up underpaying all year and getting a huge bill in 2013, or you could end up overpaying and being stuck with the bill every month.

If you have recently changed jobs or started a new source of income, you should be especially careful to ensure that you are assigned the correct code.

What you need to know…

The L-Code – for most people

Tax codes are usually a series of numbers and a letter. The most common letter is L. This means you are under 65 and are entitled to the basic allowance – this is the amount you can earn before income tax is due. The basic allowance for 2012-13, which applies to low and middle earners with an annual income of less than £100,000, is £8,105.

This exact allowance (divided by 10) will be prefixed to the letter in your code. So for the 2012-13 tax year starting next week, 810L will be one of the most common codes – it means you are under 65 and earn less than £100,000, and so are entitled to a personal allowance of £8,105 before income tax is due.

(Related link: Free guide to legal tax savings)

The K-Code – for untaxed income

Another code that many people have is the K code. This is essentially the opposite of an L code and is used when your additional tax-free income exceeds your personal allowance.

To go back a step, the tax officer will want to know whether you receive additional income from your employer – often in the form of social benefits. This income will deduct and reduce your personal allowance.

Let’s consider the following example: Your employer provides you with a brand new BMW company car that you can use both at work and at home. All your petrol is paid for, as is the registration and taxes for the vehicle. The tax authorities calculate an amount for the income you receive from it (for private journeys) and deduct this from your personal allowance.

This will give you a tax code that still ends in L, but is preceded by a smaller number. So if the taxman decides that you have £5,000 of income from your company car, your new tax code will include the code 310L (£8,105 – £5,000 = £3,105 or 310).

However, if this additional income exceeds your personal allowance and consumes it completely, you will be redirected to the K code.

To continue our example, if the taxman decides that you receive £15,000 of extra income from the BMW company, you will see 689K as your tax code. This means that you will have to pay income tax on all of your income plus the £6,895 of extra income from the company car that exceeds your personal allowance.

The T-Code for income over £100,000

If you earn a lot, the situation gets a little more complicated. For every £2 you earn over £100,000, you lose £1 of your personal allowance. At this point, you should be given a T code, preceded by a number indicating the amount of your remaining allowance, assuming that workplace benefits don’t force you into a K code.

For example, if someone has an income of £110,000 without any tax-free benefits or other allowances, they will see the code 310T, indicating a personal allowance of £3,105.

When your income reaches £116,210 you will lose all your allowance and all your income will be subject to the relevant income tax rates. From this point onwards you will be assigned code 0T.

Pensioner codes P and Y

If you are on a low or middle income and are aged between 65 and 74, you will be assigned the P code, which allows you to earn £10,500 (after deducting certain allowances such as donations or pension contributions) in 2012/13 before you have to pay tax.

If you are 75 or over, this allowance increases to £10,660 – indicated by the code Y.

However, there is also a cap for pensioners at the upper end of the income scale.

For every £2 you earn over £25,400, you lose £1 of your personal allowance until it reaches the basic amount – £8,105 for the next tax year.

Unless your income exceeds £100,000, this allowance will remain. If it does, your basic personal allowance will start to diminish again, at the same rate (£2 earned = £1 lost) as for those under 65.

It is also worth noting that the basic state pension is paid tax-free – although it is taxable. Most people choose to have this included in their personal allowance.

Second jobs and pensions

You will normally be given a tax code for each source of income. If you have multiple sources of income, you will be asked to indicate your main source of income. The relevant personal allowance will then be applied to this.

All other income is taxed without any allowance. If you pay the basic tax rate, additional sources of income receive the code BR, taxpayers with a higher tax rate receive the code D0, and those paying the additional tax rate receive the code D1.

An NT code is issued when there is no tax to be deducted. This may be because your total income is less than your personal allowance or because you are a self-employed contractor who has to pay national insurance contributions but no income tax.

Emergency codes

An emergency tax code is issued when HMRC does not have enough information about you to send your employer the correct code. This usually happens when you start your first job and receive your first source of income during the financial year, or if you have not received a P45 from a previous employer.

The emergency tax code for 2012-13 is 810L – the same as the basic allowance code. This will normally ensure that you receive the basic tax-free amount each month, but will not take into account any other reliefs or allowances.

You may also see W1 (for weekly wages) or M1 (for monthly wages). This means you’ll be taxed as if it were the first week or month of the financial year. However, if you don’t start work until the middle of the year, a W1 or M1 code could cause you to pay too much tax – because your personal allowance is spread over too many months.

For example, if you start your first job five months into the financial year, you should receive one seventh of your personal allowance with each monthly pay package. With code W1 or M1, you only receive one twelfth – which means you are paying too much.

However, when you hand over your P45 or P46 to your new employer, your tax code should change – and you should be refunded any losses. If you still haven’t been refunded any overpaid tax at the end of the tax year, you should get it back in the form of a refund.

If your tax number is incorrect

If you think your tax number is incorrect, you must tell HMRC as soon as possible so that it can be corrected. You must have your tax number and National Insurance number to hand – you can find these on your payslips or letters from HMRC.

You can get all HMRC contact details on the company website.

The story continues

(Related link: Don’t miss out on your tax-free saver’s allowance – open an ISA now)

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