What is PAYE? Pay As You Earn Explained

Pay As You Earn, commonly known as PAYE, is a tax system in the United Kingdom designed to collect income tax and National Insurance contributions directly from employees' paychecks. It simplifies the tax process by deducting the necessary amounts before the employee receives their salary, making it a convenient and efficient method for both employers and employees.

PAYE stands for Pay As You Earn, and it is a system through which individuals contribute to their income tax and National Insurance (NI) payments directly from their earnings. The primary goal of PAYE is to ensure that taxes and NI contributions are paid consistently and promptly, reducing the risk of tax evasion and streamlining the tax collection process.

How the Pay As You Earn System Works

In the PAYE system, employers are responsible for deducting income tax and National Insurance contributions from their employees' salaries before paying them. The deducted amounts are then sent to HMRC on behalf of the employees.

As the tax year ends, from 6 April to 5 April, employee gets a P60 form showing the amount of tax paid throughout the year.

Employee can verify PAYE details anytime by inquiring the employer, reviewing the payslip or past P60, or calling HMRC.

People's pension income can have tax deductions through the PAYE system. In this process, the pension provider subtracts the owed amount before paying out any income.

The PAYE system ensures that individuals meet their tax obligations regularly, eliminating the need for a lump sum payment at the end of the tax year. This approach contributes to financial stability for both employees and the government.

How is PAYE Calculated?

PAYE calculations take into account various factors, including the employee's salary, tax code, your eligibility for the personal allowance, and any applicable deductions. The tax code is a crucial element, as it determines the amount of tax-free income an individual can earn in a given tax year. The calculation also considers other sources of income, benefits in kind, and tax-free allowances.

The personal allowance is the money you can earn without paying taxes each year. For 2024-25, the personal allowance is £12,570

Once you surpass the personal allowance, you'll be charged a tax rate of 20%, 40%, or 45%, depending on whether you fall into the basic rate, higher rate, or additional rate taxpayer category. Your income determines the applicable PAYE rate.

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What Else Does the PAYE System Collect?

In addition to income tax and National Insurance contributions (NICs), PAYE also makes deductions like student loan repayments or pension contributions.

Setting up PAYE payroll is quite simple. While some companies prefer using small business accountants, most businesses can easily set it up themeselves.

You need to:

1. Register as an employer with HMRC. After registering, you'll receive a PAYE Online login credentials within five working days.
2. Choose reliable payroll software. Payroll software help manage employee details, calculate pay and deductions, and report it to HMRC.

After setting up your PAYE scheme, you'll have monthly responsibilities:

1. Keep accurate records of all payments to employees. These records will be reported to HMRC.
2. Inform HMRC about your employees and any changes (e.g., new hires or departures).
3. Record pay, make deductions, and report to HMRC either on or before the first payday.

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You need to pay your PAYE bill to HMRC by the following deadlines:

• If you pay monthly, it's due by the 22nd of the next tax month.
• If you pay quarterly, for instance, from 6 April to 5 July, it's due by the 22nd after the quarter ends, like 22 July.

If you're making the payment via cheque through the post, make sure it reaches HMRC by the 19th of the month.

Watch below video from HMRC to find out more about when and how to pay PAYE:

PAYE Forms

Several forms are associated with the PAYE system, each serving a specific purpose.

P60: The P60 form, provides a summary of an employee's total earnings and deductions for the tax year.

P45: The P45 form is issued when an employee leaves a job, detailing their income and tax paid during the employment.

P11D: The P11D form reports any expenses or benefits provided to employees, ensuring accurate taxation.

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Pensions are subject to PAYE deductions, just like regular earnings. The money you receive is what you get after tax deduction.

Your pension provider, usually a pension scheme or annuity firm, will collect the tax you owe and send it to HMRC. They will also deduct any tax you owe on your state pension.

If you receive payments from different providers, like a workplace pension and a private pension, HMRC will ask just one to deduct the tax for your state pension payments.

How often they take out tax depends on how often you get paid.

Remember:

1. If your only income is from the state pension, you have to send a self-assessment tax return to HMRC.
2. If you keep working while getting your state pension, your employer will take out the PAYE you owe from your earnings and the PAYE from your state pension.
3. If you have other income, it's your job to declare it, and you might need to do a self-assessment tax return.

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Self-employed individuals are responsible for managing their own tax affairs, including income tax and National Insurance contributions. While self-employed individuals don't use the traditional PAYE system, they are still required to pay taxes on their earnings. They use Self Assessment tax returns to report your income and calculate taxes.

However, you also have the option to make your tax payments through PAYE, which means you don't need to stress about missing a payment; your tax will be taken care of automatically.

To be eligible for PAYE tax payments, a few things matter:

1. Your tax bill must be less than £3,000.
2. You are already making tax payments through PAYE.
3. You've submitted your paper tax return by 31 October or your online tax return by 30 December.

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PAYE is the mechanism that allows the UK government to collect income tax and National Insurance contributions in a timely and efficient manner. By understanding how PAYE works, both employers and employees can handle the taxation system with greater ease, ensuring that everyone contributes their fair share to support public services and infrastructure.

For small businesses dealing with PAYE and other financial matters, our team of small business accountants is here to assist you. Our experts know how to handle payroll, stick to tax rules, and offer useful tips to improve financial processes. By engaging our small business accountants, you can concentrate on your core operations while ensuring that your financial obligations are expertly managed. This smart move not only keeps finances in order but also boosts the success and lasting power of small businesses in the ever-changing world of UK business.

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