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clientservices@lsrpartners.comMost people assume that because their employer runs payroll, their employment income tax is handled correctly. In our experience, that assumption is wrong more often than people realise.
Most employed people assume their tax is sorted. Payroll handles it every month. HMRC reconciles everything at the year end. There is nothing to worry about.
That assumption is wrong more often than most people realise.
600,000 people are estimated to have overpaid tax through PAYE. HMRC uses estimated figures when setting tax codes. Payroll applies whatever code it receives with no ability to override it. Simple assessment misses errors. And the people who discover problems are almost always the ones who looked rather than the ones who assumed.
Employment income UK tax is an area where the gaps between what the system is supposed to do and what it actually does can be significant. Here is what you need to understand.
HMRC issues a tax code to your employer. Your employer applies it. That is the entire PAYE system.
The standard 1257L code gives you one twelfth of your personal allowance each month, plus one twelfth of your basic rate band and higher rate band. As long as the code is correct and your income is consistent, the system works reasonably well.
The problem is that HMRC gets the code wrong with enough regularity that you cannot simply assume it is right. And once a wrong code is issued, payroll applies it without question. There is no discretion, no override, no mechanism for payroll to flag that something looks incorrect. The code is the code.
If you start a new job mid-year on a cumulative code, the system looks back at how much of your annual allowances you have already used and catches you up on any unused portion. You benefit from the allowances you were entitled to but did not use in earlier months.
On an emergency or month one code, that look-back does not happen. You receive only one twelfth of your allowances for that month regardless of how many months earlier in the year you were not working. The result can be significant overpaid tax that sits unnoticed until someone examines it.
The rule requiring anyone earning over £100,000 to file a self assessment tax return no longer applies. HMRC replaced it with simple assessment, a process where they reconcile your tax position at the year end using your P60 and the information they hold.
In theory this sounds efficient. In practice it misses things. Tax reliefs go unclaimed because simple assessment does not prompt you to consider them. Overpayments go unnoticed. Underpayments accumulate until HMRC raises them, sometimes months later.
HMRC has also been adjusting tax codes based on estimated rather than actual figures, contributing to the estimated 600,000 overpayments through PAYE.
Benefits in kind such as private medical insurance, company cars and dental cover all have a taxable cash value even though no cash changes hands. How they are taxed depends on how your employer reports them.
Through payroll, the taxable value processes each month in real time alongside your salary. The tax collects as you go.
Through a P11D, your employer reports the benefit at the year end. HMRC then adjusts your tax code for the following year to collect the tax. This creates a timing gap where you have taxable income from the benefit that has not yet been taxed.
P11Ds are being abolished in April 2026. From that point everything must go through payroll in real time. Until then, the timing gap means your code is often slightly behind where it should be, particularly for benefits like private medical insurance that increase in value year on year.
Pension contributions create tax problems in two opposite directions.
Salary Sacrifice Versus Relief at Source
Salary sacrifice means your pension contribution comes out of your salary before tax. Your taxable income drops automatically and the full relief is built in with nothing further required.
Relief at source means you contribute from post-tax income. Your pension provider claims 20% basic rate relief back from HMRC and adds it to your pot. But if you pay tax at 40% or 45%, the additional relief above 20% does not come automatically. You have to claim it through a self assessment tax return.
Many higher rate taxpayers with relief at source pensions have never made this claim. They are getting 20% relief where they are entitled to significantly more. The additional relief works by extending your basic rate tax band, reducing the proportion of your income taxed at the higher rate. It is a meaningful financial benefit that requires active claiming.
The Annual Allowance and Over-Contributions
The annual pension allowance is currently £60,000. This covers all contributions: yours, your employer's, personal contributions and HMRC's relief at source top-up. Everything counts toward the same ceiling.
For higher earners, the allowance tapers downward once adjusted income exceeds £260,000, reducing to a minimum of £10,000 at adjusted income above £360,000.
Contributing beyond your tapered allowance means receiving tax relief you were not entitled to. HMRC charges you on the excess at your marginal rate. For additional rate taxpayers that is a 45% charge on the over-contribution amount.
Unused allowance from the previous three tax years can be carried forward to offset an over-contribution in the current year. In the first year someone finds themselves in the taper, this carry-forward often provides protection. Once it is used up, it is gone.
The government is capping salary sacrifice pension contributions at £2,000 per year. This was presented as a minor change. In practice it is a stealth tax rise.
Currently, salary sacrifice contributions reduce the salary on which employer National Insurance is calculated. An employer whose employee sacrifices £1,000 per month saves approximately £150 per month in employer National Insurance on that contribution alone.
Cap salary sacrifice at £2,000 per year and employers lose that saving on everything above the threshold. The financial incentive that made generous matching contributions worthwhile largely disappears.
The likely consequence is that many employers who currently offer generous matching will reduce or remove it once the cap comes in. The window to benefit from existing matching arrangements is closing. Maximising employer pension contributions now while the current rules still apply is the rational response.
Anyone whose salary sits near £100,000, a bonus or equity vesting event can create a tax bill that nobody anticipated.
For every £2 your income exceeds £100,000, you lose £1 of personal allowance. By the time total income reaches £125,140, the personal allowance is gone. Income in that band faces an effective 60% tax rate, one of the highest in the entire UK tax system.
Your tax code is set at the start of the year based on expected salary. HMRC does not know a bonus or equity vesting event is coming. When it arrives and pushes total income above the threshold, the tax on the lost personal allowance goes uncollected. Simple assessment catches it at the year end.
The result is a tax bill of approximately £5,000 to £5,600 arriving for people who are simply employed, on a standard tax code, and who genuinely did not see it coming.
Employment income UK tax is the area where people most commonly assume someone else is handling everything. The evidence suggests the system has more gaps than most people realise.
If you have a relief at source pension and you have never claimed the additional higher rate relief through a tax return, that is worth addressing. Receiving any form of variable pay if your salary sits near £100,000, understanding the threshold and planning around it is essential. Making pension contributions when you are not certain whether they fall within your tapered annual allowance, getting that checked before the problem compounds is considerably easier than correcting it afterwards.
LSR Partners help you pay the right tax in the right place at the right time. Book a call with us at lsrpartners.com.
This article is for general information purposes only and does not constitute tax advice. Your individual circumstances will affect how these rules apply to you. Please contact us to discuss your specific position.
You can listen to the full episode of the Tax Compass Podcast here.
