Aug 6, 2023

Top 5 Payroll Mistakes UK Small Business Owners Make and How to Avoid Them


In the intricate world of business management, payroll stands as a critical component, especially for small businesses. Ensuring accurate payroll is not just about paying employees on time; it's about upholding the company's reputation, maintaining employee morale, and avoiding potential legal ramifications. Many business owners are turning to online payroll services, including fully managed payroll service options, for a multitude of reasons:

  • Efficiency: Automated systems and cloud-based payroll software reduce manual calculations and data entry, saving time and reducing errors, streamlining the payroll process.
  • Compliance: With ever-evolving payroll legislation in the UK, these services ensure businesses, especially small businesses, remain compliant, automatically updating tax rates and regulations.
  • Accessibility: Cloud-based platforms allow employers to access payroll information anytime, anywhere, ensuring flexibility and real-time updates.
  • Integration: Many online payroll services seamlessly integrate with other business tools, such as accounting software, further streamlining operations.

With the increasing demand for efficient payroll services, including payroll outsourcing services, it's essential for every business owner to understand the common pitfalls of payroll management and how to sidestep them.

1. Mistake #1: Incorrect Tax Code Application


Tax codes are issued by HMRC (Her Majesty's Revenue and Customs) to employers, indicating how much tax should be deducted from an employee's salary. These codes are based on an individual's tax-free income allowance and other financial factors. A common tax code you might come across is "1257L". Breaking this down:

  • 1257 represents the tax-free income allowance, which in this case is £12,570 for the year.
  • L indicates that the employee is entitled to the standard tax-free Personal Allowance.


Using our 1257L example, if an employer mistakenly applies a lower tax code, say "1100L" (indicating a tax-free allowance of £11,000), the employee would be overtaxed by £1570 at their tax rate. Conversely, if a higher tax code were applied erroneously, it would result in underpayment of taxes, leading to potential penalties from HMRC and back taxes owed by the employee.


To ensure the correct tax code is always applied:

  • Regularly communicate with employees to confirm any changes in their financial situation or tax code.
  • Use reliable payroll services that offer automatic tax code updates and checks, ensuring that the most recent and accurate code from HMRC is always in use.

2. Mistake #2: Missing or Late PAYE (Pay As You Earn) Payments


PAYE is a system where employers are responsible for deducting tax and National Insurance contributions from employees' wages and then paying these amounts to HMRC. It's crucial to note that employers are responsible for both the employee's and their own employer contributions. The process typically follows this order:

  • Running the payroll to calculate the due amounts.
  • Submitting a Full Payment Submission (FPS) to HMRC, detailing the deductions.
  • Paying the employees their net wages after deductions.
  • Remitting the deducted amounts (tax and NI contributions) to HMRC.


Failure to remit the correct amounts to HMRC on time can lead to significant penalties. The penalties for late PAYE payments are tiered based on the number of late payments in a tax year:

  • 1-3 late payments: 1% penalty on the total amount that is late in the tax year.
  • 4-6 late payments: 2% penalty.
  • 7-9 late payments: 3% penalty.
  • 10 or more late payments: 4% penalty.

Additionally, if a payment is over 6 months late, a penalty of 5% of the amount owed is added, and another 5% if it's over 12 months late.


To avoid late PAYE payments and the associated penalties:

  • Ensure a clear understanding of the payroll process, from running the payroll to remitting payments to HMRC.
  • Set up automated reminders for all HMRC deadlines.
  • Consider investing in payroll services that not only help with FPS submissions but also track and remind about due payment dates to HMRC.

3. Mistake #3: Inaccurate Record-Keeping


Maintaining a clear and accurate record of all payroll transactions is fundamental for any business. These records serve as evidence of compliance with tax and employment laws and can be crucial during financial reviews or audits.


Inaccurate or incomplete records can lead to potential audits, disputes with employees, and financial discrepancies.

  • Audit Process & Implications:
    Audits can be initiated by various bodies, but when it comes to payroll, HM Revenue & Customs (HMRC) is the primary authority.
  • When & Why: Companies might be selected for an audit based on random selection, discrepancies in their submitted records, or in response to reported issues. The primary goal is to ensure that the company is compliant with tax and employment regulations.
  • How It Happens: During an audit, representatives from HMRC will review the company's financial records, including payroll, to verify accuracy and compliance. They might request specific documents, interview key personnel, and cross-check reported figures with their records.
  • By Whom: HMRC auditors, who are specialists in tax and employment regulations, conduct these reviews.
  • Experience: Being audited can be a rigorous process. Companies might find it time-consuming, and if discrepancies are found, they can face penalties or be required to make additional payments.


To ensure impeccable record-keeping and reduce the risk of audits:

  • Systematic Process Implementation:
  • Digital Tools: Adopt payroll software that automatically logs all transactions, ensuring accuracy and easy retrieval.
  • Regular Reconciliation: Set a routine (e.g., monthly) to cross-check payroll records with bank statements and other financial documents.
  • Document Everything: Whether it's a change in an employee's salary, a bonus, or a deduction, ensure there's a paper or digital trail.
  • Training: Ensure that staff responsible for payroll are adequately trained and are aware of the latest regulations and best practices.
  • Backup: Regularly backup records, either digitally or through physical copies, to prevent data loss.
  • Seek Expertise: Consider consulting with or hiring a payroll specialist, especially if the business is growing or entering new markets.

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4. Mistake #4: Overlooking Employee Benefits and Expenses


Employee benefits, often referred to as 'benefits in kind', can range from company cars, health insurance, to interest-free loans or bonuses. These benefits have tax implications because they have a monetary value and are considered part of an employee's remuneration package, but aren't included in their salary.


When these benefits are provided to employees, they can increase the amount of tax and National Insurance contributions (NICs) due. For instance, if an employee is provided with a company car, the value of the car's private use is considered a benefit in kind and is subject to tax. This means the employee's tax code may need to be adjusted to account for this additional 'income', resulting in higher tax deductions from their salary.


To accurately account for all benefits and ensure compliance:

  • Maintain a detailed record of all employee benefits and expenses provided throughout the tax year.
  • At the end of the tax year, employers need to report these benefits to HMRC using the P11D form. This form details the value of each benefit provided to each employee.
  • Once the P11D forms are submitted, HMRC will adjust the employee's tax code if necessary, ensuring the correct amount of tax is paid in the following year.
  • Employers also need to pay Class 1A National Insurance contributions on most benefits, which is calculated based on the total value of all benefits provided.
  • Consider using payroll services that offer comprehensive benefits and expenses tracking, as well as assistance with P11D form submissions, ensuring accuracy and compliance.

5. Mistake #5: Not Staying Updated with Legislation Changes


Payroll legislation in the UK is dynamic and subject to change. These changes can be influenced by various factors, including economic conditions, government policies, and feedback from businesses and the public.


The frequency of these changes can vary. Major reforms might occur annually, typically announced in the government's Budget, while minor adjustments or clarifications can happen throughout the year. Failing to stay updated can lead to non-compliance, resulting in hefty fines and potential legal challenges.

  • Decision Makers:
    Changes to payroll legislation are primarily decided by the UK government, specifically by HM Treasury and executed by HM Revenue & Customs (HMRC). They consider a variety of factors, including economic data, public consultations, and feedback from industry experts.


To stay abreast of all legislative changes:

  • Official Channels: Subscribe to updates directly from HMRC. They provide regular bulletins and newsletters detailing any changes.
  • Industry Associations: Join industry associations or bodies like the Chartered Institute of Payroll Professionals (CIPP). They often provide insights, training, and updates on legislative changes.
  • Workshops & Seminars: Attend workshops or seminars focused on UK payroll legislation. These events often feature experts who can provide insights into upcoming changes and their implications.
  • Professional Payroll Services: Partner with professional payroll services that guarantee compliance with the latest regulations. These services often have dedicated teams that monitor legislative changes and ensure their systems are updated accordingly.


Navigating the complexities of payroll is a task that demands precision, awareness, and diligence. As we've highlighted:

  • Tax Code Accuracy: Every business owner must ensure they apply the correct tax codes, as provided by HMRC, to avoid over or under-taxing their employees, making the payroll process smoother.
  • PAYE Payments: It's imperative for small businesses to understand the sequence of running payroll, submitting FPS, paying employees, and then remitting the deducted amounts to HMRC. Timeliness and accuracy in this process can save businesses from hefty penalties.
  • Record-Keeping: Maintaining meticulous and accurate payroll records is not just a good practice—it's a safeguard against potential audits and disputes. Employers must be prepared for audits, understanding their purpose, the process, and potential implications.
  • Employee Benefits: Benefits in kind, such as company cars or health insurance, have tax implications. Employers need to declare this payroll information to HMRC using forms like P11D and ensure they're factored into tax calculations.
  • Legislation Updates: The dynamic nature of payroll legislation requires businesses, especially small businesses, to stay informed about changes, which are primarily decided by the UK government and executed by HMRC.

In light of these complexities, the benefits of payroll services, especially cloud-based payroll software, become even more pronounced. Such services offer:

  • Efficiency: Automated systems streamline the work processes, reducing manual errors.
  • Compliance Assurance: With ever-evolving payroll requirements, payroll services ensure businesses remain compliant, updating systems in line with new rules.
  • Integration: Many services integrate seamlessly with other business tools, offering a holistic approach to business management.
  • Expertise: Access to specialists who can provide guidance, ensuring best practices are always followed.

In essence, while managing payroll can be intricate, with the right knowledge and tools—especially reliable payroll services—businesses can ensure smooth, compliant operations, allowing them to focus on growth and innovation.

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We have been using Moonworkers for quite some time and compared to other software in the market, we found it very simple to use and excellent. Moreover, the customer service is great.
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