How does PAYE work?
Once you become an employer, you’ll need to set up a pay-as-you-earn (PAYE) scheme.
All businesses that employ people earning above the National Insurance (NI) lower earnings limit (£120 per week) must register with HM Revenue & Customs (HMRC) as an employer and operate their own PAYE scheme. This applies even if you’re a company owner taking a salary.
But what does ‘pay-as-you-earn’ actually mean?
Putting PAYE into action
In simple terms, PAYE is the process of deducting income tax from your employees’ earnings at source, and then paying the deducted income tax to HMRC.
Once you have employees, you’ll need to operate PAYE and run a regular payroll. This allows you to calculate your employees’ wages, make all the necessary deductions, pay their salaries, and send the appropriate reporting and income tax to HMRC.
To run your payroll, you can either use free HMRC-approved software, specialist paid third-party payroll software (which can often be included with your cloud accounting platform) or you can outsource your payroll to a third party, such as us, your accountant.
Each employee is allowed to earn a certain amount tax-free. This generally accrues over each pay period, and earnings above that are subject to PAYE. There is also an amount of earnings per pay period above which NI contributions become payable.
Software will help calculate deductions from wages and salaries paid, which include PAYE, NI and student loan repayments. HMRC needs to be notified of details of earnings and deductions before each payment is made.
When employees are off work, you can also make claims to HMRC in respect of certain amounts such as some Covid-related statutory sick pay or parental leave – NOTE: most Statutory Sick Pay (SSP) is not claimable.
Other in-year reporting includes notifying HMRC of any starters and leavers, and when anyone on payroll is either appointed as a director or stops being a director.
Pay cycles are normally either weekly or monthly, but some businesses do pay fortnightly and four-weekly. What you choose is likely to be based on what’s usual in your industry or sector.
If your employees receive fringe benefits – things like a company vehicle or medical insurance etc – these perks can often be included in the payroll calculations so that the tax is collected each pay period.
As well as PAYE and NI deducted from employees, there may also be employers’ NI. Depending on circumstances, many businesses can get an employers’ allowance which waives the first £4,000 of employers’ NI.
PAYE and NI should be paid to HMRC on a monthly basis but can be paid quarterly if the amount due is normally less than £1,500 per month.
In addition to the regular in-year reporting, at the end of the tax year, the final Full Payroll Submission (FPS) needs to be marked as being the last one for the year. Additional reports must be submitted to HMRC detailing employees’ expenses and benefits. There may be additional employer NI contributions due on any benefits provided.
Employees need to be given earnings certificates (P60s) by 31 May and a report of expenses and benefits (P11D) by 6 July.
When you take on employees as a business, you’ll also have to provide a workplace pension scheme as soon as any eligible employee is taken on. Often, the workplace pension scheme is administered in conjunction with payroll processing.
Talk to us about setting up your payroll and PAYE
You may think that you can take on ‘casual’ employees without putting them through a formal payroll – but this is a misapprehension. If you employ anyone over a rate of £120 per week, all your employees must be processed through a payroll system.
Running your own payroll may sound straightforward, but it can become more complex than it first appears. PAYE and NI rules change over time, calculations need amending and workplace pensions requirements add to the workload.