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Manage your PAYE tax code - and don't overpay your tax

Contractors should keep an eye on their tax codes, making sure they have the correct tax code, and be aware of measures that HMRC takes to claim tax payments ahead of schedule to ensure that their contributions remain consistent with their income.

This is according to James Abbott, owner and head of tax at contractor accountant Abbott Moore, who warns: “Unless you have said to the contrary – and particularly if you haven’t completed a tax return – HMRC will attempt to estimate and retrieve your tax via your coding notice.

“It’s not entirely a bad thing, because whilst some taxpayers want to delay their payment for as long as possible, others want to make payments more frequently to avoid a large tax burden at the end of the year.”

However, Abbott notes that estimates are exactly that – estimates. Contractors may find that they are being overcharged or undercharged. To avoid this potential problem, contractors are advised to monitor their tax codes and take the necessary steps to prevent HMRC from claiming tax payments early.

HMRC keen to claim tax early

Some contractors will find that their tax codes have been radically reduced as HMRC attempts to collect dividend tax, as well as income tax and National Insurance Contributions (NICs), ahead of schedule. By adjusting PAYE code numbers, HMRC allows itself to claim tax payments at intervals throughout the year.

This may not necessarily be a bad thing for contractors who are keen to make regular contributions to avoid a large bill at the end of the tax year. However, reductions are based on estimates derived from dividends that contractors received in the previous tax year.

Contractors could be left out of pocket – for now

Due to the fluctuating nature of dividends, this approach is somewhat flawed as it means contractors who plan to withdraw less dividends than they did in a previous tax year will end up out of pocket – at least temporarily.

As Abbott explains, the approach by HMRC could also cause further problems for contractors who are already making tax contributions through the payment on account system:

“Say your tax bill for a previous tax year was £4,000. HMRC will naturally assume that your upcoming liability is the same and will request two payments of £2,000 through payments on account in January and July – meaning you’ve paid £4,000 towards your personal tax liability.

“However, HMRC may then estimate that you owe £4,000 for the personal tax on your dividends, and code in an additional tax of £4,000 to be collected through your salary. So by the time you get to July, you’ve paid double - £4,000 through your code for the year and £4,000 through the self-assessment payment on account system.”

Adjustments are easily reversed

Fortunately, Abbott explains that contractors aren’t obliged to comply with these estimated deductions and so amending a tax code to avoid these is a very straightforward process.

“Firstly, if HMRC is trying to collect tax on dividends from you, there will be significant adjustments made to your code, which will stick out like a sore thumb,” Abbott notes.

“It’s also worth mentioning that HMRC doesn’t actually have the right to claim dividend tax sooner because it isn’t classed as employment or pension income. As such, contractors can amend their tax codes simply by calling HMRC or by completing an online coding notice query.”

Contractors need to opt out

To ensure that they avoid this issue altogether, contractors need to be attentive when filling out their tax return, which allows a contractor to elect to opt out from allowing HMRC to withdraw tax early.

“Contractors who find they are unexpectedly having tax deductions taken ahead of time usually find that they have overlooked an election when filling out their tax return,” Abbott explains. “Within the return, there’s a box that you must fill in to indicate that you don’t want HMRC to estimate your tax liability and collect on other sources of income.

“HMRC always prefers to collect as much tax as soon as possible, and so it has deliberately worded the clause so that taxpayers have to opt out, as opposed to opting in. This means anybody who misses the box authorises HMRC to take payment early.”

Tax codes susceptible to adjustments throughout the year

Abbott explains that there are three points throughout the year where HMRC might be expected to alter a contractor’s coding notice. The first will be just prior to the beginning of the tax year.

Contractors who complete a P11D form to claim expenses or benefits may also find their coding notices have been adjusted once their claims have been processed. There is also potential for adjustments once a contractor has filed their personal tax return.

“There’s a lot that can go into the code that can work to either your advantage or disadvantage,” Abbott explains. “If there are significant adjustments made at any time that you don’t understand, you should query them with your accountant or with HMRC.

“If it’s the difference between a couple of hundred pounds, there’s no need to be overly concerned, because it’ll be sorted out at the end of the year when you file your tax return. But more significant adjustments could potentially cause a large overpayment or underpayment, which you’re obviously better off knowing about.”

Contractors need to remain vigilant when monitoring tax codes

Abbott warns contractors against complacency when dealing with their tax code, and says they shouldn’t simply assume that it is being checked by their accountant:

“Your tax adviser or accountant will typically receive a copy of most items of correspondence from the taxman, but HMRC no longer sends the accountant a copy of the client’s coding notice. So contractors should never rely on their accountant to keep tabs on their code, unless they forward their notice specifically.”

Abbott concludes: “Otherwise, contractors just need to remember two things. Firstly, to check their coding notices carefully and ensure they’re happy with any significant adjustments. Secondly, that they can always change it if needs be.”

Published: 23 September 2016

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