PAYE (Pay As You Earn) is the system used by employers to handle tax and National Insurance contributions due on employees’ pay. Detailed PAYE tax calculations and processes can be complex, but payroll services or software can deal with most of the paperwork for you.
You are legally obliged to operate PAYE for any employee with an income above the lower earnings limit (£109 per week, £473 per month in 2013-14) based on what the employee earns and their personal allowances. Company directors, high earners and employees with complex tax affairs will also need to complete their own self-assessment tax return at the end of the year to work out how much tax is due.
PAYE is also used to deduct employee National Insurance contributions. The employee’s deductions, together with the employer’s National Insurance contributions, are then paid over to HM Revenue & Customs (HMRC).
Statutory payments (such as statutory maternity pay) and deductions such as student loan repayments are also handled through PAYE. Tax and National Insurance on employee benefits are also dealt with using PAYE — either as part of the regular payroll or at the end of the tax year.
If you take on employees, you will need to set up and operate a PAYE scheme for those employees and register as an employer with HMRC.
Visit the HMRC website to read Taking on a new employee - first steps for detailed guidance on the process.
You also need to decide how you want to manage your PAYE affairs. You can deal with PAYE yourself using HMRC’s own basic tools and calculators, but this is complex and time-consuming. As employers now have to sumit their PAYE information to HMRC whenever their staff are paid (known as Real Time Information or RTI), many businesses opt to use RTI compatible payroll software. Compatible payroll software will include a PAYE calculator that works out deductions and will automatically complete PAYE forms and information for you.
Small businesses can use HMRC’s own basic tools, which include a PAYE calculator, will deal with the key PAYE forms and report your PAYE information to HMRC. But the HMRC software will not handle pension contributions and other deductions, or produce payslips. Commercial software can offer a more complete solution that is easier to integrate with your other systems.
Alternatively, you may want to outsource PAYE to a payroll service — your accountant may offer this.
The new RTI PAYE system is also linked to benefit payments (to be known as Universal Credit). It really is worth discussing how you plan to handle PAYE with your accountant.
If you use payroll software or HMRC’s basic tools, this will include a PAYE calculator.
If you have decided to operate PAYE yourself, or just want to see how different pay levels and tax codes will affect deductions, you can use an online PAYE calculator.
Online PAYE tax calculators use the individual’s PAYE tax code to work out how much tax-free pay is allowed in the year and how the income is to be taxed. Different letters indicate which allowances the code is based on and whether special tax treatment applies. For example, the emergency code for 2013-14 is 944L. To use a PAYE calculator to work out National Insurance contributions, you also need to know the employee’s National Insurance category letter. This is because different National Insurance rates apply, depending on whether the employee is a member of a contracted-out pension scheme and other factors.
Popular content on PAYE
Find more articles and tools on PAYE in the Resources box on the right.