Please note the calculations on this page are for the tax year 2022. We have an updated page for 2024 here.
Like all employees on UK payroll, you will need to pay tax on earnings above your tax free allowance, employee NI on any earnings above the upper primary threshold and your employer will need to pay NI on your income above the secondary threshold.
Tax free allowance
This is usually set in your tax code. For example, the standard tax code of 1257L means that you will get £12570 of income tax free. For the time being, until the new employee NI threshold comes into effect, you will be charged employee NI above £9880 a year, and after July 5, for earnings above £12570. The employer NI will still be in effect on earnings above £9100 a year.
So how is the tax free allowance calculated?
Although you might have the tax code 1250L, which roughly translated means you can earn 10x your tax code tax free. In this example, that is 1250 x 10, so £12500 tax free. If you are on a non-cumulative payroll basis, for example you are on the Month 1/Week 1 tax code, then whether it is April (tax month 1) or March the following year, (tax month 12), it will make no difference to how much you will be given tax free.
Let's take a few examples to help elucidate this.
You are on 1250L. You are subject to Month1/Week 1. In April 2022 you earn £2000.
Bam, you are charged income tax.
Why did this happen?
I haven't earned £12500 yet! Well, this is a common misunderstanding for newbies usually starting their first jobs. You are on a system called PAYE, 'pay as you earn'. That's why some summer interns who work for 8 week get charged tax because the annual earnings are above the tax free allowance and the tax free allowance is calculated per pay period. However, if you are a summer intern, you should ask your employer not to charge you tax because you will not earn more than the tax free amount in the year. Speak to your HR person to get this done.
How to calculate your tax free allowance?
- Step 1 - take your tax code and multiply it by 10 (e.g. 1257 x 10 = £12570)
- Step 2 - divide your annual tax free allowance by the number of pay periods (for example, if you are paid monthly divide it by 12, or if you are paid weekly divide it by 52) (£12570/12= £1047.50)
- Step 3 - Take your pay in the pay period, e.g. if your gross pay is £2000 (like the example above), then take £2000 - £1047.50 = £952.50. This last figure of £952.50 is your taxable pay.
- Step 4 - take 20% (or 40% if applicable - in this case it isn't since our example person earns £24,000 per annum) of the taxable pay. £952.50 x 20% = £190.50
If you were to repeat this exercise in March 2023, you will be charged the same amount of tax. That is because in this example the earner is subject to Month1/Week1 and hence the tax free allowance isn't cumulative. What does it mean to be cumulative? Well, it means that your prior earnings period is taken into account.
How does this change things?
Well, let's say you earned nothing since your first April 2022 pay and it is now March 2023. Since you have not earning anything in the whole tax year, you have your total tax free allowance available from the previous months. Remember we calculated it as £1047.50 tax free each month. So let's say you earn a whopping £10000 in March 2023. You will not pay a dime in tax because your tax free allowance is £1047.50 x 12. Let's say you get that nice income because you've been unemployed for 1 year and you suddenly get the job at a big corporate and it is February 2023. Will you be taxed?
To work that out, we do your tax free allowance of £1047.50 x 11 = £11522.50. Here your tax free allowance is higher than your earnings, so you will not be charged tax on your February salary. However, on your March salary of £10,000, you will be taxed as you get £12570 a year and if you are paid £10000 in March, then your earnings will be £20,000. How much tax, well that's easy, anything above £1047.50 x 12 = £12570. So in this case £20000 - £12570 = £7430. £7430 x 20% = £1486.
bold text****bold textNow the question you are wondering is if I had been earning £10000 from the beginning of the tax year, how much would I have to pay in tax. Easy, £10000-£1047 = £8953. Now one extra step, as your earnings now take you above the basic rate of 20% since £10000 is £120000, you now have to split the basic and the higher rate. Basic is up to £37701 / 12 = £3141.75 and you'll pay 40% on earnings up to £150k, so that's the incremental amount up to £12500.
- So, now you do £8953-£3141.75 = £5812
- Your tax is therefore
- £3141.75 @ 20% = £628.35
- £5812 @ 40% = £2324.80
- Total = £2952.35
Summary
- £1047 = tax free
- £3141.75 @ £628 tax
- £5812 @ £2325 tax
- Total income = £10000
- Total tax = £2952
Don't forget you'll also be paying employee NI and your employer will be paying employer NI. Both of these use the same principles for applying deductions to your income in the specific pay period. That is why you may end up paying deductions during the year even when your annual income doesn't exceed the thresholds. You can claim back the surplus paid after the end of the tax year. Every summer intern if he or she has mistakenly paid tax during the summer will be lining up to claim this tax refund.
Does PAYE automatically update for this scenario?
That depends on the software that you use. If the employee falls back inside of the tax free allowance based on the monthly periods, then he or she may have a negative tax amount based on the person has already paid. Otherwise, it will be for the person to claim back the tax that has been overpaid after the end of the tax year.
