As a business owner, it’s your responsibility to calculate and deduct income tax and National Insurance if you draw a salary or manage a team – and then pay it to HMRC.
For most salaries, you’ll do this via a system called PAYE. But what is PAYE and how does it work?
In this guide, we explain PAYE for both limited company directors and employers, when and how to register for PAYE, which PAYE deductions you must make – and how to report and pay to HMRC.
What is PAYE?
PAYE stands for Pay As You Earn. It’s the system that enables businesses to calculate and pay the correct amount of income tax and National Insurance owed to the government.
Whether you need to pay yourself or your team from your company, you’ll use payroll processing to calculate the appropriate deductions and payroll benefits before any payslips are issued.
Because income tax and National Insurance are automatically deducted on the employee’s (or your own) behalf, no further tax needs to be paid on that specific salary income thereafter.
When to register for PAYE
Registering for PAYE as a limited company director
This is one of the most common educational gaps for new business owners. Even if you’re the sole director of a limited company and have zero employees, you’re legally classed as an employee of your own business.
If you want to pay yourself a salary and take money out of your business this way, you must register for PAYE and run payroll. Running payroll is the only compliant way to process a director's salary, utilise your tax-free Personal Allowance, and maintain your National Insurance contributions for your state pension.
Registering for PAYE as an employer
You must register for PAYE if, in the current tax year, your company has an employee who meets at least one of the following criteria:
is paid at least £123 per week
gets expenses and company benefits
receives a pension
has had another job, or
has received Jobseeker’s Allowance, Employment and Support Allowance or Incapacity Benefit.
Setting up PAYE payroll
If you meet the requirements for PAYE, you must register as an employer with HMRC. This enables you to get your employer PAYE reference number and login details to use with PAYE online. Registering for PAYE and getting your employer PAYE reference number is just the first step towards setting up an effective and compliant payroll system. Find out more in our complete guide to payroll for small businesses.
Do sole traders need to register for PAYE?
Generally, no. A sole trader is a self-employed worker and not an employee of the business. This means they handle their own income tax and NICs via their annual Self Assessment tax return – and do not need to use PAYE or payroll to take money out of their business.
However, if a sole trader decides to build a team and takes on at least one employee, they must then register for PAYE in the same way a limited company would.
Reporting pay and deductions to HMRC
You must report all payments and deductions to HMRC on or before payday.
To do this, you’ll need to complete a Full Payment Submissions form (FPS) – for which you’ll need the correct tax codes and category letters.
Payments you must report to HMRC include:
Wages or salaries (including your director salary)
Tips and bonuses
Expenses and benefits
Statutory sick pay
Statutory maternity pay
Deductions from pay that must be reported include:
Income tax
National Insurance Contributions
Student loan repayments
Pension contributions
In addition to your FPS, you’ll need to send HMRC an Employer Payment Summary (EPS) if you want to reclaim any statutory maternity, paternity, adoption, parental bereavement or shared parental payments.
Once you’ve submitted these reports, you’ll be able to see how much you owe by signing into your HMRC online account.
In addition to these reports, you must tell HMRC when a new employee joins or if a current employee’s status changes within the company. For instance, if they become a director or they reach the State Pension age.
You’ll also need to run annual reports at the end of the tax year, informing HMRC of annual employee expenses and benefits.
How PAYE tax and NICs are calculated
The amount of income tax individuals must pay depends on how much they earn, and most people are eligible for a tax-free personal allowance of £12,570.
Once they earn more than this amount, standard income tax rates and bands apply:
Income Tax rates and bands
Band | Taxable Income | Tax Rate |
|---|
| | |
| | |
| | |
Tax codes
To find out how much tax to deduct, you need the correct tax code. A new employee’s tax code is found on their P45, which their previous employer must give them.
PAYE tax codes are composed of a string of numbers with a letter at the end. When multiplied by ten, the number shows how much tax-free income an individual can earn in a tax year.
The most common tax code is 1257L, which applies to people with one job and no untaxed income, taxable benefits, or unpaid tax.
National Insurance Contributions (NICs)
You are also responsible for deducting National Insurance contributions (NICs) – known as secondary Class 1 NICs – from gross pay.
Similar to income tax, the amount of NICs you must deduct depends on how much is earned and the correct NICs category letter.
Most people fall into category letter A. If not fall into category A, it’s because they’re one of the following:
A married woman or widow entitled to pay reduced National Insurance (category B)
Over the state pension age (category C)
An apprentice under 25 (category H)
An employee (of any age) who can defer National Insurance because they’re already paying it in another job (category J)
An employee under the age of 21 (category M)
An employee who is working in their first job since leaving the armed forces (category V)
An employee under 21 who can defer National Insurance because they’re already paying it in another job (category Z)
Employer National Insurance rates
Category letter | £123 to £175 a week (£533 to £758 a month) | £175.01 to £967 a week (£758.01 to £4,189 a month) | Over £967 a week (£4,189 a month) |
|---|
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
The thresholds range from the lower earnings limit (£123 per week, £533 per month, £6,396 per year) to the upper earnings limit (£967 per week, £4,189 per month, £50,270 per year).
You can only make NICs on earnings at or above the lower limit, which explains why the entirety of the lower earnings limit category is 0%.
For example, if you pay an employee £1,000 per week, you would pay:
Nothing on the first £175
13.8% of the wages above £175 (13.8% of £825 is £113.85)
The right payroll software can help you simplify tax filings, ensure you pay the right amount of tax and NI to HMRC, automate calculations and streamline your financial admin. Learn more about how to upgrade your payroll software in our guide to how to switch payroll providers seamlessly.
How to make PAYE payments to HMRC
Usually, you have to pay HMRC what you owe by the 22nd of the next tax month.
However, if you’re a small employer or company director whose total monthly payroll deductions are less than £1,500 a month, you can arrange to pay HMRC on a quarterly basis. In this case, you would pay by the 22nd of the month in which the quarter ends.
You can make same or next day payments to HMRC via online or telephone banking with Faster Payment or CHAPS.
Alternatively, allow three working days if you choose to pay by:
Debit or credit card online
Direct Debit (allow 4 days if it’s the first payment after set-up)
Via post using a cheque (must reach HMRC by 19th of the month)
To check that HMRC has received your payment, you can look at your HMRC online account. Payments should show within six working days.
PAYE forms and documents for employees
Your obligation to provide accurate PAYE payroll information extends to your team, and to yourself as a director.
Firstly, this means providing a payslip on or before each payday that shows:
Pay before any deductions
Deductions – eg tax and National Insurance
Pay after deductions
The number of hours worked (if the pay varies according to time worked)
And second, it means providing important PAYE forms annually or whenever somebody leaves the business:
P60 – shows how much has been paid in tax and National Insurance during the year (issued by 31 May).
P11D – shows how tax has been paid on certain benefits like company cars. You should provide P11D forms to anyone who has received company benefits before 6th July every year.
P45 – shows what an employee has paid in income tax and National Insurance during the tax year. You must provide this when employees stop working for your business.
Claiming a PAYE refund if you’ve overpaid
If you’ve overpaid tax to HMRC, you can apply for a tax refund. Overpaid tax is most commonly used as credit against future payments. If you prefer, you can apply for a PAYE tax refund at the end of the tax year.
Overpaid tax should be reimbursed to the relevant person via payroll.
Wrapping up
Properly implementing a PAYE system is essential for deducting the correct amount of tax and ensuring HMRC receives contributions on time. When you manage PAYE payroll efficiently, you streamline your financial admin and keep your business fully compliant.
The good news is, Tide Payroll can do it all for you. Whether you want to pay yourself or your team from your company, it calculates salary, tax, and National Insurance deductions in an automated way, before automatically filing them with HMRC.
Take the pain out of payday with our reliable and HMRC-recognised software. Send payments in minutes, with one click from the app – just add in all the details, choose your pay run date, and our software will take care of the rest.
Photo by Polina Tankilevitch, published on Pexels
