Income tax system and you

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HM Revenue and Customs has begun sending letters to some 1.4 million people telling them they have underpaid their tax, and need to make up the difference.

It is telling some six million people in the UK that they have paid the wrong amount of tax, with most paying too much.

Between September and Christmas, HMRC says about 4.3 million taxpayers will receive rebates after over-paying through the Pay as You Earn (PAYE) system.

John Whiting from the Chartered Institute of Taxation gives advice on paying back the taxman

How might someone have under or overpaid income tax?

There are a number of reasons why people may have under or overpaid their tax:

  • Your employer may have used the wrong tax code, because you started a new job or you had an emergency tax code for a while.
  • You may have only worked for part of the year or you had more than one job at the same time.
  • You may not have told HMRC right away about changes to benefits you got through your work, or your circumstances changed.
  • You were made redundant or became self-employed and therefore your income reduced.
  • Other income such as investments or rental income may have reduced but you didn't tell HMRC.
  • It could also be that HMRC made a mistake with your tax.

How does PAYE work?

If you are an employee your employer will deduct income tax directly from your wages and pass it on to HMRC.

The amount deducted is based on your total taxable income, taking into account any tax allowances and your individual tax code as provided by HMRC.

At the end of the financial year, HMRC compares the amount of tax it has received from each taxpayer with the amount it would expect to receive according to their tax code and income. Anyone on the wrong tax code could end up paying too much or too little.

Why have so many discrepancies occurred?

The PAYE system was originally devised around employers since at the time it was introduced many people tended to stay with a single firm for life.

Until recently it was possible to keep an accurate record of employees, but since the 1970s work patterns have been transformed with workers now often having many jobs during their lifetimes. Taxable benefits like health cover and company cars have complicated matters further.

In response the system was overhauled, and in June 2009 a new IT system was introduced focusing on the employee. Where previously, all the data for an individual could be spread across as many as 12 databases, it is now all in one place.

An HMRC spokesman said the new system enables it to keep much more up-to-date records, so initially more mistakes will be highlighted. However, in the future more people will pay the correct tax at the right time, thus reducing the number of corrections.

How will I know if I am affected?

If you are one of the estimated six million people affected you will receive a letter from HMRC between now and Christmas.

The first 45,000 people will receive their letter, known as the P800, in the week of 6 September. The majority of these have paid more tax than they should but some 15,000 have not paid enough.

If I have underpaid, how will I pay the extra I owe?

In most cases, for sums less than £2,000, underpayments will be recovered during the 12 months of the financial year 2011/12 through your salary. This will happen automatically via a changed tax code, so you will not need to do anything unless you believe the information in your P800 letter is wrong. If so, you should contact HMRC.

HMRC says that in some circumstances they will consider writing off underpayments, but only if they are provided with sufficient evidence to prove that an individual provided all the information needed to get their tax right in the first place, and could have reasonably expected their PAYE deductions to be correct.

Taxpayers will also have to show that HMRC did not use the information within 12 months of the end of the tax year in which it was received.

What if I cannot afford to repay the tax? Can I refuse to repay?

HMRC says that if someone genuinely can not afford to repay the tax, they should contact their local tax office. In genuine hardship cases, the repayments may be spread over as much as three years. And in these cases normal interest payments will not be charged.

If I have overpaid, how will I get the money back?

Money that was overpaid will be returned via a cheque.

How can I find out my tax code and keep it up-to-date?

You will find your code on your P45 form, given to you by your employer when you stop working for them, which is why you should make sure you give that form to your next employer. If you have lost your P45 and want to find out your code you should contact your local Tax Office or ask your employer.

If you think your tax code is wrong or you think you may need to update it, you should also contact your Tax Office.

Sometimes when you start a new job your employer will put you on an emergency tax code until HMRC has worked out what it should be. While you are on this emergency code you may be over or underpaying the right tax.

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