Small business owner's guide to PAYE

If you employ staff in your small business, then your payroll will pay the tax they owe directly out of their wages.

Here you can find out how PAYE works and what you as an employer need to do to manage it successfully.

What is PAYE?

Pay As You Earn (PAYE) is the standard method for ensuring your employees pay the right amount of income tax and National Insurance (NI).

Under PAYE, tax and NI is deducted from pay packets before they’re issued, so each employee receives a net amount and doesn’t have to pay any further tax on that income.

Businesses of all sizes use PAYE as part of their payroll function.

Do I need to use PAYE?

You need use PAYE if any of your employees meet one or more of the following criteria:

• Earn £242 a week or more, or £1,048 per month (this is expected to remain the same in 2025)
• Claim expenses and/or receive employee benefits
• Have another job
• Receive pension contributions from you

As soon as you’ve decided to employ someone who falls into this category, you need to register your business as an employer with HMRC. You can do this online.

Even if you don’t need to use PAYE but you do employ people, you need to keep payroll records.

This applies if the employee is automatically enrolled in the workplace pension scheme, which is a legal requirement for eligible employees.

How to get started with PAYE

You (or your payroll department) must ensure that both HMRC and your employees are paid the right amounts.

Payroll software is available that can work out each employee’s gross pay, income tax, NI and net pay, and will send this information to HMRC.

However, it’s your responsibility as an employer to make sure you input the correct information.

Making HMRC payments through PAYE

To find out how much income tax to deduct from each employee, you’ll need to know their tax code.

The government website has a tool for finding out an employee’s tax code. This is easier if you have their P45 (issued by their previous employer, if they had one).

HMRC provides new tax codes when employees' circumstances change. Employers should also be aware that if no P45 is provided, they may need to apply an emergency tax code until the correct information is available.

National Insurance works a bit differently, but also uses codes. People will fit into a category based on their age and employment circumstances (most employees are category A).

Enter each employee’s tax and NI codes into your payroll software, and the appropriate deductions will be made.

You may also need to deduct student loan repayments and make pension contributions for employees enrolled in your workplace pension scheme.

If you have a large number of employees, an accountant or payroll department can make this process much easier.

Do I deduct PAYE before or after sick pay, benefits, bonuses and expenses?

Sick pay, bonuses and benefits are taxable like ordinary income, so you still need to deduct PAYE before paying these.

Expenses (such as work-related travel) are not income (because the employee has to pay for them and then be reimbursed) so these are not subject to tax and NI.

Your payroll software should have a function that lets you pay expenses before PAYE is deducted (and you’ll still need to inform HMRC).

Note that if you reimburse an employee for more money than their actual expenses, the extra sum must be declared as income and be subject to PAYE.

For certain non-taxable benefits (like approved mileage allowances), no tax or NI is due, but reporting is still required.

What do I need to tell HMRC?

You must tell HMRC what you’ve paid employees and everything you’ve deducted.

You will do this reporting through Full Payment Submissions (FPS), and must submit it to HMRC on or before payday. You can send FPS reports through your payroll software.

What happens if I am late with my FPS?

A late FPS report usually results in a penalty or at least a warning if it’s your first time being late. Penalties depend on the size of the employer and can escalate with repeated late submissions.

Other exceptions may include circumstances where your employee hasn’t given you a P45 or you have to pay your employees on a non-banking day.

These exceptions come with numerous rules attached, so it really helps to have an accountant who knows what they are doing.

What do I need to watch out for with PAYE?

Here are some of the other PAYE pitfalls that could cause issues with HMRC.

• Adjustments – not outlining or calculating changes in pay, such as pay rises, bonuses or overtime.
• Incorrect details – not separately outlining or calculating expenses, sick pay and pension payments.
• Tax codes – using the wrong codes for employees.
• Employees leaving – forgetting to take them off the payroll.

If you use a professional accountant, they should manage all aspects of the payroll for you and make sure each FPS is correct.

Do I need to generate P45s, P60s and P11Ds?

There are several forms associated with PAYE, and it’s useful to know what each one is for and what information it covers.

P45 – This is generated when an employee stops working for your business and outlines what they’ve paid in tax and National Insurance during the tax year so far. If you don’t give ex-employees these, HMRC may chase you for them.

P60 – A P60 for every employee is generated at the end of every tax year and show what they’ve paid in tax and National Insurance throughout the year. You need to give them to your employees by the 31^st May each year.

P11D – This form explains how tax has been paid on certain benefits, such as company cars. You should issue a P11D to every employee with certain benefits by 6 July each year. Employers don't need to produce P11Ds if registered for payroll benefits.

You need to produce P45s and P60s, but you don’t have to generate P11Ds. You can however do all three using your payroll software.

Get expert financial advice

As a business owner or employer, you must use PAYE if any of your employees earn more than £242 per week, receive benefits, have other jobs, or receive pension payments from you.

While it is ultimately your responsibility to ensure that your PAYE information is correct at all times, using payroll software and the guidance of a financial adviser or accountant can simplify the process and ensure that your PAYE calculations and reports to HMRC are accurate.

Let Unbiased match you with a qualified accountant or expert financial adviser who can assist you in navigating your PAYE obligations, streamline your accounting processes, and maintain compliance with UK tax laws.