2025 UK Tax Code Changes Explained: What Small Business Owners Need to Know

Want to learn about UK tax code changes? Minor adjustments can impact your take-home pay, business expenditures and overall cash flow.

The 2025/26 tax year in the UK has introduced different tax codes and policies that are implemented and can prove beneficial for businesses. These thresholds and compliance rules are necessary to avoid tax mistakes and stay compliant.

This article will help break down the 2025 UK tax code changes, and how to manage your business finances effectively.

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What is The UK Tax Code?

A tax code is a series of characters like 1257L assigned by HMRC. These numbers represent the individual’s tax-free personal allowance, and the letter provides additional information about their tax position.

A UK tax code is the combination of letters and numbers used by employers and pension providers to determine how much income tax to deduct from an employee’s pay through the PAYE system.

Purpose of the UK Tax Code

Its purposes include:

• Calculating deductions accurately.
• Simplifying tax collection.
• To reflect on personal circumstances.

Connection Between Tax Codes and Business Compliance

For employers, tax codes are integral to fulfill their PAYE obligations. A business’s compliance relies on accurately implementing the PAYE system using the tax codes provided by HMRC. Its key responsibilities include:

• Using HMRC-recognised payroll software to calculate and process wages, taxes, and other deductions.
• Using the Real-Time Information (RTI) system, employers must report employees’ pay and deductions to HMRC each time they are paid, rather than only at the end of the year.
• Businesses must deduct and pay the correct amount of Income Tax and National Insurance Contributions (NICs) from employees’ pay and forward these payments to HMRC timely.
• Employers should use the correct tax code sent to them by HMRC. A business is responsible for underpayments that arise from using an incorrect tax code. The employer then informs HMRC, who will issue an official tax code.

Understanding Common UK Tax Codes

Here are the most commonly used tax codes in 2025, and their uses:

1257L – This tax code applies to most employees, it represents the standard Personal Allowance of £12,570.

BR (Basic Rate) – It is for the individuals with a second job or pension where the personal allowance is already used by their main income source. All the income from any specific job or pension is taxed at the basic rate of 20%.

D0/D1 – In this tax rate, no tax-free allowance is given. All the income is taxed at the higher rate (40% for D0) or additional rate (45% for D1). It is for the higher earners with more than one job, where the main income source has used up both the personal allowance and the basic rate band.

K codes – It is for directors, employees with company benefits, or those with unpaid tax from a previous year. This means you have a negative Personal Allowance, and tax is levied on the portion of your income that exceeds your standard pay.

W1/M1/X – It is preferred for the new hires without a P45, first-time employees, or those returning from to work after being self-employed. These are the emergency tax codes used when HMRC does not have full financial information. This code typically provides only one week’s or one month’s proportion of the tax-free allowance.

OT –  It is used when a person’s tax-free allowance has been used up. In this, no Personal Allowance is applied and all income is taxed at the applicable basic, higher and, additional rates.

Key 2025 UK Tax Code Changes

UK tax code changes for 2025-26 bring significant adjustments affecting payroll, dividend income and reporting for small businesses.

The changes reflect the frozen personal tax thresholds alongside increases in employer National Insurance contributions and the Employment Allowance.

Updated Personal Allowances And Tax Brackets

The personal allowance stays frozen at £12,570 for the 2025-26 tax year. The income tax bands will also stay at their current levels:

• For incomes between £12,571 and £50,270 the basic rate of 20% is applied.
• For incomes between £50,271 and  £125,140 the higher rate of 40% is applied.
• For any income above £125,140, the additional rate of 45% is applied.

Adjustments to NICs

These changes bring the following adjustments to NICs:

• The employer NICs rate increased to 15% from April 2025 on earnings above the Secondary Threshold, although this rise is largely offset for smaller businesses by an increase in the Employment Allowance.
• Decrease in employer threshold, from £9,100 to £5,000 annually.
• The Employment Allowance was increased from £5,000 to £10,500, with the previous £100,000 eligibility threshold being removed.
• There are no compulsory Class 2 National Insurance Contributions (NICs) in 2026, as this requirement for the self-employed was abolished in April 2024. Since then, paying Class 2 NICs has been entirely voluntary.

New HMRC Compliance Measures

• The MTD roadmap will now be mandatory for sole traders and landlords with an annual income above £50,000 starting in April 2026 and above £30,000 from April 2027.
• Investing in new digital tools, including AI-powered assistants, to improve customer service and compliance. New online services will allow PAYE taxpayers to manage their tax affairs more easily.
• The government is consulting on adopting e-invoicing standards and plans to pre-populate Self-Assessment tax returns with more data to reduce errors.
• New legislation increased the interest rate for late payments, effective from April 2025. This change raised the interest charged on overdue tax to the Bank of England base rate plus 4%, separate from any late payment penalties that may also apply.

Impact On Small Business Owners

UK tax code changes for the tax year 2025/26 brought significant shifts affecting payroll, cashflow, and director finances.

For the small business owners, the core changes include a higher employer National Insurance rate, a reduced threshold, an increased Employment Allowance, and new detailed dividend reporting requirements for company directors.

Impact On Employee Tax Codes And Payroll Calculations

Various changes to NICs will impact payroll for the 2025/26 tax year, requiring adjustments to payroll software and calculations.

• The main employer NIC rate increased from 13.8% to 15% on earnings above the secondary threshold.
• The secondary threshold was reduced from £9100 to £5000. This means employer NICs are now payable on a larger portion of earnings, increasing the cost of employing staff.
• To offset the higher NIC costs, the Employment Allowance was increased from £5000 to £10,500.
• While not directly related to the NIC changes, tax codes for employees with multiple income streams, benefits in kind, or missing information may require frequent adjustments by HMRC.

Effect On Business Cash Flow And Budgeting

Changes increase a business’s payroll-related expenses, requiring adjustments to financial planning. This effects on:

• Increase in operating costs like, higher staffing costs.
• Budgeting the payroll to reflect higher employer NICs, even with the expanded Employment Allowance.
• Reconsider recruitment or delaying new hirings.
• Reviewing their compensation strategy, weighing salaries against dividend, especially given the increased employer NICs.

Implications For Company Directors And Dividend Payments

Directors of close companies can face new detailed requirements for dividend income. It can imply on:

• Enhanced dividend reporting
• Mandatory disclosure
• Increased compliance scrutiny
• Reduced dividend allowance

Common Mistakes Businesses Make With Tax Codes

Here are the most common tax code mistakes businesses make:

• Poor record keeping: Not tracking all of your income and expenses accurately makes it easy to make mistakes.
• Mixing personal and business finances: Using a personal account for business transactions makes it hard to separate which expenses are for the company and which are for yourself.
• Missing deadlines: Late filings and payments lead to penalties and interest charges.
• Claiming incorrect expenses: Businesses sometimes claim personal expenses as business costs or overstate deductions.
• Misclassifying employees and contractors: Confusing the two can lead to significant tax penalties.
• Not setting aside money for taxes: Many businesses spend all their money, not realising they need to save some for their tax bill.
• Neglecting professional help: Trying to handle taxes alone, especially as a business grows, often leads to expensive mistakes.

How to Avoid These Mistakes:

• Stay informed about tax code updates
• Educate your team on tax code usage
• Use reliable payroll software
• Review tax codes regularly to ensure accuracy

Adjusting New Tax Codes

UK business owners must be aware of significant changes to employers’ NICs and adjustments to tax codes.

Steps To Update Payroll Software

Following steps are to be followed to update the payroll software:

• Running year-end procedures starting April 6, 2025.
• Updating your payroll software to the latest version to reflect new thresholds and rates. If you use HMRC’s basic PAYE tools, these changes will automatically be applied.
• Processing coding notices issued by HMRC for individual employees.
• Clearing the W1/M1 flags for all existing employees.
• If a coding notice includes tax figures or previous pay, then you should manually enter them into your payroll system for the relevant employee.

Communicating Changes To Employees

• Informing employees of PAYE notices.
• Encouraging personal checks.
• Explaining NIC changes.

Strategies to Minimise Tax-Related Risks

To ensure a business operates smoothly, you can implement different strategies to minimise tax-related risks.

Reviewing Payroll And Tax Codes Regularly

• Updating payroll software.
• Managing employee tax codes.
• Conducting internal audit for accuracy.

Keeping Detailed Records Of Employee Tax Status

• Implementing digital record-keeping or updating accounting software.
• Keeping track of document key changes like, employee’s tax status, specifically for directors who receive PAYE.
• Maintaining records and detailed receipts of all allowable expenses.

Planning For Cash Flow Adjustments Due To Tax Changes

• Forecasting and calculating new liabilities based on your payroll costs.
• Planning the timing of your dividends to manage the tax year in which they are taxed.
• Strategic purchasing, planning significant capital expenditure.

How PAYE And Self Assessment Work Together

If you are paying tax through PAYE, then you may also need to file a Self Assessment tax return

• If you are earning more than £1000 as self-employed.
• If you own any rental property.
• If you are taking dividends.

HMRC can adjust your tax codes to recover the Self Assessment Tax that is unpaid.

What Employers Should Know

As an employer you should keep in mind that running a business or paying employees involves some important factors:

• Applying tax code notices like P6, when they are sent to you.
• Keeping accounting software like Xero, QuickBooks, FreeAgent up to date.
• Submitting payroll through RTI each month.

If you are unable to act on these coding changes, this can result in incorrect payslips, staff complaints, or HMRC penalties.

Why Tax Codes Matter For Planning

Understanding tax codes is essential not just for administrative details, but they are also fundamental to financial planning for small business owners, especially those who are company directors or sole traders. It is necessary because:

• It provides accurate payroll budgeting for monthly payroll and Income Tax obligations.
• Tax codes influence how a director structures their pay through salary versus dividends.
• It helps forecasting tax liabilities. If a business owner has a lower tax-free allowance due to benefits, their PAYE tax could rise. This can impact their overall tax liability at the end of each year.
• Incorrect tax codes can lead to underpayments and unexpected tax bills. Staying on top of your employees’ tax codes can help you remain compliant with HMRCrules and avoid penalties.

Bottom Line

Understanding the UK tax code changes in 2025 is necessary for small business owners. Staying up to date with it is necessary to protect your business and income.

Tax rules change and evolve every year, so it is necessary to stay up to date with the latest UK tax code changes to help you stay compliant. Getting to know about allowances and thresholds can help you avoid making mistakes and plan effectively for the next year.

You can ask Chartered accountants in London to help you guide about the UK tax changes and their impacts on your business! Get in touch with us today! 

Disclaimer: All the information provided in this article on UK Tax Code Changes, including all the texts and graphics, is general in nature. It does not intend to disregard any of the professional advice.