When it comes to paying employees, things can get complicated fast. As an employer, you have legal responsibilities to meet, and as an employee, you want to make sure your paycheck is accurate. That’s where PAYE (Pay As You Earn) comes in. A system designed to handle income tax and National Insurance deductions directly from wages.
Understanding PAYE is essential for both employers and employees. Whether you’re running payroll for the first time or wondering why your paycheck looks the way it does, let’s break it down in a way that makes sense.
What Is PAYE?
PAYE is the system used by HM Revenue & Customs (HMRC) in the UK to collect income tax and National Insurance Contributions (NICs) from employees’ salaries before they receive their wages. Instead of employees handling their taxes at the end of the year, deductions are made automatically each payday, ensuring consistent tax payments and avoiding large year-end bills.
This system simplifies the process for workers but creates responsibilities for employers. Including accurate calculations, timely payments, and proper reporting to HMRC.
How PAYE Works for Employers
If you hire employees, you must register for PAYE with HMRC. Here’s what that involves:
1. Running Payroll
Employers must deduct income tax, NICs, and other relevant contributions. Such as student loan repayments or workplace pension contributions. Before paying employees. This is done through payroll software that calculates how much tax and NICs to deduct based on an employee’s tax code and earnings.
2. Reporting to HMRC
Every payday, employers must send a Full Payment Submission (FPS) to HMRC, detailing each employee’s earnings and deductions. This keeps everything transparent and ensures compliance with tax laws.
3. Paying HMRC
The amounts deducted from salaries must be paid to HMRC by the 22nd of each month (or the 19th if paying by post). Missing a payment can result in penalties, so staying on top of deadlines is crucial.
4. Issuing Payslips and End-of-Year Reports
Each employee needs a payslip showing their earnings and deductions. At the end of the tax year, employers must provide a P60 to any worker still on the payroll, summarizing their earnings and tax contributions for the year.
On top of that, if an employee leaves, employers are responsible for issuing a P45, which helps ensure the correct tax code when starting a new job.
What PAYE Means for Employees
For employees, PAYE means you don’t have to calculate your own taxes. Your employer does it for you. But that doesn’t mean you shouldn’t keep an eye on things. Mistakes can happen, and understanding your payslip can help you spot any discrepancies.
1. Understanding Your Payslip
A standard payslip includes:
- Gross pay – Your earnings before deductions
- Income tax – Tax withheld based on your tax code
- National Insurance – Contributions towards state benefits
- Pension contributions – If you’re in a workplace pension scheme
- Student loan repayments – If applicable
Your payslip might show other deductions, too, depending on your situation. Keeping track of your earnings ensures you’re not over- or underpaying tax.
2. Tax Codes Matter
Your tax code dictates how much tax is deducted from your paycheck. HMRC issues tax codes based on your personal allowance and circumstances. If your tax code is incorrect, you might be paying too much or too little tax. If that happens, it’s worth getting in touch with HMRC to correct it.
3. Claiming Tax Refunds
Overpayments aren’t uncommon. If PAYE deductions were too high. Perhaps because of an emergency tax code or changes to your income. HMRC may owe you a refund. You can claim refunds online or wait for HMRC to issue a rebate automatically.
Common PAYE Mistakes and How to Avoid Them
Whether you’re an employer or employee, mistakes with PAYE can lead to headaches. Here are some of the most common issues and how to prevent them:
Employers:
- Missing reporting deadlines – Late FPS submissions can lead to penalties. Using payroll software with reminders can help.
- Incorrect tax codes – Ensure tax codes are updated when employees start, leave, or change circumstances.
- Failing to submit pension contributions – If your company offers auto-enrollment pensions, you must deduct and pay contributions correctly.
Employees:
- Not checking payslips – Always review your tax code and deductions to ensure accuracy.
- Ignoring P45 and P60 forms – These documents help track what you’ve paid in tax and are useful for refunds or future employment.
- Forgetting to update HMRC – If you switch jobs, get a second job, or start earning differently, inform HMRC to avoid tax issues.
PAYE and Self-Employed Workers
For self-employed individuals, PAYE doesn’t apply directly. Taxes are handled through Self Assessment. However, if you have another job alongside self-employment, that portion of your income will be taxed through PAYE, while your self-employed earnings must be reported separately.
Some people mistakenly assume PAYE covers all their income when they have multiple sources. Double-checking how your taxes are calculated can prevent unexpected tax bills.
Final Thoughts
PAYE keeps tax deductions hassle-free for employees while imposing strict responsibilities on employers. Whether you’re running payroll or receiving a paycheck, understanding how deductions work ensures accuracy and compliance.
For employers, staying on top of payroll obligations can prevent fines and unnecessary stress. For employees, checking payslips and tax codes can prevent costly errors. If in doubt, reaching out to HMRC or a financial advisor is always a smart move.
Running payroll or managing tax deductions doesn’t have to be overwhelming. Just stay organized, keep records updated, and don’t hesitate to ask for help when needed.