YF AccountingLast updated: 23 July 2026
7 min read
PAYE (Pay As You Earn) is the system your employer uses to deduct income tax and National Insurance from your pay before it reaches your bank account. In 2026/27 most people have the tax code 1257L, which gives a £12,570 tax-free personal allowance, with income above that taxed at 20%, 40% or 45%, plus National Insurance at 8% and 2%. Bonuses go through exactly the same system — which is why a £5,000 bonus never adds £5,000 to your take-home. Here is how it all actually works, with a calculator at the end so you can run your own numbers.
What is PAYE and how does it work?
PAYE is HMRC’s method of collecting tax at source. Each payday, your employer works out the income tax and National Insurance due on that period’s pay, deducts it, and reports it to HMRC in real time — before you are paid, not after. The tax year runs from 6 April to 5 April.
The point of the system is that most employees never need to file a tax return: the right amount is (in theory) collected as you go. The two inputs that drive everything are your tax code and your pay to date in the tax year. When either of those is wrong, your deductions are wrong — so it pays to understand both.
What does tax code 1257L mean?
Your tax code tells your employer how much tax-free pay to give you before deducting tax. The standard code for 2026/27 is 1257L: multiply the number by ten and you get your £12,570 personal allowance. Your employer gives you one-twelfth of that (£1,047.50) tax-free each month, or one fifty-second each week.
Codes move away from 1257L when HMRC adjusts your allowance — for a company car or private medical insurance, a second job, or to collect tax you underpaid in an earlier year. The common ones are worth recognising:
| Code | What it means |
|---|---|
| 1257L | Standard code — full £12,570 personal allowance |
| BR | All pay taxed at 20% — usually a second job or pension |
| D0 / D1 | All pay taxed at 40% / 45% |
| 0T | No allowance at all — often a new job with no P45 |
| K codes | Deductions exceed your allowance — tax is added, not relieved |
| W1 / M1 suffix | Emergency basis — each payday taxed in isolation |
How is tax calculated on each payslip?
Income tax under PAYE is normally cumulative. Each payday, your employer looks at your total pay since 6 April, works out the tax due on that so far using the annual bands spread evenly across the year, and deducts the difference between that and what you have already paid. This is why a pay rise, a missed month or a corrected code can produce an odd-looking payslip — the system is always truing itself up to the year-to-date position.
The 2026/27 bands for England, Wales and Northern Ireland (Scotland has its own rates):
| Band | Income | Rate |
|---|---|---|
| Personal allowance | Up to £12,570 | 0% |
| Basic rate | £12,571 – £50,270 | 20% |
| Higher rate | £50,271 – £125,140 | 40% |
| Additional rate | Over £125,140 | 45% |
Above £100,000 the personal allowance is withdrawn at £1 for every £2 of income, disappearing entirely at £125,140 — an effective 60% rate on that slice.
National Insurance works differently. Employee Class 1 NI is 8% on earnings between £12,570 and £50,270 a year, and 2% above that — but unlike income tax it is calculated on each pay period in isolation, not cumulatively. Monthly, that means 8% on earnings between £1,048 and £4,189, and 2% on anything above. That distinction matters a great deal when a bonus lands, as you are about to see.
How is PAYE calculated on a bonus?
A bonus is not taxed at some special punitive rate — it is simply added to your pay in the period it is paid and taxed at your marginal rates. Take someone on £35,000 a year (£2,916.67 a month) who receives a £5,000 bonus in one month:
- Normal month: roughly £373.83 income tax and £149.49 NI, leaving take-home of about £2,393.
- Bonus month (£7,916.67 gross): the extra £5,000 sits within the basic rate band (total income £40,000 is under £50,270), so it attracts £1,000 of income tax at 20%.
- NI on the bonus: because NI is per-period, part of the bonus month’s pay falls above the £4,189 monthly threshold and is charged at only 2%. Total NI that month is about £326 — only around £176 more than usual.
- Net result: of the £5,000 bonus, roughly £3,824 reaches the bank account.
Two things surprise people here. First, the per-period NI rules mean a lump-sum bonus often suffers less NI than the same amount paid as monthly salary — one of the few pleasant quirks in the tax system. Second, if your salary is close to a band edge — say £48,000 — part of the bonus tips into the 40% band, and the deductions look much heavier. Neither is an error; it is just the maths of the bands.
If you want to keep more of a bonus, the main lever is pension contributions — paying some or all of it into your pension via salary sacrifice avoids tax and NI on that slice, which is particularly valuable if the bonus pushes you into the 40% band or the £100,000 taper. If you run your own company, the equivalent decision is covered in my salary vs dividends guide.
What is an emergency tax code?
If your employer does not have enough information about you — typically a new job with no P45 — they apply an emergency code such as 1257L W1/M1 or, in some cases, 0T. On a W1/M1 (week 1/month 1) basis, each payday is taxed in isolation with one period’s worth of allowance, ignoring the year to date. On 0T, you get no allowance at all.
Emergency codes usually sort themselves out within a payslip or two once HMRC issues the correct code, and any overpaid tax comes back through the payroll automatically. But “usually” is doing some work in that sentence — I have seen emergency codes linger for months when nobody chases them. If the code on your payslip still has a W1 or M1 suffix after two paydays, contact HMRC.
How do I check my tax code is right?
Your code appears on every payslip, on your P60 after the year end, and in your Personal Tax Account or the HMRC app — which will also show how the code was built. Check it whenever your circumstances change: new job, new benefit in kind, second income, or a letter from HMRC about an underpayment.
The most common causes of a wrong code I see in practice are out-of-date benefit figures (the company car you handed back a year ago), duplicated employments after a job change, and second jobs on BR when the first job does not use the full allowance. A wrong code is rarely dramatic, but left alone it quietly costs you money every month — or builds up a bill for later. My payroll and PAYE guide covers this from the employer’s side too.
Bonus salary calculator to work out your own position
Rather than reverse-engineering your payslip by hand, run your own figures — salary, bonus, pension and all — through this excellent free tool:
Bonus: Link to The Salary Calculator to work out your own tax contributions!
Frequently asked questions
Are bonuses taxed at a higher rate in the UK?
No. There is no separate bonus tax rate. A bonus is added to your normal pay and taxed at your marginal income tax rate — 20%, 40% or 45% — plus National Insurance. It can feel heavily taxed because the lump sum may reach into a higher band than your regular salary does, but over the year you pay exactly what the bands dictate.
Why is my tax code not 1257L?
HMRC adjusts codes for benefits in kind such as a company car or medical insurance, for untaxed income, for a second job, or to collect tax underpaid in a previous year. Your Personal Tax Account shows exactly how your code was built. If any item looks out of date, tell HMRC — the code will be corrected and your payroll will true up the difference.
What is a K tax code?
A K code means your deductions — usually large benefits in kind or tax owed from earlier years — exceed your personal allowance. Instead of receiving tax-free pay, a notional amount is added to your taxable pay each period. K codes deserve a close look: they often follow an HMRC estimate, and estimates are sometimes wrong.
Does National Insurance work differently on a bonus?
Yes, and often in your favour. NI is calculated per pay period rather than cumulatively, so a large one-off payment pushes much of that period’s earnings above the upper threshold, where the rate drops from 8% to 2%. A £5,000 bonus typically suffers far less NI than £5,000 spread over the year as salary would.
Will HMRC automatically refund overpaid PAYE tax?
Often, yes. Within the tax year, a cumulative code corrects overpayments through your next payslip. After the year end, HMRC reconciles most employees’ records and issues a P800 calculation with a refund where one is due. But do not assume the system catches everything — if you have been on an emergency or incorrect code, check your Personal Tax Account rather than waiting.
Need a hand with PAYE or payroll?
I am a Manchester-based, fixed-fee accountant. If you run a business and want your payroll run properly — or you have a tax code or personal tax question that a calculator cannot answer — I am happy to help. Sole traders from £35 a month, limited companies from £50 a month, one point of contact throughout.
Get in touch or call 0161 531 0959 for a free, no-obligation chat.
This article is general information, not personal tax advice. For advice on your own situation, please get in touch.
Founder of YF Accounting — a fixed-fee, fully digital accountancy practice in Manchester serving SMEs, sole traders and landlords across the UK. One point of contact, unlimited support, no surprise bills.
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