PAYE Tax – a guide for small businesses

Pay As You Earn (PAYE) is HMRC’s system to collect Income Tax and National Insurance contributions.

With the PAYE system, employers and occupational pension payers, as part of their payroll and where applicable, make deductions of tax, National Insurance Contributions, Student Loan and Postgraduate Loan deductions, pension contributions, and to also to report payments and deductions on or before each payday

Most UK employers use a PAYE payroll system to accurately Calculate the tax and NIC due on the gross pay and then deduct this from wages before they are paid.

Deductions are determined by an employee’s tax code and their National Insurance category letter (see more on these below).

There's no need to register for PAYE if none of your employees are paid £118 or more a week, if they don't get expenses and benefits, have another job, or get a pension.

However, you must keep payroll records.

Failing to pay the correct PAYE tax to HMRC when required can lead to interest and penalty payments.

It is the responsibility of the employer to ensure the correct deductions are made at the correct time, even if an agent is used.

Understanding payroll and PAYE tax is important for any small business owner to ensure you avoid penalties and staff are paid accurately and on time.

Learn more with HMRC's Guide to PAYE video.

Getting ready to employ staff

Before employing staff there are a number of steps you need to go through to ensure your business is compliant with employment law.

From understanding your business needs to ensuring your workplace is both safe and accessible for employees, there's a lot to think about before hanging the metaphorical 'help wanted' sign.

To lean more, read out guide on employing staff.

Setting up your PAYE payroll

If you’re starting up and aren't outsourcing payroll services, you can set up a payroll system yourself.

But before you can do this, you’ll must:

• Register as an employer with HMRC. This so you can get your employer PAYE reference number and be able to login to use PAYE Online. Even if you're only employing yourself, for example as the only director of a limited company or the sole director of a limited company, you must register.
• Choose your payroll software. The software must be able to report PAYE information in real time to HMRC.
• Record all sums paid to your employees. This needs to include deductions taken from their earnings, and you'll need to report these sums to HMRC on or before payday and then submit Income Tax and NICs payable to HMRC.
• Maintain accurate payroll and PAYE tax records. You must also tell HMRC about relevant changes regarding your employees.

How to use employee PAYE payslips

You must give your employees a payslip on or before payday.

It should detail their gross wages (earnings before deductions), deductions, net wage or take-home pay, hours worked and rate of pay, their National Insurance number and tax code as well as the earnings and deductions taken so far within the current tax year.

Payroll software produces a payslip for each employee, which you can print and give to them or simply email it to them.

How does PAYE work?

Most employers use payroll software, which makes calculating pay and deductions easier and quicker.

For PAYE tax purposes, pay can also include tips, benefits, bonuses, commission and statutory maternity or sick pay.

Employee payments and deductions must be reported to HMRC on or before payday.

Commercial payroll software can report PAYE information to HMRC online in real time.

Employers must tell HMRC if they take on a new staff member.

They must also let HMRC know if an existing employee’s circumstances change, for example, if they reach state pension age or become a director.

Understanding PAYE forms – P11D, P11D(b), P60 and P45

At the end of the tax year which ends on 5 April, employers must submit a P11D form to HMRC for employees who have received expenses or benefits.

You also need to submit a P11D(b) form must have submitted a P11D online form online by 6 July if you’ve previously submitted any P11D forms; you’ve paid employees’ expenses or benefits through your payroll or if requested by HMRC.

You must also give your employees a P60 at the end of the tax year.

This is a statement summarising their pay and deductions for that tax year.

You must give your employees a P45 and let HMRC know when they leave your employment.

How to pay PAYE deductions to HMRC

Based on the data you input, your payroll software will tell you how much PAYE tax and NICs you need to pay HMRC.

This is usually payable each month, however small businesses that expect to pay less than £1,500 a month can arrange to pay quarterly.

If your business qualifies, you can contact the HMRC payment enquiry helpline on 0300 200 3401 to discuss this.

Employers use the HMRC PAYE Online service to access tax codes and notices about their employees, as well as receive alerts from HMRC when reports or payments are late or appeal any penalties.

You use payroll software to send a Full Payment Submission (FPS) to report to HMRC payments made to your employees and deductions taken from their earnings.

To do this, you’ll need to enter your PAYE reference and Accounts Office reference into your payroll software – you get both reference numbers when you first register as an employer.

The FPS must be sent either on or shortly before payday, even if you pay HMRC each quarter (rather than monthly).

There are circumstances when sending an FPS after payday is allowed. Your payroll software should provide instructions on how to complete and send your FPS.

'If you did not pay any employees, you should send an Employer Payment Summary (EPS) instead of an FPS, to advise 'no payment for period'.

Otherwise HMRC may calculate an estimated amount due, based on your previous FPS.

Ways to pay HMRC

Same or next day payments can be made to HMRC using online or telephone banking or CHAPS using the PAYE HMRC account details for payments.

Allow three working days to pay online either by BACS, debit card, or company credit card, Direct Debit, or by cheque via the post.

You can make a single direct debit payment or set-up an automatic Direct Debit instruction, which enables HMRC to automatically collect your payments when they are due, calculated from the amounts you have reported in your submissions.

The service can be accessed through GOV.UK website or directly through your HMRC PAYE Online account.

If paying via cheque, you’ll need to use your 13-character accounts office reference number as the payment reference, to ensure the payment is allocated to your PAYE account.

To verify that HMRC has received your payment, you can check your HMRC online account.

The payment should show within six working days.

Key PAYE tax deadlines to know about

• In the next tax month, you can access your HMRC online account from the 12th day of the month to see your FPS and find out how much in tax and NICs your business owes.
• If paying electronically, you must pay HMRC deductions taken from your employees’ earnings in the previous month as reported on your FPS by the 22nd of the month.
• If paying by cheque through the post, your payment must reach HMRC by the 19th of the month.

The Government provides more in-depth payroll and PAYE guidance for employers on managing your payroll obligations.

How to get a PAYE tax refund

You can claim a reduction (though employment allowance) on the money you owe to HMRC by sending an Employer Payment Summary (EPS) by the 19th day of the month, with the balance paid on the 22nd day, or the 19th day if you’re paying by post.

Overpayments or credits will reduce your next PAYE bill, or you can apply for a PAYE tax refund.

Overpaid tax should be refunded through payroll to the respective employee if, for example, a payroll mistake was made and too much income tax paid.

Understanding PAYE tax codes

To find out how much tax to deduct from an employee’s pay, you can enter their tax code into your payroll software.

A new employee’s tax code can be found on their P45, which they must receive when they leave their former employer.

Remember that if an employee begins working for you without a P45 you need to inform HMRC.

An employee’s PAYE tax code is made up of a number and a letter or letters.

Once multiplied by 10, the number shows how much tax-free income they can earn during that tax year.

The most common tax code for tax year 2023-2024 is 1257L.

It applies to people with one job and no untaxed income, unpaid tax or taxable benefits such as a company car.

The letters in an employee’s tax code refers to their employment/tax circumstances and how this affects their Personal Allowance e.g., M refers to an employee whose spouse or civil partner has transferred some of their Personal Allowance.

You may need to update your employee’s tax code at the start of a new tax year, because the number can change.

If the tax code changes during the year, HMRC will let you know.

Then you can update your payroll records to ensure the correct amount of tax is deducted.

PAYE tax tips

1. If you've ten employees or less, use free payroll software that is HMRC approved. It must be able to report PAYE information to HMRC online in real time. HMRC has a list of free payroll software to choose from.
2. If you've ten or more employees, you can use paid-for software that enables your business to report in real time. HMRC has a list of paid-for payroll software to choose from.
3. The payroll software you choose should give you the full range of capabilities your business needs. For example, you may need it to produce payslips or make pension payments.
4. When completing your Full Payment Submission (FPS) to report payments and deductions to HMRC, split staff into groups to make the task more manageable. For example, do employees first, then directors, or full-time staff first, then part-timers.
5. If you’ve made a mistake in your FPS, correct it as soon as possible. HMRC may ask you to amend the FPS for previous years if an error is found
6. Check if you need to deduct child maintenance directly from an employee’s earnings or pension.
7. You must inform HMRC if you haven’t paid any employees for at least one tax month. You do this by filling in an Employer Payment Summary (EPS), which must be sent by the 19th day of the month following the tax month when no employees were paid. Failure to do so can lead HMRC to send you a notice estimating how much you owe, while you may also have to pay a penalty.
8. If your payroll software does not produce P60s, you can order copies from HMRC.
9. Make sure you update your payroll software so that it uses the latest rates and thresholds.
10. If your business does not maintain full PAYE/payroll records, HMRC may estimate how much is payable – and hit you with a penalty of up to £3,000.
11. You need to tell HMRC straight away if your business stops employing people.
12. A PAYE Settlement Agreement (PSA) allows you to make one annual payment to cover all the tax and National Insurance due on minor, irregular or impracticable expenses or benefits for your employees.