How PAYE works: a complete guide for UK employers

Around 30.3 million employees in the UK are paid through Pay As You Earn [1], and every employer paying at least one person at or above £129 per week is legally required to operate it [2]. The employer NI rate rose to 15% on 6 April 2026, its highest level in over a decade [3], making accurate payroll calculation more consequential than at any point since the system was introduced.

PAYE distributes each employee's income tax and National Insurance liability across every payrun rather than demanding a lump sum at year-end. The employer calculates deductions, subtracts them from gross pay, and reports the figures to HMRC in real time. Getting the mechanics right from the first payday protects the business from late-filing penalties, NI miscalculations, and emergency tax-code disputes that are costly and time-consuming to unwind.

Key takeaways

• PAYE is mandatory once any employee earns at or above £129 per week, the Lower Earnings Limit for the 2026-27 tax year [4].
• Income tax is calculated cumulatively using the employee's tax code, with `1257L` reflecting the standard Personal Allowance of £12,570 [5].
• Employer National Insurance is charged at 15% on earnings above £5,000 per year following the increase on 6 April 2026 [3].
• Every employer must submit a Full Payment Submission on or before each payday under Real Time Information [6].
• Eligible employers can reduce their Class 1 NI bill by up to £10,500 per year through the Employment Allowance [7].

What PAYE is and why it exists

PAYE is HMRC's statutory mechanism for collecting income tax and National Insurance contributions at source from employment income [2]. The system places the collection obligation on the employer rather than the employee, so tax reaches HMRC throughout the year in step with earnings. Before PAYE was introduced in 1944, employees received their full salary and settled tax in an annual lump sum, creating large liabilities and significant collection shortfalls.

The obligation to operate PAYE arises once any employee earns at or above the Lower Earnings Limit of £129 per week [4]. This threshold is intentionally low: a worker on as few as 10 to 12 hours per week at the National Living Wage can trigger the requirement. Employers who fall below the threshold can still register voluntarily, which is common among sole traders who want to pay themselves a director's salary for State Pension purposes.

The employer acts as HMRC's collection agent. The employee's gross pay, tax code, and National Insurance category together determine the exact deductions for each payrun. HMRC-recognised payroll software performs these calculations automatically and submits the results to HMRC without the employer needing to master the underlying specification documents.

How income tax is deducted under PAYE

Income tax is calculated on the portion of earnings that exceeds the employee's tax-free allowance for each period [5]. The standard Personal Allowance is £12,570 per year, encoded in the tax code `1257L`. Payroll software applies this on a cumulative basis by default: each pay period references total earnings and total tax paid year-to-date, correcting automatically for any under or overpayment as months accumulate.

The income tax bands for England and Northern Ireland in the 2026-27 tax year are as follows [8]:

Scottish taxpayers diverge above £43,663, where the Higher Rate rises to 42% and a Top Rate of 48% applies on earnings above £125,140 [8]. Scottish employees carry an `S` prefix on their tax code, such as `S1257L`, and Welsh employees carry a `C` prefix. Payroll software must apply the correct regional rates based on the tax code on the employee record, not the location of the employing business.

HMRC prohibits any single PAYE deduction from exceeding 50% of an employee's gross pay, regardless of how large a back-tax liability the employee may have accumulated [9]. This cap operates as a built-in safeguard that prevents employees receiving a negligible or negative net pay due to tax debt, a rule that many smaller employers are unaware of.

How National Insurance is calculated under PAYE

National Insurance is separate from income tax but deducted through the same payrun. Both the employee and the employer contribute, at different rates and on different thresholds [10].

The Secondary Threshold of £5,000 per year is notably lower than the Primary Threshold of £12,570 where employees begin paying [4]. This asymmetry means employers pay Class 1 NI on the band between £5,000 and £12,570 even when the employee owes nothing on those same earnings. For an employee earning the full Personal Allowance, this gap costs the employer roughly £1,131 per year before any income-tax liability applies at all.

The 15% employer rate took effect on 6 April 2026, rising from 13.8% [3]. For a business with 10 employees each earning £35,000, the increase adds approximately £4,200 to the annual wage bill compared with the prior rate, before any Employment Allowance offset.

Certain worker categories attract zero employer National Insurance. Employees under 21 (NI category M) and apprentices under 25 (NI category H) both benefit from a 0% employer rate on earnings up to £50,270 [10]. Armed forces veterans in their first 12 months of civilian employment also qualify for zero employer NI up to the same cap. SME payroll software assigns NI category letters automatically, ensuring these reliefs are applied without any manual configuration.

Real Time Information and the Full Payment Submission

Since 2013, PAYE has operated under Real Time Information. RTI requires every employer to report payroll data to HMRC on or before each payday rather than in a single annual return [6]. This gave HMRC a continuously updated picture of UK employment and payroll, which underpins Universal Credit calculations, student-loan repayment tracking, and automated compliance analytics.

The primary RTI submission is the Full Payment Submission. An FPS is required every time an employer runs payroll and must reach HMRC on or before the payment date. Each FPS contains the employee's name, National Insurance number, tax code, gross pay, income tax deducted, and employee and employer NI contributions for the period [6].

A second submission type, the Employer Payment Summary, is used to notify HMRC of months in which no employees were paid, to claim statutory payment recoveries, and to report Employment Allowance claims [2]. PAYE payments to HMRC are due by the 22nd of the following month when paying electronically, or the 19th by cheque [11].

Late FPS submissions attract graduated monthly penalties based on employer size [12]:

The first late submission in the opening month of a new scheme is forgiven. After three months of outstanding returns, HMRC adds a further £100 per month to the cumulative penalty. A multi-client payroll platform tracks FPS deadlines across every employer scheme a bureau manages, preventing the accidental late submissions that generate these charges.

Tax codes explained

A tax code tells the employer how much of the employee's income to treat as tax-free in each pay period [5]. The number in the code, divided by 10, gives the annual tax-free amount. The most common codes and their meanings are:

When a new employee cannot provide a P45, the employer completes a starter declaration and HMRC assigns an emergency tax code [13]. Emergency codes such as `1257L W1` (weekly paid) or `1257L M1` (monthly paid) calculate tax on a non-cumulative basis: each period is assessed independently rather than against year-to-date totals, which typically results in overpayment until HMRC issues a corrected cumulative code, usually within two to four weeks of the first FPS.

HMRC updates tax codes throughout the year by issuing P6 (new employee) or P9 (in-year change) notifications via PAYE Online [14]. An employer who delays applying a new code risks under-deducting or over-deducting tax, both of which can prompt compliance queries.

Registering as a new employer

An employer must register with HMRC before the first payday [15]. Registration is completed online and HMRC issues a PAYE reference number (formatted as `123/AB456`) and an Accounts Office reference for making payments. Registration also activates PAYE Online, the government portal where employers view tax-code notices, check the PAYE balance owed, and submit authorisation for agents or payroll bureaux.

An activation code for PAYE Online arrives by post within 10 days and must be used within 28 days of the letter date. New employees are registered with HMRC through the first FPS that includes them, using the starter declaration to set the opening tax code. Sole-trader payroll software can guide a first-time employer through registration and first FPS in a single workflow, reducing the risk of missing the pre-payday deadline.

Employment Allowance

The Employment Allowance reduces an eligible employer's Class 1 NI liability by up to £10,500 in the 2026-27 tax year [7]. It is claimed by submitting an EPS to HMRC at the start of the tax year and is offset against monthly PAYE payments until the £10,500 is exhausted. Eligible employers can effectively pay no employer NI at all in the first few months of the year.

Most businesses and charities qualify. The £100,000 prior-year Class 1 NI liability cap that previously excluded larger employers was removed from April 2025, widening access significantly [7]. One restriction remains: a company in which the sole director is also the only employee cannot claim the allowance, which catches many owner-managed businesses paying themselves a low salary supplemented by dividends.

Conclusion

PAYE is the backbone of UK employment taxation. It distributes income tax and National Insurance collection across every payrun, placing compliance responsibility squarely on the employer. The three foundations of a compliant PAYE scheme are HMRC registration before the first payday, payroll software capable of submitting RTI returns, and accurate tax-code data for every employee.

The April 2026 rise in employer NI to 15% raised the financial exposure on every payrun. Employers using HMRC-recognised payroll software benefit from automatic rate updates, built-in RTI submission, and real-time liability tracking, removing the risk of manual miscalculation across every payrun of the year.

Frequently asked questions

When does a business have to start operating PAYE?

A business must register with HMRC and begin operating PAYE before the first payday on which any employee earns at or above £129 per week, the Lower Earnings Limit for the 2026-27 tax year. Registration is completed online through HMRC's employer registration service. Employers who miss the pre-payday registration deadline can face late-registration penalties under Real Time Information, so registering as early as possible once a hiring decision is confirmed is the safest approach.

What is the difference between a Full Payment Submission and an Employer Payment Summary?

A Full Payment Submission is required on or before every payday and reports each employee's gross pay, income tax deducted, and National Insurance contributions for that period. An Employer Payment Summary is submitted in months where no employees are paid, or when the employer needs to notify HMRC of statutory payment recoveries, Employment Allowance claims, or adjustments that reduce the net PAYE payment due. Both submissions are sent through HMRC-recognised payroll software under the Real Time Information framework.

Can a small employer pay PAYE quarterly rather than monthly?

Yes. Employers who expect to remit less than £1,500 per month in combined income tax and National Insurance can ask HMRC to switch to quarterly payments. Monthly payment is the default, with electronic payments due by the 22nd of each following month. Employers wishing to arrange quarterly payments must contact HMRC directly before the first quarterly due date, as the arrangement is not applied automatically.

What happens if a new employee does not have a P45?

When a new employee cannot provide a P45, the employer completes a starter declaration to establish the employee's tax position: whether this is their only job, a second job, or they receive another pension or benefits alongside this employment. HMRC then issues an emergency tax code based on the declaration. Emergency codes calculate tax non-cumulatively, meaning each pay period is assessed independently, which can result in temporary overpayment until HMRC issues a corrected cumulative code, typically within two to four weeks of the first FPS.

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