What happens if HMRC applies the wrong tax code to my self-employed income?

Understanding what a “tax code” means when you’re self-employed

If you’re self-employed in the UK, you might assume tax codes are mainly something that applies to employees through PAYE. Most of the time, that’s true: a tax code is the instruction HM Revenue & Customs (HMRC) gives to a payer (usually an employer or a pension provider) that tells them how much Income Tax to deduct from payments before you receive them. If your main income is self-employment profits, there often isn’t a “payer” running PAYE on those profits, because you’re paid by clients and you handle your own tax through Self Assessment.

However, tax codes can still collide with self-employed life in a few important ways. You might have a part-time job alongside your business, you might receive a pension, you might be paid under the Construction Industry Scheme (CIS), or HMRC might attempt to collect a Self Assessment underpayment through a PAYE code in a later year (the “coding out” process). That’s when a wrong tax code can suddenly feel like it’s been applied to your self-employed income, even though what’s really happening is that your tax code is being used to adjust tax collected from your PAYE income to account for your overall position.

This article explains what can happen if HMRC applies the wrong tax code in situations that affect self-employed people, how it can show up in your finances, what the risks are, and how you can fix it and protect yourself going forward.

How a wrong tax code can affect a self-employed person

There are a few common scenarios where self-employment and tax codes intersect. Understanding which one you’re in makes it much easier to diagnose what’s going wrong and what to do next.

1) You have both self-employment and PAYE income

Plenty of people run a business while also working as an employee (or receiving a pension). Your PAYE tax code dictates how much tax comes off that employment or pension income. If the code is wrong, the tax deducted at source will be wrong too. Even though the underlying issue is your PAYE code, you might experience it as “my self-employed income is being taxed incorrectly,” because the mismatch often relates to how HMRC estimates your business profits or accounts for them within your overall tax position.

2) HMRC is “coding out” a Self Assessment bill

If you owe tax through Self Assessment and meet certain conditions, HMRC can collect it by adjusting your tax code for the next tax year so extra tax is deducted from PAYE income. If HMRC gets the amount wrong or codes it out when it shouldn’t, you can end up paying too much (or too little) through PAYE, even though the source of the adjustment is your self-employed tax position.

3) You work under CIS and tax is deducted at source

Under CIS, contractors often deduct tax from payments to subcontractors. While this isn’t a “tax code” in the standard PAYE sense, incorrect deductions can still happen and can feel similar to coding issues because money is coming off your payments before you receive them. Sometimes confusion between CIS deductions and PAYE coding leads people to think the “wrong code” has been used when the real issue is CIS status, verification, or the contractor’s deduction rate.

4) HMRC adjusts your tax code to reflect estimated self-employed profits

In some cases, HMRC can include an estimate of untaxed income (like self-employment profits) in your PAYE coding calculation so that some tax is collected during the year via PAYE. If HMRC’s estimate is wrong, your code can be wrong, leading to overpayment or underpayment. This is more likely where you have significant PAYE income and HMRC is trying to smooth collection, but it can happen in other mixed-income cases.

What “wrong tax code” looks like in real life

A wrong tax code is rarely announced as “we used the wrong code.” It usually shows up as something else: lower take-home pay from an employer, a surprising Self Assessment bill, a refund you didn’t expect, or a letter that doesn’t match your reality. Here are common warning signs.

Your PAYE deductions suddenly jump (or fall) without explanation

If you have a job or pension alongside self-employment, your net pay may change noticeably after a coding notice is issued. This often happens at the start of a tax year, when a new code is applied, or mid-year after HMRC updates your record.

Your tax code includes unusual letters or numbers

Many people recognise standard-looking codes such as 1257L, but if you see something like BR, D0, D1, K codes, or a much lower number than expected, it can indicate that your allowances are being removed or your tax is being collected at higher rates. Sometimes this is correct; sometimes it’s based on inaccurate assumptions about your business income or other untaxed sources.

You get a P2 notice (or an online coding notice) that includes income you don’t recognise

Your tax code calculation may include entries like “untaxed interest,” “benefits in kind,” “estimated profit,” or “underpayment from earlier year.” If any of these are wrong, your code can be wrong.

Your Self Assessment calculation doesn’t match what you’ve already paid

You might notice that you’ve paid a lot through PAYE but still owe more than expected, or that you’re due a refund despite having a sizeable tax liability. This can happen when PAYE collection doesn’t align with your true income, or when underpayments are coded out incorrectly.

The consequences of HMRC applying the wrong tax code

The impact of a wrong tax code depends on direction: you might pay too much or too little. Both can be disruptive, and both can carry knock-on effects. The key is recognising that a tax code is a mechanism for collecting tax during the year; it doesn’t change what you legally owe overall. Your final tax position is determined after the year ends (or after you submit your return), based on your actual income and allowable expenses.

If you pay too much tax because of a wrong code

Overpayment is the most immediately painful in a cashflow sense because it reduces the money you have available to run your business and cover personal costs. For a self-employed person, cashflow is often more important than “profit on paper” because you need liquidity for stock, tools, software, advertising, travel, insurance, and simply paying yourself.

Common outcomes of overpayment include:

1) Reduced take-home pay from employment or pension — If the wrong code is applied to your PAYE source, you might see smaller net pay, making it harder to manage variable business income months.

2) Extra strain around tax deadlines — Ironically, paying too much through PAYE can still leave you anxious at Self Assessment time, because it’s not always clear how it will net off until the calculation is done. Some people hold back money “just in case,” which can further tighten cashflow.

3) Missed opportunities — Overpaying tax can mean postponing investment in your business, delaying equipment upgrades, or declining work because you can’t fund materials or subcontractors up front.

4) A refund later rather than money when you need it — Overpayments may be refunded after HMRC reconciles your year or after you submit Self Assessment, but that timing may not align with when you needed the funds.

If you pay too little tax because of a wrong code

Underpayment can feel pleasant at first because you have more money in your pocket during the year. The danger is that it can create a nasty surprise later. When your Self Assessment is calculated, the tax bill reflects what you owe based on actual income, minus what you’ve already paid. If too little has been collected, you’ll owe the difference, and possibly payments on account too.

Common outcomes of underpayment include:

1) A larger Self Assessment bill — You may face a lump sum you weren’t expecting, which can be difficult if your business income is seasonal or irregular.

2) Payments on account creating a “double hit” — Many self-employed people have to make payments on account towards the next year’s tax. If your bill is higher due to under-collection, your payments on account can also increase, making the total due feel disproportionately large.

3) Late payment interest and potential penalties — If the underpayment leads to late payment and you miss deadlines, HMRC can charge interest on late payments and penalties depending on circumstances. Even if the original issue started with an incorrect code, the charges can still apply if the tax isn’t paid on time.

4) Budgeting chaos — Underpaying during the year can distort your sense of what you can afford. It may encourage spending that would have been avoided if the correct amount of tax had been set aside.

Does the wrong tax code change what you actually owe?

No. A tax code is about collection, not liability. Your legal Income Tax and National Insurance liability for self-employment is determined by the tax rules and your actual figures. A wrong tax code can cause the “collection journey” to be bumpy—more or less tax taken earlier than it should have been—but ultimately, your Self Assessment calculation (or end-of-year PAYE reconciliation, if relevant) is what determines the final result.

That’s why two people can experience the same wrong code very differently. Someone with stable PAYE income may experience an over/underpayment that is tidied up automatically at year end. A self-employed person with volatile income may experience it as a serious cashflow event.

Why HMRC might apply the wrong tax code in mixed self-employed situations

Tax coding is built on information HMRC holds: prior year data, information from employers/pension providers, benefits information, and estimates. Wrong codes are often caused by mismatches or timing issues rather than anything sinister. Common reasons include:

Out-of-date profit estimates

HMRC may estimate your self-employed profits based on a prior year. If your profits have dropped (or surged), the estimate becomes inaccurate. This can lead to too much or too little tax being collected through your PAYE code if HMRC is using it to account for untaxed income.

Duplicate employments or incorrect PAYE records

Sometimes an old employment record stays “live” on HMRC’s system, or an employer submits data that causes HMRC to think you have two jobs. That can alter how allowances are allocated and can push you into codes like BR or even create a K code situation.

Underpayments coded out incorrectly

HMRC may include an underpayment from a previous year in your tax code to collect it through PAYE. If the amount is wrong, or if your circumstances change and it shouldn’t be coded out, the code becomes distorted.

Benefits in kind or expenses not updated

If you receive benefits through employment (company car, medical insurance, etc.) and the benefit values change, the coding can be wrong if the information isn’t updated or is updated late.

Incorrect assumptions about your Personal Allowance allocation

If you have multiple sources of income, HMRC decides where to apply your Personal Allowance. If it’s applied to the “wrong” source, your deductions can look wrong. Sometimes it’s a matter of preference (where you want the allowance used); sometimes it’s an error.

How to check whether the tax code is wrong, and what it’s based on

The first step is to identify where the tax code is being used. If you are purely self-employed with no PAYE income and no coding out, there may not be an active tax code affecting your payments directly. If you do have PAYE income, the code will appear on your payslip, P60, or pension statement, and HMRC usually issues a notice of coding.

To check whether the code makes sense, focus on:

1) The allowance and deductions inside the code calculation — Look for entries that don’t match your reality, such as an estimated profit figure that’s far off, an underpayment you don’t recognise, or a benefit you don’t receive.

2) Whether your Personal Allowance is allocated where you want it — If you have both a job and self-employment, most people want their allowance used against the employment income so they feel the benefit in their net pay, but your overall tax will balance out either way when you file.

3) Any “coding out” entry — If HMRC is collecting a past bill through PAYE, confirm the amount and whether it’s appropriate for the year.

4) Whether the code aligns with your current-year expectations — If business profits have changed significantly, it’s worth updating HMRC’s estimate to avoid large swings later.

What to do immediately if the wrong tax code is causing money problems

If a wrong tax code is hurting your cashflow—perhaps your PAYE deductions have spiked—take practical steps quickly. The goal is to stop the bleed, get clarity, and protect yourself while HMRC corrects the record.

1) Ring-fence funds for tax while you investigate

If your net pay has increased because too little tax is being deducted, set aside the difference so you’re not caught short later. If your net pay has dropped because too much is being deducted, review your business and personal budgets so you can continue meeting essential costs while the issue is resolved.

2) Keep evidence of your actual income and profits to hand

HMRC corrections are easier when you can explain your figures clearly. Have your most recent Self Assessment, your year-to-date bookkeeping, and a rough profit estimate ready. If you use accounting software, consider producing a simple profit and loss report for the current tax year-to-date.

3) Document what you see and when you saw it

Save a copy of your coding notice, take screenshots of your tax account if relevant, and keep payslips showing the changed deductions. If you later need to challenge something, having a timeline helps.

4) Consider the impact on payments on account

If the coding issue is likely to lead to a higher bill, start planning for payments on account too. If your profits have genuinely fallen, you may be able to reduce payments on account, but you need to do so carefully because reducing them too far can create interest if you underpay.

How to get the tax code corrected

Fixing a wrong tax code is usually straightforward once you identify the incorrect assumption. The key is to ensure HMRC has the right information and that it’s applied to the right year and the right income source.

1) Update HMRC with your best estimate of current-year profits (if relevant)

If the problem is that HMRC is using an outdated estimate of your self-employed profits, providing a better estimate can lead to a revised tax code. Be realistic and keep it under review; it’s better to update again later than to cling to a number that no longer reflects reality.

2) Correct or remove entries that don’t apply to you

If your coding notice includes untaxed income you don’t have, benefits you don’t receive, or a duplicated employment, ask HMRC to correct the record. In many cases, this means they need to remove an income source, close an old PAYE record, or adjust a benefit figure.

3) Check whether an underpayment is being coded out and whether the amount is correct

If an underpayment is being collected through your code, confirm it matches the amount you actually owe for that earlier year. If it’s too high, you could be overpaying. If it’s too low, you may still face a balancing payment later. If you’d rather pay the underpayment directly instead of through PAYE (for example, to stabilise your monthly cashflow), ask about options.

4) Ask for confirmation of the updated code and when it will take effect

Even after HMRC updates your record, employers and pension providers apply codes on their payroll cycle. Clarify when the new code will be issued and when your payer is likely to implement it. Then check your next payslip to confirm it’s actually changed.

What happens after the code is corrected

Once HMRC issues a corrected code, one of two things usually happens:

1) The correction adjusts tax going forward only — Your ongoing deductions become more accurate from that point, but what happened earlier in the year is resolved through end-of-year reconciliation or Self Assessment.

2) The correction triggers an in-year adjustment — Depending on payroll timing and the code change, your employer’s PAYE system may automatically adjust later payslips to account for over/under-deductions earlier in the same tax year. This can mean you see a larger-than-usual deduction or a smaller one for a period as it “catches up.”

For self-employed people, it’s important not to assume that a corrected code means everything is fully settled. You still need to look at your overall position: your business profits, your Class 2/Class 4 National Insurance (if applicable for the year), your student loan if relevant, and any other income streams. A code fix improves the collection mechanism but doesn’t replace proper year-end checking.

Will HMRC refund me automatically if I’ve overpaid?

Sometimes. If the overpayment is in PAYE and HMRC reconciles it after the tax year ends, they may issue a refund. If you’re within Self Assessment, overpaid tax may show as a credit on your account after your return is processed. In some cases, an overpayment can be refunded sooner, but it depends on the type of overpayment and what HMRC can confirm at the time.

Practically, you should assume that the cleanest way to settle everything is through the normal cycle: accurate records, correct return, and then the system balances out. If the overpayment is significant and is creating hardship, it may be worth contacting HMRC to ask about options, but you should be ready to explain clearly why the overpayment occurred and how you know you’re entitled to a refund.

Can a wrong tax code lead to penalties?

A wrong tax code by itself doesn’t automatically create a penalty, because penalties are generally linked to failures such as late filing, late payment, or inaccuracies in returns. However, a wrong code can indirectly contribute to situations where penalties arise. For example, if too little tax is collected during the year and you don’t set aside money, you might struggle to pay your Self Assessment on time, leading to late payment interest and potential penalties.

Equally, if you rely on the code as proof that everything is “taken care of” and you don’t submit an accurate Self Assessment return (where required), you can end up facing penalties for late filing or for inaccuracies. The safest mindset is: a tax code is a best-effort collection tool; your return and your record-keeping are what protect you.

How wrong coding interacts with National Insurance for the self-employed

One reason self-employed people get confused about “wrong tax codes” is that self-employment often involves National Insurance calculated through Self Assessment (depending on the tax year and your circumstances). PAYE tax codes mainly affect Income Tax collected from employment or pension income. They don’t directly collect self-employed National Insurance in the same way, although your overall tax bill in Self Assessment includes both Income Tax and relevant National Insurance components.

So if HMRC uses your PAYE code to collect more money because of untaxed income, that extra collection is usually aimed at Income Tax liability. Your National Insurance related to self-employment is still ultimately handled through Self Assessment calculations. This is another reason a wrong code can cause a mismatch: you might see extra tax taken at source, but your Self Assessment bill can still include National Insurance, leading you to wonder why you’re “still paying.” The answer is that different components of the bill are being settled through different channels.

Examples to make it concrete

Example A: Overestimated profits lead to too much tax through PAYE

You run a small design business and also work two days a week as an employee. Last year your business profits were high, but this year you’ve had fewer clients. HMRC uses last year’s profit to estimate your untaxed income and adjusts your tax code so more tax is deducted from your employment pay. Your net salary drops, even though your business is quieter. You feel squeezed from both directions: less business income and less net pay. Once you update HMRC with a more realistic profit estimate, they issue a revised code and your net pay stabilises.

Example B: Underpayment coded out causes surprising deductions

You filed your Self Assessment and owed a balancing payment, which HMRC then decides to collect through your PAYE code next year. But the coded-out amount is higher than expected because of an error or because it includes something already paid. You notice your monthly pay is lower. After querying it and correcting the coded-out underpayment, HMRC issues a corrected code and your deductions reduce.

Example C: Too little tax collected leads to a bigger Self Assessment bill

You have a small PAYE job and your self-employment grows quickly. HMRC doesn’t update your record promptly, so your code remains generous and too little tax is deducted from your wages. You enjoy higher net pay for months, but at Self Assessment time you face a large bill plus payments on account. The code wasn’t “wrong” in a malicious sense—it was simply not updated to reflect your new reality. The lesson is to set money aside and keep HMRC informed when profits change.

How to reduce the chance of a wrong tax code affecting you again

You can’t always prevent HMRC from making an incorrect assumption, but you can reduce the chance of it harming you and shorten the time it takes to fix. A few habits make a big difference.

Keep bookkeeping up to date and monitor profits monthly

When you know your approximate year-to-date profit, you can spot when HMRC estimates look unrealistic. You can also budget for tax more confidently and avoid nasty surprises.

Review your tax code notice when it arrives

Many people ignore coding notices, especially if they assume Self Assessment will handle everything. If you have PAYE income alongside your business, the code notice is worth reading. It’s often the earliest warning that HMRC’s assumptions have drifted away from reality.

Tell HMRC promptly when your circumstances change

Changes like starting or ending an employment, starting a pension, receiving a taxable benefit, or a major change in self-employed profits can all affect coding. The sooner HMRC has the right information, the less likely your code is to be wildly wrong.

Maintain a separate “tax savings” pot

A dedicated savings account for tax is one of the simplest protections. If the wrong code causes under-deduction, you’re less likely to be caught short. If it causes over-deduction, you at least know you’re not spending money that should have gone to tax, and you can plan around the temporary cashflow dip.

Consider professional support if your income sources are complex

If you have multiple employments, benefits, a pension, CIS work, and self-employment all at once, coding can get messy. An accountant or tax adviser can help you interpret coding notices and estimate what you should be paying, which can be reassuring and can reduce costly errors.

What if HMRC’s wrong code causes financial hardship?

If the wrong tax code has resulted in deductions you can’t afford—especially if it has suddenly reduced your net pay—don’t ignore it and hope it will resolve itself at year end. Take action quickly. Explain clearly that the code appears incorrect and that it is causing hardship. Keep your explanation factual: what the code is, why you believe the assumptions inside it are wrong, and what your actual situation is.

If you have a tax bill you can’t pay because of the consequences of incorrect collection, HMRC may be able to discuss payment arrangements depending on your circumstances. The practical point is to engage early rather than waiting until deadlines are missed.

Key takeaways

If HMRC applies the wrong tax code in a way that affects you as a self-employed person, the biggest impact is usually on cashflow and timing—how much tax is taken now versus later—rather than on the final amount you owe. The wrong code can make your PAYE deductions inaccurate, can code out the wrong amount of underpayment, or can reflect an incorrect estimate of your untaxed income. The result can be overpayment (tightening your monthly budget) or underpayment (creating a larger bill later).

The good news is that wrong tax codes are usually fixable once you identify what assumption is wrong. The best approach is to understand which income stream the code applies to, check the coding breakdown for incorrect entries, update HMRC with realistic figures, and verify the corrected code is actually implemented by your employer or pension provider. Pair that with solid bookkeeping and a habit of setting aside tax, and even when a coding error happens, it’s far less likely to derail your finances.