How to Handle UK Payroll: Essential Guide for Business Owners [2025 Rules]

Did you know that UK payroll errors cost businesses thousands of pounds each year in penalties and back payments?

Managing payroll UK operations correctly is essential for every business owner. From registering with HMRC to submitting Real-Time Information (RTI), the process demands attention to detail and compliance with ever-changing regulations. The 2025 rules bring additional requirements that you must understand to avoid costly mistakes.

Whether you employ a single person or manage a large team, establishing proper payroll systems protects your business and ensures your employees are paid correctly and on time. Many business owners find payroll administration overwhelming - but it doesn't need to be.

This guide breaks down the entire UK payroll process into manageable steps. You'll learn how to register with HMRC, understand PAYE requirements, process payroll efficiently, handle all necessary deductions, and decide whether to use software or outsource your payroll functions. Let's get started with mastering UK payroll management.

Registering and Setting Up Payroll in the UK

Before you can process your first payroll in the UK, you need to complete several essential steps. Setting up correctly from the start will save you time and prevent costly errors later.

Register as an employer with HMRC

You must register as an employer with HM Revenue and Customs (HMRC) when you start employing staff or using subcontractors for construction work. This requirement applies even if you're only employing yourself as the sole director of a limited company ^[1].

The registration process should be started before your first payday to ensure you receive your employer PAYE reference number in time. However, HMRC doesn't allow registration more than 2 months before you start paying people ^[1].

You only need to register if any of the following conditions apply:

• You pay an employee at or above the secondary threshold of £96 a week (£417 a month or £5,000 a year) in 2025/26 ^[1]
• Your worker has another job or receives a state/other pension
• Your worker receives taxable benefits in kind ^[1]

Most limited companies can register online through HMRC's employer registration tool ^[2]. Care and support employers must register by phone so HMRC can discuss additional help they might need ^[1].

If you need to pay employees before receiving your employer PAYE reference number, you should still run payroll, store your full payment submission, and then send a late submission to HMRC once registered ^[1].

Get your PAYE reference number

After registration, HMRC will issue two important references: your Accounts Office reference (format: 123PA00045678) and your PAYE reference (format: 123/A246) ^[1]. These are typically sent within 5 working days to your registered office address ^[3].

The PAYE reference consists of two parts: a three-digit HMRC office number followed by a unique reference for your business, typically appearing as 123/AB56789 ^[2].

Each reference serves a specific purpose:

• Use your Accounts Office reference when making payments to HMRC and for payment-related communications
• Use your PAYE reference for all other HMRC contacts and on payroll records ^[1]

Furthermore, once you have these references, you'll need to register for PAYE Online for employers separately. This requires creating a password and activating the service within 28 days of receiving your activation code ^[1].

Choose payroll software or a service provider

To handle UK payroll correctly, you'll need HMRC-recognised payroll software. This software helps you:

• Record employee details
• Calculate pay and deductions
• Report payroll information to HMRC
• Work out HMRC payments
• Calculate statutory payments like sick pay or maternity pay ^[4]

When selecting software, consider which features you need. Some software has limitations and may not:

• Produce payslips
• Record pension deductions
• Make pension payments
• Pay different people over different periods
• Send an Employer Payment Summary (EPS) report ^[4]

HMRC provides a list of recognised payroll software, some of which is free for businesses with fewer than 10 employees ^[5]. Additionally, you can choose between managing payroll in-house with software or outsourcing to a service provider.

In-house management gives you more control, whereas outsourcing can reduce compliance risks and administrative burden. The cost of outsourcing depends on your team size, industry, and benefit structure ^[6].

Regardless of your choice, prioritise HMRC compliance, data security, and support options when selecting your payroll solution ^[6].

Understanding PAYE and Real-Time Information (RTI)

The PAYE system forms the backbone of UK payroll operations. Once you've registered as an employer, you'll need to understand how this system works alongside Real-Time Information (RTI) reporting requirements.

How PAYE works for tax and National Insurance

Pay As You Earn (PAYE) is HMRC's system for collecting Income Tax and National Insurance directly from employee pay. Rather than requiring employees to pay a lump sum at year-end, PAYE spreads tax payments throughout the tax year (6 April to 5 April) ^[7].

Your payroll software calculates tax using employee tax codes. These codes, typically a combination of numbers and letters (such as 1257L or K396), tell you how much tax to deduct ^[7]. For 2025/26, the personal allowance remains £12,570, with basic rate tax (20%) applying to earnings between £12,571 and £50,270 ^[8].

National Insurance contributions work differently:

• Employees don't pay NI on earnings below £242 weekly (£1,048 monthly) ^[7]
• Between £125-£242 weekly (£542-£1,048 monthly), employees are treated as having paid NI, protecting state pension entitlement ^[7]
• Employers pay NI on employee earnings above £96 weekly (£417 monthly) ^[9][7]

Unlike tax (calculated cumulatively), National Insurance is calculated on each payday's earnings in isolation ^[7]. Eligible employers can claim Employment Allowance (up to £10,500) to reduce employer NI bills ^[7].

What to include in RTI submissions

RTI requires two main submission types:

Full Payment Submission (FPS) - The primary report sent each time you pay employees, containing:

• Employer information (PAYE reference, Accounts Office reference) ^[1]
• Employee details (name, address, date of birth, gender, NI number) ^[1]
• Payroll ID information ^[1]
• Payment amounts and all deductions ^[10]
• Employment starter/leaver information ^[1]

Employer Payment Summary (EPS) - Used to report:

• Statutory payments recovered ^[1]
• NI compensation on statutory payments ^[1]
• Construction Industry Scheme deductions ^[1]
• No payments to employees in a tax month ^[1]

For new employees, you must ask the starter questions previously found on P46 forms. Though P45s aren't submitted to HMRC, you still need their information to determine the correct tax code ^[11].

Deadlines for reporting to HMRC

FPS submissions must be sent on or before each payday ^[2]. Your software should submit this electronically with the actual payment date, not an earlier or later date, even during bank holidays ^[2].

If you make no payments in a tax month, submit an EPS by the 19th of the following month ^[12]. After submitting FPS reports:

• View your tax and NI liability from the 10th of the next tax month ^[2]
• Claim reductions via EPS by the 19th ^[2]
• Pay HMRC by the 22nd (or 19th if paying by post) ^[2]

Missing deadlines triggers automatic penalties based on company size:

• 1-9 employees: £100 fine ^[10][13]
• 10-49 employees: £200 fine ^[10][13]
• 50-249 employees: £300 fine ^[10][13]
• 250+ employees: £400 fine ^[10][13]

Additional penalties apply after three months of non-compliance ^[14]. At tax year-end (5 April), you must mark your final submission as "Final Submission" ^[1], provide P60s to employees by 31 May ^[15], and report employee benefits via P11D forms by 6 July ^[16].

Step-by-Step Payroll Processing

Running payroll involves a series of systematic steps that must be completed in sequence each pay period. Following these procedures correctly ensures compliance with UK tax laws while maintaining accurate records for your business.

Collect employee data and timesheets

The first step in payroll processing requires gathering complete information about work hours and employee status. You must track regular hours, overtime, holidays, and paid time off for each employee ^[4]. For hourly workers, accurate time records are essential for calculating correct wages. Payroll records must be kept for at least 3 years from the end of the tax year they relate to ^[5]. Failing to maintain proper records can result in HMRC estimating what you owe and imposing penalties up to £3,000 ^[5].

Calculate gross pay and deductions

Once you have gathered all timesheet data, calculate each employee's gross pay based on their salary, hourly rate, or other compensation arrangements. After establishing gross pay, determine all necessary deductions:

• Income tax (based on tax code and thresholds)
• National Insurance contributions (paid on earnings above £242 weekly) ^[17]
• Student loan repayments
• Pension contributions
• Other deductions (court orders, child maintenance)

Your payroll software should automate these calculations, particularly for tax and National Insurance ^[17]. Remember that employers must also calculate their own National Insurance contributions on employee earnings above £96 weekly ^[17].

Generate and distribute payslips

By law, you must provide payslips to all employees on or before payday ^[18]. Every payslip must show:

• Gross pay (before deductions)
• All deductions (tax, NI, etc.)
• Net pay (after deductions)
• Hours worked (if pay varies by time worked) ^[18]

You can distribute payslips either in printed form or electronically, depending on your company policy ^[18]. Many payroll software packages offer built-in payslip generation and distribution features ^[19].