What is Payroll? A Complete Guide

Payroll header image by Pixabay

If you’re starting to hire people in your business, payroll is something you can’t ignore.

While paying your employees is intuitively straightforward, legalities and requirements make the payroll process more complex than simply issuing paychecks.

For starters, all businesses in the UK must be registered with the government. In order to remain legal and avoid financial penalties, you must adhere to certain rules, like deducting tax and National Insurance, if applicable, and reporting these deductions to HMRC within a set timeframe.

Payroll management can be a bit tricky. But if you do your homework and invest in the right software, you can save your business tons of precious time and money.

In this article, we’ll help you understand what payroll is, what HMRC needs from you, and how to successfully pay your employees without getting into legal trouble.

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 received by an employee.

More importantly, it includes important tax deductions and responsible reporting to HMRC.

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

  • Calculating employee pay and paying them
  • Calculating deductions such as income tax and National Insurance
  • Reporting information to Her Majesty’s Revenue and Customs (HMRC)

To make the entire process easier to understand, we’ll be moving step-by-step.

First, let’s take a look at what HMRC is and what it needs from you.

What is HMRC?

Her Majesty’s Revenue and Customs (or HMRC) is a non-political department of the UK government. It is responsible for not only the collection of taxes but also the payments to be made to people who are eligible for state support.

What does HMRC need from you?

To carry out its responsibilities, here’s a list of things that HMRC needs from you:

Register yourself as an employer

Every firm in the country must be registered with HMRC before they can begin employing and paying people.

Keep in mind that you need to register as an employer at least 4 weeks in advance, and no more than 2 months in advance before employing someone.

The registration process itself can take up to 2 weeks.

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

Note: If your employees earn less than £118 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.

Report employee changes

Businesses go through changes on a day-to-day basis.

HMRC requires businesses to report all their employee changes so they can keep a record of employees and how much a firm owes HMRC.

For example, every time a new employee joins or leaves your company, it must be communicated to HMRC so employees can be tracked.

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

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

Report employee pay

A business must report employee pay and deductions to HMRC in what’s called the Full Payment Submission (FPS).

The FPS has to be sent on or before your employee’s payday, regardless of the fact that you’re making payments to HMRC on a quarterly basis instead of 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 in your payroll software and follow the instructions.

We’ll go into further detail about the specifics of reporting employee pay lower down.

Pay HMRC the deductions

Businesses are legally required to pay HMRC all of the deductions from employee wages every month.

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

  • Tax
  • National Insurance
  • Pension contributions
  • Student loan repayments
  • Child maintenance payments

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

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 of 2.75% for every day you’re late (rate at the time of writing—October 2019).

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. 

Table of late penalties from HMRC
Source: GOV.UK

What makes up employee payroll?

There are various elements involved that make up the entire payroll process, such as figuring out employee pay and tax deductions and preparing payslips.

In this section, we’ll discuss the different types of information you’ll need to be aware of and calculate in order to set up an effective payroll system.

We’ll also help you understand the different categories of employee pay and some specific laws that you need to keep in mind.

Employee details

You must have access to employee information, including name, address, salary details, bonuses received, and national insurance number.

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 promised hours. But you must make sure that they are putting in the agreed 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.

Businesses must also keep track of sick days taken by employees and/or if they have worked overtime.

Employee pay

The most important feature of the payroll process is the payment made to employees.

There are a lot of different factors that affect total employee pay, such as salaries, benefits in kind, and tax deductions.

Here are some of the basic elements of employee pay that you need to know:

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 25 to get the national living wage.

Here’s a list of current (at the time of writing—October 2019) wage rates that apply:

  • Apprentice – £3.90
  • Under 18 – £4.35
  • Aged 18-20 – £6.15
  • Aged 21-24 – £7.70
  • Aged 25 and above – £8.21

Note: Rates of the national living wage and the national minimum wage change every April.

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).

In 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.

To determine net pay, you need to work out all the taxes and other deductions, such as National Insurance.

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 wish to provide to your employees.

Since benefits in kind are taxable items, employers need to inform the employee and HMRC of the benefits in kind 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.

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.

Statutory Sick Pay (SSP)

If your employee is unable to make it to work due to medical reasons, they may be eligible to qualify for £94.25 per week of Statutory Sick Pay (SSP) for up to 28 weeks.

The statutory amount may exceed £94.25, depending on whether your company has a sick pay scheme.

Learn here whether your employees are eligible for SSP.

Tax and deductions

Every employee is legally bound to pay tax and national insurance from their total gross pay. The amount they pay depends on the total amount they earn.

It’s 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.

Payslips

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

Now that we’ve covered the basics, let’s find out how you can pay your staff.

PAYE: How to pay your staff

In this section, you’ll learn what PAYE is and what you’re required to do through PAYE as an employer.

What is PAYE?

Pay As You Earn (or PAYE) is the system used by Her Majesty’s Revenue and Customs (HMRC) to collect Income Tax and National Insurance from employees of an organization.

If you’re running a business and have engaged people to work for you, you need to operate PAYE as part of your payroll.

As an owner of the firm, you’re required to do the following through PAYE:

Calculate employee pay

This includes the salary, wages, allowances, commissions and bonuses received by an employee.

Calculate deductions

This includes income tax, National Insurance and/or student loan repayments (if applicable).

Report to HMRC

The third part of the PAYE process is reporting information to HMRC.

This has to be done on or before the payday.

If you’re using a payroll software, it’ll work out everything you owe to HMRC each month, including the employer’s National Insurance contribution on each employee’s earnings above £166 a week.

In case you want to claim any reductions and desire revisions, simply send a report to HMRC.

If none of your employees are paid £118 or more a week, there’s no need to register for PAYE.

For example, if your employee earns £120 per week, you will need to register for PAYE. However, in this scenario, your employee will still be below the National Insurance (NI) minimum. Yet, because he is above the PAYE threshold, but below the NI minimum, he will not have to pay towards National Insurance Contributions (NIC). Instead, he’ll be eligible to receive NIC credits available to use towards potential entitlements.

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.

How to operate PAYE

There are three ways to operate PAYE:

Do it manually

The cheapest option is to manage payroll on your own by hand.

But executing payroll manually can be risky and time-consuming. 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.

Additionally, a payroll error could upset your employees. This small, innocent mistake could lead to reduced trust thus affecting your positive workplace culture. Make sure to adequately check your work before submitting to avoid this scenario.

Hire payroll services

Another option is to get professional help instead of doing it all manually. 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

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 pay cheques, and making payments to HMRC on time.

But remember, hiring an accountant can be an expensive option. If you’re a small business with a tight budget, our short guide on how to choose an accountant will assist you with this decision and next steps.

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 a payroll software for your business, you need to find out if the software offers all the features that you’ll need.

Consider features like the ability to record employee details, calculate pay and produce payslips, report to HMRC, make deductions, and make pension payments.

Note: HMRC provides a list of approved software, including free payroll software if you have fewer than 10 employees and paid-for payroll software for larger companies. Tide also integrates with many accounting software systems that can assist you with payroll and offers accountants access to your account using Tide’s account reader.

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.

Photo by Pixabay, published on Pexels

Darren Bates-Hirst

VP People & Culture

Tide Team

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