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How underpayments of tax affect your tax code

You may end up paying too little tax if your income increases but HM Revenue & Customs (HMRC) doesn't know about it right away so hasn't adjusted your code, or if your employer or pension provider uses the wrong tax code. Either way you'll often be able to pay back the 'underpayment' - for the current or earlier tax years - through an adjustment to your tax code.

When you might have paid too little tax

You might have underpaid tax if:

  • you started getting company benefits - like a company car or medical insurance and HMRC didn't know about it right away
  • other income you have - like investment or rental income - has increased since you last told HMRC about it
  • you started getting the State Pension and HMRC didn't know right away
  • your employer or pension provider used the wrong tax code

It's very important that you tell HMRC about changes to your income or company benefits as soon as possible so that you don't end up with a large tax bill at the end of the tax year.

What happens if you've paid too little tax

If HMRC knows about your underpayment during the year

HMRC will adjust your current year's tax code right away so that you don't continue to pay too little tax. They will send you a 'PAYE Coding Notice' telling you what this new code is. This will be based on the latest information that HMRC holds and will make sure that you pay the correct amount of tax for the rest of the year. However, this adjustment will not collect your underpaid tax.

HMRC will also give you an 'estimate' of how much tax you underpaid during the time when your tax code was too high. They will explain how they'll collect it by adjusting your tax code for the next year.

Bear in mind that the amount HMRC tells you is underpaid is only an estimate - they are just part way through the year and other changes may occur. HMRC may have to amend the underpayment when check it again at the end of the tax year. You'll get another PAYE Coding Notice telling you what you have to pay back.

If HMRC doesn't know about your underpayment until the end of the year

In this case HMRC will amend your tax code for the next year or year after that and send you a P800 Tax Calculation telling you how the underpayment happened and how much tax you have underpaid. Just before you're due to start paying back what you owe you'll get a new PAYE Coding Notice - you'll find the amount owed under the entry 'Reduction to collect unpaid tax'.

How to check your underpayment

Step one: Take the amount by which your tax-free allowances have been reduced and multiply this figure by the highest percentage rate at which you pay tax.

Step two: Multiply this figure by the number of weeks from 6 April to the date HMRC changed your tax code and divide by 52.

Example

You pay tax at basic rate (20 per cent) and your allowances dropped by £1,500 in November because you told HMRC that you'd started to get a company benefit.  

To work out your underpayment:

  • multiply £1,500 - in this case the value of your company benefit - by 20 per cent
  • multiply the resulting figure (£300) by 32 - the number of weeks from 6 April to the date of the change in code - and divide by 52

Your underpayment is £185 - the amount of tax you've underpaid up until the point your tax code changed.

How to work out the adjustment in your code for paying back your underpayment

To work out the amount by which HMRC will reduce your allowances the next year - multiply the amount of your underpayment by 100 and divide the figure by the highest rate of tax that you pay.

Example

You pay tax at basic rate (20 per cent) and have an underpayment of £185 from the previous year.

To work out the amount HMRC will reduce your allowances by multiply £185 by 100 and divide the figure by 20. The extra amount you'll have to pay tax on is £925 (£925 times 20 per cent is £185 tax). HMRC adds this amount to any other deductions you might have and subtract the total amount from your allowances for the next tax year.  

Paying back your underpayment

Underpayments of less than £2,000

If you owe less than £3,000 you will usually be able to pay back the amount through your tax code. If you owe £3,000 or more different arrangements apply. Follow the link below to find out more.

If your income is above £150,000

For 2010-11 your tax code did not take account of the new 50 per cent tax rate (and this was not reflected on your PAYE Coding Notice). This means that if HMRC needed to take account of earlier unpaid tax that you owe, your tax deductions may not be accurate. HMRC will work out how much tax you are actually due to pay when you send in your 2010-11 Self Assessment tax return.

Your new tax code will take into account the 50 per cent tax rate ‘adjustments’ to collect the right amount of tax.

If you don’t normally complete a Self Assessment tax return, and you become aware during the tax year that you need to complete one, follow the link below to register for Self Assessment.

More useful links

Tax evasion

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