UK Tax calculation on payment for contract serverence

Question

I was recently made redundant from a role at a UK company. They were very reasonable about the situation and offered to pay off my 3-month notice period rather than make me work it.

As a result, I was lucky enough to get a big windfall: my wages this month were three times higher than normal - let's say it came to £10k (it didn't, but it's a nice round sum to use). I do not pay top-rate tax so I was expecting to pay tax on this at 20% and see £2k go to HMRC. It is possible this windfall will take me into the top-rate band later this financial year, but it has not so far.

However, according to my payslip, the actual figure I've paid is much higher, nearly £3k. To be clear this does not include National Insurance, which is listed separately.

I queried this with HR at my former employer and got this reply:

"You are able to earn a set amount each month which is tax-free (determined by your tax code). Anything you earn above this amount is taxed, therefore your tax this month would be greater because you’ve taken home essentially 3 times as much in 1 month.

For example, if you earned £2000 a month and your tax-free amount was £1000, you would pay £400 in tax (if you’re a higher rate taxpayer) – times this over three months and you pay £1200 in tax. However, if you earn the whole £6000 in one month, your tax-free amount is still £1000 and you end up paying £2400 in tax."

Now the calculation here is easy enough to follow. What I don't understand is how this applies to me because I've still paid tax on this at 30% rather than 20%.

I notice that the tax code on this payslip ends in M1 which I believe means it's an emergency code, which may explain why I've been overtaxed. However, before I query this with HR or HMRC and make myself look stupid I thought I'd better check: am I right in thinking I have been over-taxed?

Answer 1

M1 makes the code "non-cumulative" - they just tax your pay on the basis of the current month's allowances and nothing else.

As well as the tax-free allowance, that also means that you only get 1 months' worth of the 20% band. The annual allowances for this year are that anything below £11,850 is tax-free, and anything above this and below £46,350 is taxed at 20%. So on a monthly basis, anything above ~£4,000 would be taxed at 40%.

If you can't get it sorted out now, at the latest you can deal with it at the end of the tax year by contacting HMRC and asking them to recalculate your full year's tax. Or before that your next job should put you on a normal cumulative tax code which means they'll look at your year-to-date earnings and your tax paid to date, and withhold less tax from you than normal until the two are back in sync.

It's strange that you have the M1 code at all though, assuming you didn't have it in previous months.