UK - Month 1 Week 1 - How things are calculated

Question

I have recently been put onto a Month 1 Week 1 tax code, and doing some reading I found this:

It means that your tax for the month does not take account of any tax paid in any previous months (since 6 April 2010) and this will continue until the end of the tax year. This could be for a number of reasons; either a reduction in your code number or the fact that there has been a gap in your employment or some details are missing about a previous employment. The effect it has is this. In month 1 of the tax year you are taxed on 1/12th of your annual salary, in month 2 you are taxed on 2/12ths of your annual salary less what you paid in month 1, in month 3 you are taxed on 3/12ths of your annual salary less what you paid in months 1 and 2, and so on. Week/month basis means that this chain is broken. So you pay on each month in isolation. There is no effect on your NI contribution as this is not calculated cumulatively anyway.

Source: Yahoo Answers

Now let's say that I earn £30,000 per year and going by this, then, this would mean that my monthly tax would be: (30000 / 12 = 2500) so I would get taxed on this months salary £2500 but I would only earn £1,957.27 so therefore, I would be in negative. I don't see how this is correct.

Can anyone offer a better explanation to how the Month 1 Week 1 tax code calculates your monthly tax?

Answer 1

The following calculations are on the basis of not working for months 1 and 2 of the tax year, then starting a job with a £30k salary in month 3 (£2500 a month). Calculations rounded to whole pounds to make my life easier.

You get £10600 per year as tax-free income, which is £883 per month. After this, you pay 20% tax on all income. (Numbers correct for 2015-16 tax year. Reference: gov.uk, which will show current rates.)

Cumulative tax

• Month 1 - Tax free allowance = £883. Income = £0. Therefore no tax paid.
• Month 2 - Tax free allowance = £883 new allowance for this month plus £883 leftover from Month 1 = £1766. Income = £0. Therefore no tax paid.
• Month 3 - Tax free allowance = £883 + 1766 = £2649. Income = £2500. Therefore no tax paid.
• Month 4 - Tax free allowance = £883 new allowance + (2649-2500) = £1032. Therefore 2500-1032 = £1468 is taxable at 20%, meaning you pay £294 in tax.
• Month 5 - Tax free allowance = £883 (no leftover from previous month). Income = £2500. Therefore you pay 20% tax on 2500-883 = 1617, giving £323 in tax.
• Months 6 to 12 are identical to Month 5.

Month 1 basis

• Month 1 - Tax free allowance = £883. Income = £0. Therefore no tax paid.
• Month 2 - Treated as month 1 (i.e. "we don't know how much allowance you have leftover from previous months, we'll assume 0). Tax free allowance = £883. Income = £0. Therefore no tax paid.
• Month 3 - Treated as month 1 (i.e. "we don't know how much allowance you have leftover from previous months, we'll assume 0). Tax free allowance = £883. Income = £2500. Therefore you pay 20% tax on 2500-883 = 1617, giving £323 in tax.
• Months 4 to 12 are as Month 3.

At the end of the year, if you're on a Month 1 basis, you'll have paid too much tax, because you didn't use your tax free allowance from months 1 and 2. You can claim this overpaid tax back from HMRC. It's not difficult, but it'd make your life easier if you could get off Month 1. Normally this means that you need to give your P45 to your new employer, so that they know how much of your allowances you'd used in your previous job.

---

To address your specific query at the end of your question: the annual salary divided by 12 is the amount that your tax is calculated on the basis of. So £30000/12 = £2500 is the amount that is taxable, not the amount of tax. You quote £1,957.27 - Presumably this is £2500 less £323 for tax and less £225 for other things (National Insurance, pension etc.)

Answer 2

Hope this clarifies a bit. Source

If your tax code is on a week1/month1 basis it means that when your pay is calculated, any previous pay you have received and any tax you have paid are not taken into consideration.

Normally, tax is calculated on a "Cumulative basis" which means that each month/week you receive an extra month/weeks worth of freepay and 20% tax bracket allowances and these are added to all all the previous allowances you have received for each pay run since the beginning of the tax year on 6th April. All your pay is added together from that date too and the tax due is then calculated. Then the tax that you have already paid is deducted and what is outstanding is then taken from the current payroll. This means that the tax is always correcting itself to make sure you don't over or under pay tax by the end of the financial year.

This does not happen on a week1/month1 basis. This could be for many reasons, one being that you have underpaid tax earlier in the financial year and HMRC have increased you code to allow for this. The week1/month1 basis will prevent you paying back the underpayment in one lump and allow you to spread it over the remaining payrolls for that financial year.