What is PAYE Payroll?

PAYE stands for Pay As You Earn and is the system HMRC uses to collect income tax and National Insurance contributions (NICs) from employees’ wages before they are paid. As an employer, running PAYE payroll is a legal obligation whenever you pay staff above certain thresholds.

How PAYE Works

Under PAYE, the employer acts as a tax collector on behalf of HMRC. Each pay period, the employer calculates the correct amount of income tax and NICs to deduct from each employee’s pay, then sends these deductions to HMRC along with a Full Payment Submission through RTI .

The process follows these steps:

1. Employee provides their tax code (issued by HMRC) or completes a Starter Checklist
2. Employer calculates gross pay including salary, overtime, bonuses and benefits in kind
3. Employer applies the tax code to determine the tax-free allowance for the pay period
4. Income tax is calculated on earnings above the tax-free amount
5. National Insurance contributions are calculated for both employee and employer
6. Deductions are subtracted to arrive at net pay

Income Tax Bands and Rates (2024/25)

The Personal Allowance is reduced by £1 for every £2 earned above £100,000, meaning it reaches zero at £125,140.

Tax Codes

Tax codes tell the employer how much tax-free pay an employee is entitled to in each pay period. The most common tax code for 2024/25 is 1257L, which corresponds to the standard Personal Allowance of £12,570.

Common Tax Code Prefixes

Emergency Tax Codes

When HMRC has not issued a tax code, employers use an emergency tax code. This applies the standard allowance on a cumulative or week 1/month 1 basis. Emergency tax codes often result in overpayment of tax that is corrected once the proper code arrives.

National Insurance Contributions

Both employers and employees pay NICs on earnings above certain thresholds. These fund the State Pension, Statutory Sick Pay, Statutory Maternity Pay and other state benefits.

Employee NIC Rates (Class 1, 2024/25)

Employer NIC Rates (Class 1, 2024/25)

Employers also receive an Employment Allowance of up to £5,000 per year, which reduces their employer NIC liability. This is available to most businesses with an employer NIC bill below £100,000 in the previous tax year.

Setting Up PAYE as an Employer

Before running your first payroll, you must:

• Register as an employer with HMRC — this provides your PAYE reference number and Accounts Office reference
• Choose payroll software that is recognised by HMRC for RTI reporting
• Collect employee information including National Insurance numbers, tax codes and bank details
• Set up a workplace pension for auto-enrolment

Registration can be done up to four weeks before the first payday, but not earlier.

Employer PAYE Obligations

Each Pay Period

• Calculate and deduct income tax and NICs from each employee’s gross salary
• Deduct any student loan repayments based on the employee’s plan type
• Deduct pension contributions under auto-enrolment
• Send a Full Payment Submission (FPS) to HMRC on or before each payday
• Provide employees with a payslip showing all deductions

Monthly or Quarterly

• Pay HMRC the total income tax, NICs and student loan deductions by the 22nd of the following month (electronic payment) or the 19th (cheque)
• Small employers paying less than £1,500 per month in PAYE may qualify for quarterly payments

Annually

• Submit a final FPS for the tax year, marking the last submission
• Provide each employee with a P60 by 31 May
• Report benefits in kind on P11D forms by 6 July
• Issue a P45 to any employee who leaves during the year

PAYE Payment Schedule

HMRC charges interest and penalties for late payments. Persistent late payment can lead to escalating penalty percentages.

PAYE Settlement Agreements

A PAYE Settlement Agreement (PSA) lets employers pay tax and NICs on behalf of employees for certain minor, irregular or impracticable benefits and expenses. This simplifies reporting of smaller benefits that would otherwise require individual P11D entries.

PSAs must be agreed with HMRC before the start of the tax year and the associated tax and NICs paid by 22 October following the end of the tax year.

Common PAYE Errors

Payroll Software and HMRC

All employers must use payroll software that can submit RTI returns directly to HMRC. HMRC provides a free tool called Basic PAYE Tools for employers with fewer than 10 employees. Larger employers typically use commercial software or outsource to a payroll bureau.

Payroll software handles:

• Tax and NIC calculations based on HMRC tax code notifications
• Generation of FPS and Employer Payment Summary (EPS) submissions
• Production of payslips , P60s , P45s and P11Ds
• Student loan and postgraduate loan deductions
• Pension contribution calculations for auto-enrolment

PAYE and the Wider Accounting System

PAYE deductions create liabilities in the employer’s accounting records . Each payroll run generates entries for:

• Salary expense (gross pay)
• Employer NIC expense
• Employer pension contributions
• Liabilities for tax, NICs and pension owed to HMRC and pension providers

These entries must be reconciled against actual payments to ensure accuracy and compliance.

Penalties for PAYE Non-Compliance

HMRC applies a graduated penalty scheme for late RTI submissions:

Additional penalties of 5% of the tax and NICs outstanding apply if payment is more than 30 days late, with further 5% charges at 6 and 12 months.