Umbrella company contractors, tax codes don’t have to be taxing

A year ago I spoke up about P9 tax code notices from HMRC going missing or just falling down the back of umbrella companies, and it seems it resonated, writes Lucy Smith, founder of Clarity Umbrella.

I also addressed the particular difficulties for those contractors who were a limited company but took an inside IR35 role via an umbrella, to find themselves on a dual employment code, usually a BR.

That too can still be a rub, as we approach the end of the 2024-25 tax year and the dawn of 2025-26 on April 6th 2025.

But first things first.

What is a tax code?

A tax code is something which is personal to you and can be affected by many things from pension and other PAYE earnings to self-assessment submissions.

Given it is a personal tax account, you are responsible (as an individual) for making sure that the code is correct.

Fair warning

If you have an accountant, then you can check with them, but for contractors working via umbrella companies, they are your employer and as much as it might be nice, your umbrella has no real necessity to let you know if they don’t think your tax code is correct!

So, when I tell contractors ‘It is important that YOU understand your tax code,’ it really is a truth-telling statement.

Ending up on an incorrect tax code can lead to end-of-year tax bills from HMRC, sometimes a tax rebate, or just a mass of confusion on all sides.

Your personal tax account just came into its own

Your personal tax account online is going to be your friend here, as it will give you an indication of what HMRC is thinking in terms of your income.

It will also show if they are yet to remove a previous employer from your account – that’s something else which would cause complications in the tax code.

Tax account/ code check-up; what to look for, precisely? 

First of all, do check to make sure that your employment status with HMRC is correct,.

For example, if your account shows an employer who is no longer part of your PAYE income as a contractor, then ask the Revenue to remove it. Changes like this may automatically update your code.

Next, look at the predicted earnings for each employment income – again if this doesn’t look right, then ask HMRC to update it.

Then, when it comes to umbrella earnings and needing to update your income, do so based on the taxable salary -- not your ‘assignment rate.’

If you are unsure as to what your taxable salary is, then ask your umbrella for confirmation (N.B. you should be able to find your taxable salary on the original illustration you received from the umbrella company).

Tax implications on tax codes: demystified

Understanding tax implications on tax codes isn’t rocket science.

But paying close attention here seems to be something that some individuals just don’t worry about.

Let’s look at the basics.

A contractor earning a PAYE combined income of under £100,000, should in theory be on a standard 1257L tax code, which gives the contractor £12,570 of earnings each year before taxes kick in (split across the year).

As soon as you reach the dreaded 60% tax bracket (earnings between £100,000 and £125,000), then your tax-free allowance diminishes and in return, you’ll end up losing around £1.00 for every £2.00 earnt.

For example, someone on £112,500 is likely to end up with a tax code of around 628T, giving only £6,280 worth of tax-free allowance for the year!

The differing earnings problem (for HMRC)

The problem is in my experience; HMRC doesn’t really understand ‘differing earnings,’ and by ‘differing earnings,’ I mean a contractor whose earnings fluctuate.

The Revenue’s coding machine is fine with those who receive a regular monthly salary as earnings for the year are easy to predict. But where days and hours may vary each pay period, and gaps in between assignments may occur, it seems to throw HMRC right off.

This is why it is important as a contractor that you keep an eye on things!

What does a T at the end of my tax code mean?

If you see a “T” at the end of the tax code, we would simply translate this as HMRC being not quite sure what’s going on.

This ‘T’ at the end of your tax code decoded? Well, it means HMRC will continue to reassess your code as the year progresses. In this instance, it is absolutely crucial you stay on top of things and let HMRC know of any potential changes to your yearly income.

What does an X on the end of my tax code mean?

An ‘X’ can cause issues if payments don’t come in consistently from the recruitment agency or client.

Any missed pay periods will simply be ignored, and any tax-free allowance can simply be missed.

The removal of the X (the non-cumulative tax code) means that the payroll can self-adjust each time you are paid and should lead to a more accurate take-home.

What about a BR or D0 tax code?

If you've been issued a BR or D0 tax code, you can rest assured that HMRC believes you have dual income. A theme is hopefully emerging for you here as, again, if it’s not the case you have dual income, reach out to the Revenue to get it removed!

Anyone on an assignment rate which places them as a 40% taxpayer who ends up on a BR (Basic Rate) tax code, may think their take-home is looking good.

But in reality the likelihood is you are going to end up with a tax bill at the end of the year which may not look too pretty, as HMRC claws back the element which should have been taxed at 40%!

Why many umbrella contractors should never see the 1257L tax code

In the umbrella company world, any contractor with an assignment rate of around £650 or above working over 48 weeks of the tax year, will almost definitively end up over the £125,000 mark, and should never be on the 1257L tax code in the first place.

The 0T code, removing all tax-free allowance, should be applied from the outset to prevent further adjustments throughout the year.

What about a ‘K’ tax code?

To complicate matters more, if you start on a standard tax code, giving you that tax-free allowance, and halfway through the year HMRC determine earnings over £100,000, then you could find yourself issued with a “K” code clawing back that original tax-free allowance, leading to a drop in your take home.

In the tech and IT labour market right now, we know that the majority of contractors fall into the 60% bracket if not hitting the 0T code, so it is absolutely crucial that you understand your code and get it right.

Or else you run the risk of a nice fat tax bill at the end of the year!

P9 coding notes; have you got yours from HMRC?

Penultimately, keep in mind that around February each year (that's now in HMRC-time – even if we are on the cusp of March), HMRC starts issuing P9 coding notices to update tax codes for all employees.

The tax department usually uses last year’s figures to calculate your code for the upcoming tax year, so if you get a letter, don’t leave it sat gathering dust!

Take a glance and check that it is what you are expecting.

Finally, process plus accountability

My view is that HMRC probably needs to tighten up their processes here, but we understand that tax codes are not an easy thing to judge when income fluctuates in this flexible workforce of ours! So maybe it’s right that the emphasis is put on individuals to keep their online personal tax account up-to-date. If you haven’t logged in recently, maybe now is the time to get checking!