Complete guide to PAYE for employers

Pay As You Earn (or PAYE) is an essential part of payroll for employers. It’s used by HMRC to collect Income Tax and National Insurance. And if you’re a business owner with employees you’ll be required to use it correctly so that wage deductions are accurate and compliant with HMRC regulations.

In this complete guide we’ll demystify PAYE and break it down, to help you feel more confident taking the next steps. Read on to learn more about PAYE, how it works, how to set it up and implement it for your business.

PAYE for employers: In summary

• PAYE stands for Pay As You Earn. It’s a tax collection system used by HMRC to automatically deduct Income Tax and National Insurance from employees. Employers are legally required to administer PAYE correctly to maintain HMRC compliance.

• PAYE calculations are often based on your employee’s salary, with the deductions rising as their wage does. Tax codes also have a large impact on PAYE deductions and are determined by HMRC.

• Setting up PAYE requires you to first register with HMRC, collect employee information, implement a payroll system that’s compliant with PAYE, and begin submitting Real Time Information (RTI) to HMRC with every payroll run. 

What is PAYE? The basics

PAYE stands for Pay As You Earn – a reference to the automatic role it plays in remuneration. For example, as an employer you’ll calculate an employee's wage, then their Income Tax (IT) and National Insurance (NI) are automatically deducted with PAYE. Without it, employees would receive their wage and be expected to make these tax payments themselves. 

It’s easy to imagine the second scenario resulting in late, or forgotten, payments, additional admin and a general sense of tedium. It’s also worth noting that PAYE isn’t a tax, it’s simply a method of paying tax. However, the term PAYE can refer to both the deduction, i.e. the money taken from a wage for IT and NI, and the HMRC framework that manages the deductions. In this guide we’ll be talking about both and will make it clear which is which.

PAYE on employee payslips

When employees look at their payslips, they’ll be able to see their PAYE deductions. While these exact deductions may vary, there should be a line under “Deductions” that reads “PAYE” or “Income Tax (PAYE)”. As the name suggests, this represents the Income Tax that has been removed/withheld from their gross salary. The amount that is deducted is based on their tax code.

PAYE vs National Insurance (NI)

With two separate taxes being paid through PAYE, it can be easy to conflate the tax and the system, especially when it comes to PAYE vs National Insurance. The two main points are:

1. PAYE is the deduction mechanism for Income Tax and National Insurance

2. National Insurance is a separate contribution to Income Tax. Both are withheld from employee pay, but they fund different things

While National Insurance is deducted from employee wages, employers also have National Insurance obligations towards their employees. As an employer, think of this as topping up your employee’s National Insurance contributions, much like matching a pension contribution. How much you have to pay as an employer will depend on an employee’s earnings and their NI category letter.  

How PAYE works

The basic PAYE process is relatively simple. It will typically involve determining an employee’s gross salary before applying their tax code. From there, you’ll be able to calculate how much to deduct for PAYE before reporting everything to HMRC via your payroll software. 

We’ll address software later, but you should know that it’s necessary for employers to accurately calculate deductions and prevent mistakes. 

The PAYE Calculation Process

A detailed look at how the PAYE calculation process works gives us the following steps:

1. Determine the employee's gross salary

2. Apply their tax code (provided by HMRC)

3. Calculate the tax-free allowance for that pay period

4. Deduct Income Tax on earnings above the allowance

5. Calculate and deduct National Insurance contributions

6. Remit both amounts to HMRC

Let’s follow the PAYE calculation process for an example employee who earns £2,000 gross a month. 

• As someone with a fixed salary, we already know that the employee’s gross salary is £2,000 a month. This may change if your employee’s shifts or hours change from week to week.

• Their tax code can be found through HMRC or, if it’s a new employee, on their P45/Starter Checklist. Let’s assume this employee has the standard tax code 1257L.

• Because the tax code 1257L gives you a tax-free allowance of £12,750 a year, the employee’s tax-free allowance would be £1,047.50 a month.

• Of their taxable income (£952.50) they would have to pay 20% of Income Tax which equates to £190.50.

• Someone who earns between £1,048 and £4,189 a month is subject to Class 1 National Insurance Contributions. This means the first £1,457.50 is taxed at 0%, with the balance taxed at 8%. This equals £76.20.

• Once you’ve calculated this, you’ll need to relay this information to HMRC on or before the day of payment. 

Tax code and PAYE deductions

Assigned by HMRC, tax codes are used by employers or pension providers to determine how much tax-free income employees should receive. While there are a wide range of tax codes available, you can only have one assigned to you at once. Tax codes are allocated based on several factors, including employee Personal Allowance, taxable company benefits, and their untaxed income (if any). 

As an employer, HMRC will update you if an employee’s tax code changes, but the most common code is 1257L. This refers to employees who receive the standard £12,570 of tax-free Personal Allowance. If you receive a tax code that looks strange, you can check it’s accurate with HMRC, but otherwise you should apply it as normal.

PAYE deductions explained

PAYE deductions are your National Insurance and Income Tax payments. If you’re an employer, you’ll be expected to calculate these deductions using the PAYE system, taking an employee’s wage and tax code into consideration. These wage deductions are made before the employee is paid and are sent to HMRC automatically. The two deductions include:

1. National Insurance: This contributes to state benefits, like State Pension, disability or sickness pay, and the NHS. 

2. Income Tax: This largely funds UK public services (the NHS and welfare), infrastructure and the government.    

Income Tax Deductions

As an employer, you’re required to deduct Income Tax from employee salaries based on their tax code and earning level. Income Tax is the primary PAYE deduction, but it’s important to understand that these deductions aren’t paid by the employer; they’re paid by the employee, with the employer making the payment on the employee's behalf. 

From an employee’s perspective, this is money that never enters their bank account, but the amount paid is based on their tax code and income level. For the employer, the deduction has to be accurate and has to be remitted to HMRC on time, which means on the day of or before the employee is paid. Depending on employee roles and remuneration packages, their pay may rise over the course of the year, which would affect their deductions. 

National Insurance contributions

Both employers and employees are required to make National Insurance (NI) contributions when an employee is paid. For the employee, NI comes straight out of their wage and is paid via PAYE. Much like Income Tax, their NI payments don’t enter their bank account but are visible on their payslip deductions. 

If you employ people, you’ll also be expected to make National Insurance contributions once they earn above a certain amount. This shouldn’t be covered by employees, from your perspective, this is a business cost. You’ll need to make a NI contribution for every employee over the age of 16 who meets the wage threshold. As with employee NI contributions, the amount you pay will relate to how much your employee is paid.

PAYE reference numbers and employer identifiers

As an employer, you’ll be provided with a unique 8-digit character code, containing both numbers and letters. This is called your PAYE Reference Number and acts as a unique identifier for your business.

It lets you remit PAYE and NI to HMRC, submit payroll information and correspond with HMRC. Your PAYE Reference Number will also appear on payslips and financial documents. 

The format for PAYE Reference Numbers usually contains three to four numbers followed by a forward slash, then an alphanumeric code. For example, 123/YZ890.

As an employer, you might find yourself inundated with references, numbers and identifiers. Fortunately, you can always find your PAYE Reference Number by logging into your HMRC PAYE online account or on your payroll software.

PAYE employee reference vs. employer reference

To make matters more confusing, employees also used to have PAYE Reference Numbers. Fortunately, these are now considered historical, and any references to Employee PAYE Reference Numbers are outdated. We’ve provided a quick guide below.

• Employer PAYE Reference: Unique to the employer, used for remitting and reporting

• Employee PAYE Reference Number: A historical identifier sometimes used by employees (now largely superseded by National Insurance numbers)

Employees will now provide their National Insurance number for PAYE purposes, instead of a separate PAYE employee reference.

Setting up PAYE: a step-by-step guide

Setting up PAYE is a structured process that employers must complete before paying their employees. It’s a process with multiple steps that involves registering with HMRC, gathering employee information, and implementing payroll systems. To keep things manageable, we’ve broken it down into easy-to-follow steps, so you can feel confident setting up PAYE.

Step 1: Register as an employer with HMRC

Setting up PAYE begins with registering as an employer with HMRC. You’ll need to register before you begin paying your employees, so plan ahead. You can register online via HMRC services or, alternatively, you can call HMRC and register over the phone. You’ll be required to provide information when you register, including:

• Details of your business, including the type of business and the person operating the scheme

• Personal details so HMRC can contact you 

• Information on your employees, including the number of employees, and their first pay date 

It may sound obvious, but you’ll only need to register as an employer if you plan to employ someone. When you register, you’ll receive a letter from HMRC which will contain your PAYE and Accounts Office references. These are necessary to report and pay PAYE tax and NI. The time it takes for the letter to be sent can vary, but you can check online to see when you can expect a reply.

If you fail to register as an employer on time, you might face backdated tax bills, financial penalties, and interest charges. 

Step 2: Gather employee information

Before you can start paying your employees, you’ll need to collect some essential information about them. The following things are essential to ensure your payments are accurate and are sent to the right employees.

• Full name and date of birth

• National Insurance number

• Address

• Starter information (P45 from previous employer, or starter declaration)

• Tax code (from HMRC or P45)

• Bank details (for payment)

• Pension scheme details (if applicable)

Step 3: Implement a payroll system

As we’ve already explored, you’re required to send information to HMRC every time you pay an employee. To do this, you’ll need to use a payroll (or manual calculation) system that is compliant with PAYE. 

The information you’re required to send is collectively referred to as Real Time Information, or RTI and contains:

• Full Payment Submission (FPS) – Must be submitted every time you pay your employees. Contains the details of an employee’s pay, their taxes and deductions. 

• Employer Payment Summary (EPS) – Must be submitted when adjustments are made to an employee’s NI or tax contributions. 

You have a number of options when submitting this information to HMRC. Many opt for payroll software, as it offers both highly accurate and automated solutions. However, becoming proficient with payroll software can take some time. Alternatively, you can choose to pay for accountancy services. Letting experts handle your payroll can bring you peace of mind but can be a costly option.

Step 4: Make your first PAYE submission

When making your first PAYE submission, it will likely be an FPS (Full Payment Submission). Which means including details of how much you’ve paid staff, but also the deductions made for tax, National Insurance, and anything else. You’ll need to submit this information to HMRC before or on the same day as you pay your employees. 

You can do this by following your payroll software’s instructions, or send it via the Government Gateway.

If you miss a deadline or send the incorrect information, you should send a corrected FPS as soon as possible. There may be financial penalties for late payments. 

Step 5: Remit PAYE and National Insurance to HMRC

Finally, you’ll need to remit, or pay, the Income Tax and National Insurance you’ve deducted from your employees to HMRC. The deadline for these payments is usually the 22nd of the following month, or the 19th if you’re paying by cheque. The most common way of paying is via Direct Debit, as this can be adjusted to reflect your PAYE submission. You can also pay online via HMRC online, via a bank transfer or by cheque. 

Your PAYE bill can include multiple things, including:

• Income Tax deductions from employees

• National Insurance

• Student Loan repayments

• CIS deductions

You can check online to see if your payment has been received after 6 working days, or request confirmation if you’re paying by post. If you’ve not paid any employees for at least one tax month, you need to tell HMRC via an EPS.

PAYE for employers: Key responsibilities

Employing staff comes with a number of responsibilities, and this extends to PAYE. You’ll be expected to keep accurate records, provide payslips and carry out year-end procedures. Read on to explore these in more detail, and discover what they mean for you as an employer.

Keeping accurate records

Employers are required to maintain detailed payroll records for each employee and pay period, whether weekly, biweekly or monthly. You should record the following details:

• Gross salary and net pay

• PAYE deductions

• National Insurance contributions

• Pension contributions

• Payslips provided to employees

• RTI submissions made to HMRC

As these records are used to prove you’ve made accurate reports, you’re expected to retain them for 3 years.

Providing payslips to employees

When you pay your staff, you’ll need to provide them with payslips either on or before the date of payment. Payslips should include:

• Gross pay

• All deductions (PAYE, National Insurance, pension, etc.)

• Net pay

• Year-to-date figures

• Payslip date and pay period

Payroll software like QuickBooks will automatically create payslips that can be shared, but if you’re generating your own, you’ll need to ensure you avoid mistakes and clearly explain any deductions.

Many employers also wonder whether they should use digital or paper payslips. Today, most companies use digital options, as they’re cheaper, easier to manage, and can be accessed by employees remotely. However, for record-keeping purposes, you may find that some employees prefer paper. Ultimately, you need to decide which operation works best for your business.

If an employee questions their payslip, perhaps because they believe you’ve taken off too much or they don’t understand why, you should begin with an internal review. Double-check your figures, and provided everything is accurate, explain anything that might be causing confusion.

Year-end PAYE procedures

At the end of the tax year (5^th April), you’re required to complete, or are expected to have completed the following procedures: 

• Issuing P60 statements to current employees (showing annual earnings and deductions)

• Issuing P45 statements to employees who leave

• Reconciling annual submissions with actual payments made to HMRC

• Submitting final RTI information

Payroll for employers FAQs

What if I don't have an employee's National Insurance number?

If you don’t have an employee’s National Insurance number, you should ask them to use the HMRC app to find it. If they don’t have login details already, they can sign up. Once logged in, they’ll be able to find their NI number under “Your details”.

If they’re still unable to find their NI number, you can leave it out until it can be found. It’s important that a NI number is found as soon as possible, as it can lead to HMRC complications and inaccurate record keeping. 

How often do I need to submit PAYE information?

The type of PAYE information submitted will affect how often it needs to be submitted. Full Payment Submission (FPS) contains employee pay, tax and deductions and needs to be submitted every pay run. Depending on your business this might be weekly, bi-weekly or monthly, but your submissions should be either on the day of or before employees are paid. 

Employer Payment Summary (EPS) includes information that impacts how much you owe HMRC. Typically, this has to be sent by the 19^th of a month following an FPS.

What's the difference between an employer's PAYE reference and a UTR?

A PAYE reference number is used for PAYE and National Insurance deductions, whereas a UTR is used for Income Tax self-assessment. You’ll likely have multiple identifiers for different reasons, so it’s important to not to get them confused.

What happens if I get PAYE wrong?

With payroll software, it’s more difficult to get PAYE wrong. But if mistakes are made, it’s important to amend the errors. You can usually do this by updating your payroll records and informing HMRC. If you fail to do this, you may face the following consequences:

• Penalties for late payments or non-submission

• Interest charges on underpaid amounts

• Potential investigations by HMRC

• Reputational damage and employee relations issues

It’s important to recognise that you’re expected to manage PAYE as an employer. So if you’re unsure about what you need to do, speaking with a professional can help.

Can employees opt out of PAYE?

PAYE is mandatory and employees cannot opt out of either Income Tax deductions or National Insurance contributions. There may be relief or exemptions in special circumstances, but these are uncommon.

What's the difference between PAYE and self-assessment?

PAYE is a system for employers and employees, while Self-Assessment is a separate tax system for self-employed individuals and those with other income. The main points are:

• Employees under PAYE typically don't need to file Self-Assessment returns (unless they have other income)

• Sole traders and partnerships use Self-Assessment instead of PAYE

• Some individuals may use both systems

Learn more about PAYE and self-assessment.

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