Why have I been charged income tax when I earned less than annual tax free allowance e.g (£12570) in 2024?

Why have I been charged income tax when I earned less than annual tax free allowance e.g (£12570) in 2024?

Article updated for 2024 tax year. If you are on the PAYE scheme, then you will need to pay employee NI and income tax and your employer will need to pay employer NI. This will take a little while to read but hopefully by the end you will be wiser.

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This article has been updated for tax year 2024. Some of the paragraphs are similar but we have updated the calculations.

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.

1. Tax and NI allowances

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. The employee NI threshold was raised by Rishi Sunak's government, you will be charged employee NI above £12,570 a year. The employer NI will still be in effect on earnings above £8,840 a year. So this means your employer will pay 13.8% on your earnings above £8,840 but you will not have any deductions on your pay until you exceed £12,570.

2. So how are the allowances calculated?

Although you might have the tax code 1257L, which roughly translated means you can earn 10x your tax code tax free. In this example, that is 1257 x 10, so £12570 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. You will be getting £12570/12, or £1047.50 a month if paid monthly or £12570/52 or approximately £12570/52, £241.73 a week. We say approximately because there are slightly more than 52 weeks in the tax year, which means the calculation is only approximate.

Like our last article for 2022, let's take a few examples to help elucidate this.

You are on 1257L. You are subject to Month1/Week 1. In April 2024 you earn £2000.

Bam, you are charged income tax.

3. Why did this happen?

You haven't earned £12570 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.

4. 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 2025, 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 in the tax year is taken into account.

5. How does this change things?

Well, let's say you earned nothing since April 2024 pay and it is now March 2024. 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 2024. 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 2025.

6. 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.

Now 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 £37700 / 12 = £3141.66 and you'll pay 40% on earnings above that, as it is annualised £125140k, so that's the incremental amount.

After £125140, the rate is 45%, but in this example your salary is just £120000, so you end up paying a mix of 20% and 40%.

  • So, now you do £8953-£3141.66 = £5811.34
  • Your tax is therefore:
  • £3141.66 @ 20% = £628.33
  • £5812 @ 40% = £2324.54
  • Total = £2952.87

Whilst we didn't do an example for someone earning more than £125K, you just add the incremental monthly amount and tax it by 45% and minus the previous amounts.

7. Summary

  • £1047 = tax free
  • £3141.66 @ £628 tax
  • £5812 @ £2324 tax
  • Total income = £10000
  • Total tax = £2953

Wow, the impact of 40% really hits! Imagine what 45% feels like. Whether you want to pay less tax or more tax depends on how you vote at the election, so make your vote count! Spend more on public services like the NHS, and pay more tax or have less government spending and pay less tax. There is no long term solution that enables less tax and more on public services. Bear that in mind when you are in the ballot box.

8. Nearly done, don't forget national insurance!

Whilst some people believe national insurance is not a tax because it is 'national insurance', it is in effect an additional tax on citizens. Quite clever branding to claim it as 'national insurance' versus, one more tax to get out of tax payers.

Both of these use the same principles for applying deductions to your income in the specific pay period. Recall that as an employer, NI is due at 13.8% after £9100 (which is called the secondary threshold). There are some differences in this rule depending on the NI letter of the employee (letter doesn't refer to the letter on the employee's NI number but the NI letter classification of the employee, such as Under 20, Veteran, etc.). Look these up here on the HMRC website.

9. What about my employee NI?

So this depends on your NI letter. Assuming you are standard, meaning letter A, you will have an NI free amount until £12570. Like tax, divide this by your months in the year to get your monthly allowance. After £12570, you will be charged at 8%. Then after you reach the upper earnings limit, you will be charges at 2%. Mind you, the employer keeps on paying at 13.80% throughout after surpassing £9100.

10. Back to our earlier example of £120K earnings

£12570 / 12 = £1047.50. Anything above this is charged at 8% up to £4189, and anything above that is at 2%.

  • As you earn £10000 a month, you pay:
  • £4189 - £1047.50 = £3141.50
  • £3151.50 @ 8% = £251.32
  • Then, £10000-£4189 = £5811
  • £5811 @ 2% = £116.22
  • Total employee NI is: £251.32 + £116.22 = £367.54

Recall, your employer has to pay above £9100. So, £9100/12 = £758.

  • £10000 - £758 = £9242
  • £9242 @ 13.80% = £1275.40

Your employer has to pay this amount above just to keep you employed! However, this amount is not deducted from your pay as it is employer NI, that is to say, it is essentially a tax on an employer for employing you. Again, there are some people who claim National Insurance is not a tax, because it is called 'Insurance". I am sure you can see that is not the case now and it is just clever PR. Do you remember a time in the UK before national insurance was levied?

10. Final summary of what you get

  • Your salary: £10000
  • Tax: £628 + £2324 = £2952
  • NI (aka another tax) = £251.32 + £116.22 = £367.54
  • Total deduction = £3319.54
  • You get: £10000 - £3319.54 = £6680.46

And your employer pays £1275.40 for the privilege of paying you £10000! In essence, it costs him or her £11275.40 to pay you £10000, and that's before adding a pension or other benefits.

Did it ever occur you that the government is taxing the same pound 3 times? The £1 gets income taxed, then the same pound gets NI applied to it, from both your view and for the employer. That's 3x tax on the same pound!

So there you go, taxes and NI worked through an example. Are you ready to calculate your own yourself now without the need for an online calculator? Try it yourself. If you are an employer or employ yourself through a Limited Company, why not try our Newpayroll software.

What will your team do with Newpayroll?