Payroll for small businesses: A complete guide

Payroll header image by Pixabay

If you’re new to hiring people, paying your employees can seem intuitively straightforward. However, the legalities and requirements surrounding payroll make it more complex than simply transferring money and issuing payslips.

As a new business, you’ve already registered your company with Companies House. But when it comes time to hire employees, you need to register with Her Majesty’s Revenue and Customs (HMRC) as an employer. This will give you a Pay As You Earn (PAYE) reference number and Accounts Office reference—both of which are necessary to file the appropriate payroll paperwork with the government.

Once set up, you’ll need to follow HMRC’s rules regarding payroll for employers, such as taking tax and National Insurance from your employees’ wages and paying it by the deadline.

Running payroll accurately can save your business precious time and money. In this post, we look at what payroll is, what HMRC needs from you and how to correctly pay your employees. We’ll also show you how Tide Payroll can simplify the process for you by streamlining your pay run. Let’s get started.

Table of contents

What is payroll?

Payroll refers to the process of calculating an employee’s pay. Other than salaries and wages, payroll also includes any bonuses, allowances, and benefits your employees are eligible for.

You’ll also need to send the total tax owed from your employees to HMRC on a monthly basis and keep detailed records and reports of their pay (we’ll explain exactly how to do this later on in this guide).

In a nutshell, here’s a list of tasks involved in the payroll process:

  • Calculating employee pay and paying them
  • Calculating deductions such as income tax and National Insurance and paying HMRC
  • Tracking and reporting accurate information to HMRC

Pay As You Earn (or PAYE) is the system used by HMRC to collect Income Tax and National Insurance from employees of an organisation. If you’re running a business and are employing people, you need to operate PAYE as part of your payroll.

To ensure you set up and manage payroll properly, follow the six stages of payroll.

The six stages of payroll

If you follow the six stages of payroll to a T, you’ll be able to manage, track, and report payroll effectively.

The six stages of payroll

1. Register yourself as an employer

First, you need to register with HMRC as an employer to receive your PAYE reference number and Accounts Office reference.

Keep in mind that you need to register 4-8 weeks in advance of employing someone—no sooner, no later. The rules state that you cannot register longer than 2 months in advance, or shorter than 4 weeks out.

The registration process itself can take up to 2 weeks. And it may take up to up to 5 working days to get your employer PAYE reference number, which is key to HMRC collecting Income Tax and National Insurance from your employees.

Even if you’re employing yourself, you must be registered as an employer.

Note: If your employees earn less than £120 a week, there’s no need to register with HMRC. But if they receive a pay rise or have an existing pension, you’ll need to register.

Top Tip: Employing someone for the first time is incredibly exciting. But, it’s important to take your time to ensure you’re hiring the right type of employee, at the right cost and within the legal frameworks. To learn more about how to tackle this new process efficiently, read our step-by-step guide to how to employ someone for the first time 📌

2. Choose a payroll system

Being organised is key. Decide at the outset if you will be keeping records manually, employing a payroll service or accountant, or using payroll software. Let’s explore each option in more detail.

Do it manually

The cheapest upfront option is to manage payroll on your own by hand. But executing payroll manually can be time-consuming and leave you open to human error.

On top of the time-consuming task of entering payroll by hand, there are plenty of laws that you must adhere to. From pay calculations to tax deductions and more, you must do it all correctly. If you fail to do so, you might end up paying penalties or get into legal trouble.

Moreover, you may accidentally make a mistake that results in paying your employees the wrong amount—resulting in unnecessary tension and uncertainty.

To avoid these potential outcomes, consider hiring a professional to help you out.

Hire payroll services

You can hire a payroll services agency to manage payroll for you. These agencies can either be accounting firms that have a payroll branch, or separate payroll bureaus devoted entirely to helping you accurately pay your employees.

Payroll services typically offer:

  • Payment calculations including deductions
  • Compliance regulation
  • Comprehensive reporting
  • Payslip production

Outsourcing these tasks frees up your time and ensures no mistakes are made.

Hire an accountant

If you’re considering hiring an accountant, you must discuss the services they’ll be offering you.

Accountants should be able to take care of the basics, such as keeping employee records, providing paycheques and making payments to HMRC on time.

Note: If you choose this option, you’re still legally bound to collect and keep records of your employee’s payroll details. Once you’ve gathered this information, your payroll agency or accountant can manage the rest of the process for you.

Use payroll software

The most effective way to manage payroll without breaking the bank is to invest in good payroll software. It’s affordable, less time-consuming and you can easily operate it on your own.

Before you choose which payroll software is best for your business, you need to find out if the software offers all the features that you’ll need.

Consider functionality such as:

  • Recording employee details
  • Calculating pay and producing payslips
  • Reporting to HMRC
  • Making deductions
  • Taking care of pension payments

HMRC has a page dedicated to helping you find compliant payroll software, both free and paid. If you search beyond this list, make sure it’s HMRC compliant before you invest too much time in your evaluation.

Top Tip: If you are looking to run Payroll with your existing software such as Sage, Xero and QuickBooks, you can use Tide’s accounting software integrations for a seamless process 🔗

Streamlining Payroll with Tide

Exciting times ahead! Our new feature, Tide Payroll, makes it easy for SMEs to conduct payroll directly from their Tide account.

The all-in-one payroll service allows you to easily set up, run and pay employees anytime, from anywhere—seriously simplifying your payroll processes and saving you time and money. There is no subscription fee and you’ll only pay for what you need.

Tide Payroll is fully HMRC compliant and allows you to set up automatic pay runs, reducing time spent on manual entries and circumventing laborious payroll processes.

Ready to seamlessly execute your payroll? Keep an eye out for Tide Payroll (coming soon!) 🎉 

3. Keep accurate records

You must collect and keep records of important information, including what you pay your employees and any deductions, for 3 years from the end of the tax year they relate to.

In order to figure out what you are paying your employees (both before and after deductions), you need to keep the following in mind:

Employee hours

This is an important element in the payroll process, especially because of the variation in employee contracts—some might be working full-time, while others on an hourly basis.

Businesses with full-time employees are fairly straightforward to address—you’ll simply need to pay the contracted amount in return for the contracted hours.

For employees working on an hourly basis, you’ll need to have a system in place to monitor the hours they work to ensure that they are paid the correct amount.

They can either self-track their hours and send them to you before payday, or you can deploy a tracking system such as a clock card or timesheet. This can be physical or virtual, depending on whether your employees work on-location or remotely.

Businesses must also keep track of sick days taken (more on this in a moment) and/or if they have worked overtime. Further, if your employee is taking entitled statutory annual leave, you must still process their payroll while they’re away. How much you need to pay them will depend on the type of worker they are, how many hours they typically work and their contact details.

Gross and net pay

You’ll need to indicate gross and net pay on employees payslips.

Gross pay is an employee’s total pay within that period and net pay is the amount they receive after tax and any other deductions.

To calculate gross pay, you’ll need to know the fixed amount and how frequently an employee gets paid (weekly or monthly). Then, simply divide their salary by the number of pay periods each year to get the gross figure.

In the case of an hourly contract, you’ll need to know the number of hours and rate per hour. To calculate and record the hours, you should have a system in place, such as a clock card or timesheet. Alternatively, ask your employee to calculate their hours worked and record them in-house once they’ve been sent over.

Once you have the necessary information, multiply the hours worked by the rate. Add in any overtime if necessary at the overtime rate.

To determine net pay, you need to work out all the taxes and other deductions, such as National Insurance. We go into more detail about these deductions in step 6 below. To calculate net pay, simply subtract the total deductions from the gross pay to get the net figure.

Note: The wonderful thing about payroll software is that it calculates gross and net pay for you—saving you valuable time.

Benefits in kind (BIK)

Other than the basic salary, you might want to offer your employees additional benefits. As an employer, it is your responsibility to keep a record of all benefits in kind you are providing to your employees.

Since benefits in kind are taxable items, employers need to inform the employee and HMRC at the end of the tax year by producing a P11D form. This form is used to adjust the tax code, which tells an employee how much to deduct (if they are filing a Self Assessment tax return).

Here’s a list of some taxable benefits in kind:

  • Accommodation
  • Company car
  • Medical coverage
  • Gym membership
  • Travel allowance
  • Interest-free loan

Here’s a list of some tax-free benefits in kind:

  • Payments made to a pension
  • Office meals and other in-office facilities provided by the company
  • Personal non-cash gifts
  • Relocation expenses of up to £8,000

Note: Even if some benefits in kind have been taxed under PAYE, it’s still important to include them when filing for a tax return.

Top Tip: There are many types of small business taxes you need to be aware of. To learn more about the various types of business tax, how to determine which ones apply to you and how to pay them, read our simple guide to small business tax

Statutory Sick Pay (SSP)

If your employee is unable to work due to medical reasons, they may qualify for Statutory Sick Pay (SSP) at £95.85 per week for up to 28 weeks (rate at time of writing—April 2021).

The statutory amount may exceed the weekly rate depending on whether your company has a sick pay scheme. The rules for what you may (or may not) need to pay also vary by employment types.

By law, you must pay SSP to employees when they meet eligibility criteria, such as if they are off sick for at least 4 days in a row, or isolating due to COVID-19. To learn more, read HMRC’s Statutory Sick Pay (SSP) employer guide.

Top Tip: If your employees need to take time off work because of COVID-19, you can claim back their SSP for up to two weeks via the Coronavirus Statutory Sick Pay Rebate Scheme. To learn more, read our guide to how to claim back Statutory Sick Pay for your staff 👈

Minimum wage

Employers in the UK are legally bound to pay their staff at least the national minimum wage. The minimum wage largely depends on the age of the employees and whether they are working as an apprentice.

Employees must be at school leaving age to get the national minimum wage or aged 23 and over to get the national living wage.

Here’s a list of current hourly wage rates that apply (at the time of writing—April 2021):

National minimum wage rates

Apprentice Under 18 Aged 18-20 Aged 21-22 Aged 23 and over
£4.30 £4.62 £6.56 £8.36 £8.91
Source: GOV.UK

From 1 April 2021, the National Living Wage began to apply for employees aged 23 and over (previously this was 25 and over).

Note: It’s important to keep in mind that the national living wage and the national minimum wage rates change every April, so make sure to check on these numbers annually.

How do apprenticeships work in regards to payroll?

Apprentices have a chance to combine their studies with practical training. They are technically employees that earn a wage and receive holiday pay. Depending on their level, apprentices can take between 1 to 5 years to complete their training.

To be eligible for an apprenticeship, your applicants need to be 16 or older, living in England and not in full-time education.

If they are indeed eligible, they are entitled to the apprentice rate (as noted in the above table). Specifically, this applies to people 19 or younger or 19+ but still in their first year of apprenticeship. Apprentices over the age of 19 earn minimum wage after their first year.

4. Tell HMRC about your employees

HMRC requires businesses to report all employee details and changes so they can keep an accurate record of your staff and how much they collectively owe.

You’ll need to gather detailed employee information in order to get their tax code and pay them accurately (taking deductions into mind). This information includes name, address, salary details, bonuses received and national insurance number.

For example, every time an employee joins or leaves your company, it must be communicated to HMRC so that their employment history can be properly tracked (either by yourself, an accountant, or a payroll service provider of your choosing).

This also includes changes in employee status, such as promotions and demotions, any promotions to directorial positions, or if an employee has reached the State Pension age.

Top Tip: To learn more about how workplace pensions work and how to enrol your workers as an employer, read our guide to everything you need to know about workplace pension schemes💡

To sum it up, you’ll need to report to HMRC each time an employee:

  • Joins
  • Leaves
  • Takes a leave of absence
  • Starts receiving a workplace pension
  • Changes their address
  • Dies
  • Changes their gender

5. Record pay, make deductions and report to HMRC

Every employee is entitled to a payslip each payday under the Employment Rights Act 1999 section 8.

A payslip must include the following:

  • Gross pay
  • Deductions—tax, national insurance, student loan payments, etc.
  • Net pay
  • Method of payment

A business must then report employee pay and deductions to HMRC in what’s called the Full Payment Submission (FPS). This includes income tax, National Insurance, student loan repayments, benefits in kind, etc.

Note: This report must include everybody you pay, even if they make less than the £120 per week threshold.

That said, if none of your employees are paid £120 or more a week, there’s no need to register for PAYE.

For example, if your employee earns £125 per week, you will need to register for PAYE. However, in this scenario, your employee will still be below the National Insurance (NI) minimum.

Because they are above the PAYE threshold, but below the NI minimum, they will not have to pay towards National Insurance Contributions (NIC). Instead, they’ll be eligible to receive NIC credits available to use towards potential entitlements (i.e. state retirement pension or childcare benefits).

Regardless of what thresholds your employees fall into, payroll record-keeping is still necessary. Plus, if you’re an employer expecting to pay less than £1,500 per month, you can arrange to pay quarterly. To learn more about this possibility, contact HMRC’s payment helpline

The FPS has to be sent on or before your employee’s payday, regardless of if you run payroll weekly, biweekly, or monthly.

HMRC requires businesses to update their FPS whenever employee information changes—such as when an employee leaves or when there are any changes in the tax code, gross and net salary, applicable bonuses or stipends.

In order to send the FPS, simply enter your PAYE reference and Accounts Office reference (the 13-digit unique code that you receive when you first register as an employer) in your payroll software and follow the instructions.

Is early reporting for FPS possible?

If your payroll staff is going on holiday, or if your regular payday falls on a bank holiday, you can send your FPS early. However, in the latter scenario, you should still enter your regular payday date on the form.

It’s also important to ensure you don’t send your FPS too early. That’s because if any changes occur after you’ve sent it, such as a change to a tax code or an employee departure, you’ll need to send a corrected FPS

Note that while you technically are allowed to send your FPS anytime, you cannot send reports for the new tax year before March.

Can you send FPS late?

Yes, you can send your FPS late, but you must have a valid reason for the tardiness. 

Here are some appropriate scenarios:

  • Your employee’s payday is on a bank holiday or a weekend and you forgot to send it early
  • Your employee has worked with you for less than a week
  • Your employee does not give you a P45 (because they are either starting their first job or taking on a second job) or is paid less than £120 a week
  • You recently registered as an employer and have yet to receive your employer PAYE reference 
  • You’ve made an ad hoc payment to your employee outside of your regular payroll (e.g. an overtime payment)

You must put the reason for the late FPS payment on your submission. That said, HMRC has the right to disagree with your reasoning. If they disagree with your explanation, or if you do not put a reason at all, they may send you an online warning message or penalty fee for your regression.

What is EPS reporting?

An Employer Payment Summary (EPS) is a document that reports any potential deductions that you are eligible for and thus could reduce your total FPS owed.

You’ll need to send an Employer Payment Summary (EPS) along with your FPS if you fall into any of the following categories:

  • You are reclaiming statutory maternity, paternity, adoption, parental bereavement or shared parental payments, regardless of whether HMRC gave you an advance payment to cover them
  • You are claiming the Employment Allowance, which is typically done once per tax year
  • You are eligible to reclaim Construction Industry Scheme (CIS) deductions as a limited company
  • You are claiming National Insurance contributions holiday for previous tax years
  • You are paying the Apprenticeship Levy if you or your employees have an annual pay bill of more than £3 million

Note: You can send an EPS instead of an FPS if you have not paid any employees during a tax month period.

If you need to send an EPS and fail to do so, HMRC may send you a notice via PAYE online, estimate how much you should pay, or give you a penalty (depending on the circumstances).

What happens if you don’t pay employees in a tax month (or for a longer period of time?)

If for whatever reason you did not pay employees in a tax month or decide to stop employing somebody, whether temporarily or permanently, you’ll need to tell HMRC in advance. To do this, simply fill in the respective dates in the ‘Period of inactivity’ fields in your EPS.

What can you do if you disagree with HMRC’s tax decision or penalty?

HMRC sends out penalty notices once a quarter. This notice will include what you owe, how to pay your penalty and how you can appeal their decision (if you disagree with it).

If you do decide to appeal, the best practice is to have your accountant file the appeal, since they are experienced and know how to follow the right process to resolve the issue.

You are responsible for paying any costs associated with appealing this decision. And if you are eligible, you may also be able to delay the payment of any penalty you owe pending a resolution on the matter.

Visit HMRC’s page dedicated to disagreeing with a tax decision to learn what counts as a reasonable excuse when disputing a tax decision.

6. Pay HMRC

Businesses are legally required to pay HMRC all of the deductions from employee wages. This must be done on or before payday each month.

It is the employer’s responsibility to make sure that the correct amount is deducted from the employee’s pay and paid to HMRC each month. Make sure you submit the payment to HMRC on time each month, or you could face a penalty (more on penalties in a moment).

Types of Payroll deductions

Here’s a list of deductions you’ll have to calculate and pay:

  • Tax
  • National Insurance
  • Pension contributions
  • Student loan repayments
  • Child maintenance payments
  • Payroll Giving (your employees can donate to a charity directly from their pay before tax is deducted)

Keep in mind that these deductions are calculated automatically once you enter accurate information into your payroll software along with employees’ applicable tax codes and National Insurance category letters.

You must pay HMRC what you owe by the 22nd of each month, or the 19th if you’re paying by post. If you fail to do so, your business may be subject to financial penalties as well as an interest fee on the amounts outstanding for every day you’re late.

Financial penalties for late payments range based on the number of tax defaults in a given year. A tax penalty percentage is applied to the total amount of your late payment. The first late payment is forgiven and as the quantity of late payments increases, so does the penalty percentage applied.

Financial penalties for late payments

Number of defaults in a tax year Penalty percentage applied
1 to 3 1%
4 to 6 2%
7 to 9 3%
10 or more 4%
Source: GOV.UK

Wrapping up

Getting payroll right is crucial for the success of your business. Not only do you need to make sure your employees get paid the correct amount and on time, but you also need to ensure that you’re not breaking any laws.

Investing in good payroll software can streamline the entire process for you while helping you save tons of money at the same time.

Glossary

Payroll: The process of calculating an employee’s pay

Her Majesty’s Revenue and Customs (HMRC): Responsible for collecting taxes as well as payments to be made to people who are eligible for state support

Full Payment Submission (FPS): The report that you send to HMRC each pay period which includes employee pay and deductions to HMRC

Employer Payment Summary (EPS): A document that reports any potential deductions that you are eligible for and thus could reduce your total FPS owed

P45: A document that shows how much tax your employees have paid on their salaries so far in the tax year

Deductions: How much tax and National Insurance to deduct from your employees’ pay

National Insurance Contributions (NIC): Mandatory tax deductions taken from employee pay and income tax in order to qualify for certain benefits and the State Pension, repay student loans and pay any apprenticeship levy

Tax codes: The code that employers enter into payroll software to work out how much tax to deduct from their employee’s pay throughout the year

National Insurance Category Letters: Employers use an employee’s National Insurance category letter when they run payroll to work out how much they both need to contribute

Benefits in Kind: If an employer provides an employee with a taxable benefit, such as using company money for travel, you might need to pay tax and National Insurance on them (the rates vary depending on the types of expenses or benefits you provide)

National Minimum Wage: The minimum wage employers are required to pay employees (which ranges depending on the employee’s age)

School Leaving Age: The age you can leave school in England, Scotland, Wales and Northern Ireland

Apprenticeships: An opportunity for people to combine their studies with practical training and thus be paid an apprenticeship minimum wage

Gross Pay: An employee’s total pay within that period

Net Pay: The amount an employee receives after tax and any other deductions

P11D: The form you will use to report end-of-year expenses and benefits to HMRC by post (if you cannot report online) 

Statutory Sick Pay (SSP): If your employees are sick they may be eligible for the SSP which is £95.85 a week for up to 28 weeks

Payslips: A written, itemised pay statement that employers must provide their employees with each payday under the Employment Rights Act 1999 section 8

Pay As You Earn (PAYE): The system used by HMRC to collect Income Tax and National Insurance from employees of an organisation

Payroll Services: Obtaining professional help to assist you with payroll

Payroll Services Agency: Professional help with payroll in the form of a professional agency 

Payroll Software: Software that allows you to easily run payroll digitally with features such as automated recording, calculations, deductions and reporting

Tide Payroll: A fully HMRC compliant, all-in-one payroll service allowing you to easily set up, run and pay employees anytime, from anywhere—seriously simplifying your payroll processes and saving you time and money

Photo by Pixabay, published on Pexels

Emily Bates

Lead Talent Partner at Tide

Tide Team

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