PAYE

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.

What is PAYE?

You are legally obliged to operate PAYE for any employee with an income above the lower earnings limit (£107 per week, £464 per month, 2012-13) 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.

Operating PAYE

If you need to operate PAYE, you must register with HMRC. You also need to decide how you want to manage your PAYE affairs.

You can deal with PAYE yourself, using a manual system, but this is complex and time-consuming. As most of the key PAYE returns must be filed online, a solution is to use payroll software. Most payroll software will include a PAYE calculator that works out deductions and will automatically complete PAYE forms for you.

Small businesses can use HMRC’s own basic tools, which include a PAYE calculator and will deal with the key PAYE forms. 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 PAYE system is being reformed this year through 2014, so employers will have to submit earnings information whenever their staff are paid. The new system will also be linked to benefit payments (to be known as Universal Credit). It really is worth discussing how you plan to handle PAYE with your accountant.

PAYE calculators

If you use payroll software or HMRC’s basic tools, this will include a PAYE calculator.

If you have decided to operate a manual system, 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 2012-13 is 810L.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.

HMRC provides two online PAYE calculators: the PAYE tax calculator and the PAYE calculator for National Insurance contributions.

Popular content on PAYE

• Payslip checker tool
• Taxcode checker tool
• HMRC Tax checker tool

Find more articles and tools on PAYE in the Resources box on the right.