An employer uses a tax code to determine how much tax should be taken out of an employee's paycheck. A tax code often consists of a combination of digits and letters, such as 1257L. It informs the employer about the employee's entitlement to tax-free earnings for a specific pay period.

The article focusses on the cumulative tax code which is most commonly used in the United Kingdom.

The cumulative tax code can be easily recognized, it does not have ‘W1 or M1’ in the code. The cumulative tax code is used to determine the amount of tax to be paid based on their total income for the tax year. This means that tax is computed on the overall amount earned rather than the amount earned during each pay period by adding up the individual's income for the entire tax year and also it considers the taxes you have previously paid this year and how much of your accumulated tax-free personal allowance has been utilized.

Main advantage of this tax code is, it allows to roll over the unused allowance for future.

For an example; Mr. John earns £300 weekly and he worked in week 1, week 2 and week 4 and not worked in week 3. His tax code is 1257L. He gets £242 (£12,570/52 weeks per year) weekly personal allowance (PA). Mr. John has to pay £ 11.60 (£300 - £242 *20%) in week 1. In week 2, his Year to Date (YTD) gross earning and PA are £600 and £484 respectively. But he has to pay only £11.60 ((£600-£484 * 20%) - £11.6). When it comes to week 4, his gross earning will be £900 and PA will be £968. Mr. John does not have to pay any tax as his total gross earning is lower than cumulative personal allowance. In this point, he has overpaid tax of £23.20 and it should be refunded to Mr. John.

The UK tax system is complex and it requires the involvement of professional accountants to handle your payroll. Get in touch with Cheylesmore Chartered Accountants. We are here to provide efficient service on your payroll matters.