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What is payroll? A guide to processing Payroll

QuickBooks UK provides a comprehensive step by step guide on how to set up and process payroll taxes and calculate payroll deductions. Find out more.

6 min read

If you’re running a business in the UK, you’ve probably come across all the complicated issues around payroll tax. Don’t worry if it all seems a bit overwhelming - this guide will help you find out everything you need to know about payroll for business.

What is payroll tax?

Payroll refers to any tax withheld from a worker’s salary by an employer, who pays the tax on their behalf. Learn more about how to set up payroll for your employees on the QuickBooks small business blog.

This article will focus on payroll for UK companies only - if you’re in the United States, you can find our US guide here.

How does payroll work?

In the UK, payroll tax works through the Pay As You Earn (PAYE) system. In simplest terms, if you’re an employer, it’s your job to work out how much tax your employees owe, subtract it from their pay packet and send it to Her Majesty's Revenue and Customs (HMRC). 

You do this every time you pay your employees - for the vast majority of businesses, that’s monthly - and the process is the same for salaried workers as for those paid by the hour. 

As always, it’s crucial you keep your accounts up to date. In addition to making sure your workers are getting paid the correct amount, you also need to send your most recent pay deductions to HMRC by the 19th of every month if you pay by post and by the 22nd if you pay electronically.

How to set up employee payroll

You need to set up payroll as soon as you hire your first employee. It can seem pretty daunting, but the process is quite simple if you break it down.

Set up PAYE for your new employee. You’re now set up to pay your new employee and work out PAYE for them. Every time you pay them, you should record their pay, calculate deductions, calculate the employer’s National Insurance contribution that you’ll need to pay, produce payslips, and report all of that to HMRC in a document called a ‘Full Payment Submission’ (FPS).

  1. Apply online for your PAYE reference number. Government should get back to you with a number within five working days. 

  2. Request the employee’s tax code. This can be found on their payslip, P60, P45 or letters pensions.

  3. Request the employee’s National Insurance number. Their NIN can be found on their payslip, P60, or letters about tax, pensions and benefits. 

  4. Request the employee’s P45 form from their previous employer. This will detail what they’ve paid in the tax year to date and will help work out the correct tax code. If they can’t provide a P45, HMRC has a checklist you can use to help you work out how much they owe. 

  5. Set up PAYE for your new employee. You’re now set up to pay your new employee and work out PAYE for them. Every time you pay them, you should record their pay, calculate deductions, calculate the employer’s National Insurance contribution that you’ll need to pay, produce payslips, and report all of that to HMRC in a document called a ‘Full Payment Submission’ (FPS).

All of the above might sound pretty complicated. If it does, don’t worry - there are plenty of resources, software and businesses to help you.

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What is a payroll tax deduction?

The most obvious payroll tax deduction is National Insurance, which employers have to pay both for themselves and for their employees when their earnings cross a certain threshold. It’s also worth noting that National Insurance contributions begin at a far lower level than formal taxes - the ‘tax-free allowance’ isn’t entirely free.

Workers who earn above a certain level will have income taxes deducted, and employers must also withhold contributions for things like student loan repayment and pensions.

Crucially, amounts will vary by a lot, dependent on government policy, your situation, and your employees’.

How to pay payroll taxes

If you’ve made it this far, congratulations - you have enough to understand what payroll tax is and how it affects your business. You know you need to register your employees, send regular updates to HMRC and report and pay any taxes owed each month.

But how do you pay payroll taxes?

The good news is you have a lot of choice over how you do it. Though the government encourages businesses to pay online, you can still pay through the mail by check, by telephone banking or even in cash at your bank branch. 

The full options are listed here.

A note on ‘withholding’

At this point, it’s worth noting a potential source of confusion. Some US sources talk about ‘withholding’ payroll tax as if it’s a separate thing. In fact, the term doesn’t seem to be used in the UK in this context, and instead refers simply to the standard way of paying payroll tax. 

Don’t worry, then, if you see US articles splitting up payroll payments into withholdings, garnishments and more - you can safely ignore all that (and that might come as a relief).

How to calculate payroll taxes

As we’ve said a few times, it can be tough to work out all the different deductions for each of your individual employees. HMRC helpfully provides a calculator, but even they present it as a way to check you’ve paid the right amount rather than a tool to work out payments from scratch. 

We could go into great detail here on how much you and your employees would need to pay in National Insurance contributions, for instance - but that wouldn’t do much more than clog up this article with a lot of numbers that might not be relevant to you and your business. 

Instead, we recommend using a specialist firm or payroll software to work it out for you. Especially as your business grows, it will take up too much time to crunch your own numbers. 

We hope that this article has answered your questions about what payroll is and how it works. To summarise, employers are required to withhold their workers’ taxes and pay them to HMRC. They do so through the PAYE system, and must keep HMRC up to date on both monthly payments and any changes to employee status. You can pay how you like, though online is recommended, and the precise amounts will vary significantly among different workers.

Stay compliant with QuickBooks

Do you have employees on payroll? Choose our easy-to-use software to automate your payroll process. For more tips for managing your small business, discover the QuickBooks blog.