Small business payroll: a complete guide for UK employers

Published Friday 15 May 2026

Table of contents

• What does payroll mean for small business?
• How does payroll work?
• How to set up payroll for the first time
• What's involved in payroll compliance?
• What are payroll deductions?
• Reporting to HMRC
• What to look for in payroll software
• Payroll software features to compare
• Payroll options for small business
• How to choose the right payroll solution
• How much does payroll cost for small businesses?
• Get your payroll running with confidence
• FAQs on payroll for small businesses

Key takeaways

• Choose payroll software that automatically calculates tax and National Insurance, submits reports directly to HMRC, and generates detailed payslips to save time and reduce compliance errors.
• Submit your Full Payment Submission (FPS) to HMRC on or before each payday and transfer collected taxes by the monthly or quarterly deadline to avoid penalties of up to 100% of underpaid tax.
• Keep detailed payroll records for at least three years, as HMRC can investigate up to five additional years back if inaccuracies are found during compliance checks.
• Consider outsourcing payroll to a service provider or accountant when your team grows beyond 10 employees or when payroll complexity takes too much of your time.

What does payroll mean for small business?

Payroll is the process of paying your employees and making the required deductions from their wages. It covers two core responsibilities: paying accurately and deducting correctly.

Paying accurately means giving employees the right amount at the right time, every time, in line with their contract and employment law. Deducting correctly means taking the right amounts for tax, National Insurance, pensions, and other obligations.

There are many rules around payroll, particularly since the Employment Rights Act 2025 introduced changes to statutory sick pay and day-one leave rights from April 2026. You need to comply with government requirements to keep your employees paid correctly and avoid penalties of up to 100% of any underpaid tax.

If you're just starting a business and planning to hire staff, understanding payroll early helps you stay compliant from day one.

How does payroll work?

Payroll repeats every time you pay your employees, whether that's weekly, fortnightly, or monthly. The process follows the same steps each pay period.

Here's how the process typically flows:

1. Collect time and attendance data. Gather hours worked, overtime, sick leave, and holiday taken for each employee.
2. Calculate gross pay. Work out what each employee has earned before deductions, including any bonuses, commission, or allowances.
3. Make deductions. Subtract income tax, National Insurance, pension contributions, student loan repayments, and any other required amounts.
4. Calculate net pay. The amount left after deductions is what your employee takes home.
5. Pay your employees. Transfer wages to their bank accounts on the agreed payday.
6. Report to HMRC. Submit your Full Payment Submission (FPS) on or before each payday.
7. Pay HMRC. Transfer the tax and National Insurance you've collected by the monthly or quarterly deadline.

Most payroll software automates steps 2 to 6. That leaves you to collect the time data and make the payments.

How to set up payroll for the first time

Setting up payroll for the first time takes some preparation, but you can work through it step by step. Getting the basics right from the start helps you avoid penalties and pay your team on time.

Here's what you need to do:

1. Register as an employer with HMRC. You must register before your first payday. This can take up to five working days, so plan ahead. HMRC will send you a PAYE reference number and an Accounts Office reference number, both of which you'll need for submissions.
2. Choose your payroll software. Pick HMRC-recognised software that handles tax calculations, payslip generation, and Real Time Information (RTI) submissions. HMRC provides free Basic PAYE Tools for businesses with fewer than 10 employees, though it has limited features.
3. Collect employee information. For each employee, gather their P45 from a previous employer or a starter declaration if they don't have one. You'll also need their bank details, National Insurance number, and personal details.
4. Set up pay schedules. Decide whether you'll pay weekly, fortnightly, or monthly. Enter your pay dates and payment method into your payroll software.
5. Run your first payroll. Enter hours worked or salary amounts, and let your software calculate gross pay, deductions, and net pay. Review the figures before processing.
6. Submit your first FPS. Send your Full Payment Submission to HMRC on or before your first payday. Your software handles this electronically if it supports RTI.
7. Set up workplace pensions. If you have eligible employees, you must auto-enrol them into a pension scheme. Check your staging date and enrolment duties.

If you're hiring employees for the first time, handling payroll setup alongside your onboarding process keeps everything organised.

What's involved in payroll compliance?

Payroll compliance means meeting all the legal requirements for paying employees and reporting to HMRC. Getting this right protects your business from fines and keeps your employees' trust.

To stay compliant, you must:

• Make accurate payments and deductions. Calculate wages, tax, National Insurance, and pension contributions correctly each pay period.
• Provide detailed payslips. Show employees exactly what you've paid and deducted. This is a legal requirement under employment law.
• File and pay taxes on time. Submit reports and payments to HMRC by the deadlines. Late submissions attract penalties.
• Pay deductions to the right places. Send pension contributions and other amounts to the correct organisations on schedule.
• Keep payroll records. Hold onto records for at least three years. If inaccuracies are found, HMRC can go back up to five more years in an investigation.

The Employment Rights Act 2025 introduced changes from April 2026 that affect payroll compliance. Statutory sick pay is now payable from the first day of absence, with no waiting days. Paternity leave and unpaid parental leave are now day-one rights, so your payroll needs to reflect these entitlements for all employees regardless of service length.

Consider applying payroll numbers to your employees. This helps with managing records and making sure the right money goes to the right person.

What are payroll deductions?

Payroll deductions are amounts you take from your employees' gross pay before paying them. There are two types: mandatory deductions you must make by law, and voluntary deductions your employee may request.

Mandatory deductions you must make:

• Income tax. Collected through PAYE based on each employee's tax code for the 2025/26 or 2026/27 tax year.
• National Insurance. Contributions for state benefits and pensions, calculated on earnings above the threshold.
• Student loan repayments. If HMRC notifies you that an employee has a student loan, apply the correct thresholds and rates for their plan type.
• Court-ordered payments. Such as child maintenance deductions.

Voluntary deductions your employee may request:

• Workplace pension contributions. Beyond the minimum auto-enrolment amount.
• Private healthcare. If you offer a scheme through your business.
• Charitable donations. Through payroll giving schemes.

You can learn more about these deductions, including the order you make them, in the guide to hiring employees.

Reporting to HMRC

As an employer, you collect taxes from your employees on behalf of HMRC. You need to report what you've collected and pay it over on schedule.

Every payday, you send HMRC a Full Payment Submission (FPS) using your payroll software. The FPS includes:

• Employee details. Names, National Insurance numbers, and tax codes.
• Pay information. Gross pay, taxable pay, and hours worked.
• Deductions made. Income tax, National Insurance, student loan repayments, and pension contributions.

If you need to report adjustments, such as recovering statutory pay, you'll also submit an Employer Payment Summary (EPS). This must reach HMRC by the 19th of the following tax month.

You can report employee expenses and benefits through your payroll. Alternatively, you can report them separately at the end of the financial year using a P11D form. The introduction of mandatory payrolling of benefits in kind (BIK) has been delayed to April 2027. That gives you time to prepare your systems for real-time reporting of benefits.

What to look for in payroll software

Good payroll software saves you time, reduces errors, and keeps you compliant with HMRC. The right choice depends on your team size and how much of the process you want to automate.

Here are the essential features to look for:

• Automatic tax calculations. Works out income tax, National Insurance, and pension contributions based on current rates and employee tax codes.
• HMRC integration. Submits your Full Payment Submission (FPS) and Employer Payment Summary (EPS) directly to HMRC through RTI.
• Payslip generation. Creates detailed payslips for each employee automatically.
• Auto-enrolment support. Manages workplace pension compliance and contributions without manual tracking.

These extra features are useful as your business grows:

• Employee self-service. Lets staff view payslips, update personal details, and request leave independently.
• Accounting softwareintegration. Syncs payroll data with your accounts so you don't have to enter it twice.
• Multiple pay schedules. Handles weekly, fortnightly, and monthly pay runs if you need them.
• Year-end reporting. Produces P60s and handles year-end submissions to HMRC.

Before choosing, ask yourself these questions:

• Does the software handle your current number of employees, with room to grow?
• Is it HMRC-recognised for online submissions?
• How much support is included if something goes wrong?

Payroll software features to compare

When comparing payroll software, look at the specific features each option offers and how they match your business needs. Not every tool includes the same capabilities, so knowing what matters most helps you make a confident decision.

Here are the key features to compare:

• Pay calculation and automation. Automatically works out gross pay, deductions, and net pay each period. This reduces manual errors and saves time on every pay run.
• Tax and NI deductions. Calculates income tax and National Insurance based on current HMRC rates and tax codes. Accurate deductions keep you compliant and protect your employees.
• Payslip generation. Produces clear, itemised payslips for every employee. This is a legal requirement and helps your team understand their pay.
• RTI submission to HMRC. Files your Full Payment Submission and Employer Payment Summary directly to HMRC. Built-in submission removes the need for separate reporting tools.
• Pension auto-enrolment. Manages employee eligibility assessments, enrolment letters, and contribution calculations. Automating this helps you meet your legal duties without manual tracking.
• Employee self-service. Gives staff access to view payslips, update personal details, and check leave balances. This reduces admin requests and puts employees in control of their own information.
• Leave management. Tracks holiday, sick leave, and other absences in one place. Accurate leave records feed directly into pay calculations.
• Reporting and analytics. Provides summaries of payroll costs, tax liabilities, and trends over time. Good reporting supports better budgeting and financial planning.
• Accounting software integration. Syncs payroll journals with your bookkeeping and accounts. This avoids double entry and keeps your financial records up to date.
• Multi-pay-schedule support. Handles different pay frequencies for different employee groups. This is useful if you pay salaried staff monthly and hourly workers weekly.

Payroll options for small business

There are several ways to handle payroll, and the right option depends on your team size and how much time you can spend on admin. The more employees you have, the more complex payroll usually becomes.

A mix of hourly wages, salaries, contractors, commission, overtime, and leave entitlements means your payroll can be different every time you run it.

Here are your main options:

• Pen and paper or spreadsheets. Suits businesses with just a handful of employees. However, HMRC requires specific formats for reporting, so you may need additional tools for submissions.
• DIY payroll software. Calculates pay and deductions automatically and fills out tax forms. You still need to make the actual payments yourself, but the admin is much simpler. Learn more about how to run payroll yourself.
• Payroll service providers. Outsource your payroll to specialists who handle everything from calculations to HMRC submissions. Some do it all, while others help with specific tasks.
• Accountants and bookkeepers. Handle payroll alongside your other financial tasks. Many offer payroll as part of a broader service package. Check out the Xero advisor directory to find one near you.

How to choose the right payroll solution

The right payroll solution depends on your business size, complexity, and how much time you want to spend on admin. Matching your situation to the right option helps you avoid overpaying or outgrowing your setup.

Choose DIY payroll software if:

• You have a small, straightforward team with similar pay arrangements
• You're comfortable using software and have time to run payroll yourself
• You want to keep costs low and stay in control

Choose a payroll service provider if:

• Your payroll is complex, with variable hours, multiple pay rates, or frequent changes
• You'd rather hand off the responsibility to experts
• You want someone else to handle HMRC submissions and stay on top of rule changes

Choose an accountant or bookkeeper if:

• You already work with one for your accounts and want everything in one place
• You need advice on tax efficiency and employment costs alongside payroll
• You value having a trusted advisor who knows your business

Ask yourself these questions before deciding:

• How many employees do you have, and how often does your payroll change?
• How much time can you realistically spend on payroll each month?
• What's your budget for payroll software or services?
• Do you need help with compliance, or just the calculations?

How much does payroll cost for small businesses?

Payroll costs for small businesses typically range from free to around £15 per employee per month. Your total depends on whether you use software or outsource to a provider.

Here's what you can expect to pay:

• Free or low-cost software. Basic payroll tools start from £0 to £5 per month, though you may pay extra for features like HMRC submissions or pension integration.
• Mid-range payroll software. Full-featured options typically cost £5 to £15 per employee per month, including tax calculations, payslips, and HMRC reporting.
• Payroll service providers. Outsourced payroll usually costs £3 to £10 per employee per pay run, plus a monthly base fee of £20 to £50.
• Accountants and bookkeepers. Rates vary widely, but expect to pay £50 to £200 per month for payroll as part of a broader service package.

Several factors influence how much you'll pay:

• Number of employees. More staff usually means higher costs, though some providers offer volume discounts.
• Payroll frequency. Running payroll weekly costs more than monthly because there are more pay runs to process.
• Complexity. Variable hours, multiple pay rates, and benefits add to the workload and cost.
• Level of service. Basic software is cheaper than full-service providers who handle everything for you.
• Add-on features. Employee self-service portals, HR tools, and advanced reporting often cost extra.

Get your payroll running with confidence

Payroll doesn't have to be complicated. Once you understand the basics of pay, deductions, and HMRC reporting, the right tools can handle most of the heavy lifting for you.

Good payroll software calculates pay automatically, fills out tax forms, and helps you stay compliant without manual effort. It saves time, reduces errors, and lets you focus on running your business.

Ready to take the next step? Get one month free and explore payroll software designed for small businesses.

FAQs on payroll for small businesses

Here are answers to common questions small business owners ask about payroll.

Can I do payroll without an accountant?

Yes. You can run payroll yourself using payroll software that calculates pay, makes deductions, and submits reports to HMRC automatically. Many small business owners manage payroll in-house, especially with fewer than 10 employees.

How much does payroll cost for a small business?

Payroll software typically costs £0 to £15 per employee per month, while outsourced payroll services range from £3 to £10 per employee per pay run plus a monthly base fee. Your total cost depends on the number of employees, payroll frequency, and level of service you choose.

Which payroll software is best for small businesses?

The best payroll software depends on your needs, but look for HMRC-recognised software that calculates tax automatically, generates payslips, and handles pension auto-enrolment. Integration with your accounting software and employee self-service features are useful extras.

Can I do payroll for free?

Some basic payroll tools are free, but they often lack features like direct HMRC submissions or pension management. HMRC provides free Basic PAYE Tools for businesses with fewer than 10 employees, though it doesn't generate payslips or handle complex deductions. Most small businesses benefit from paid software that automates compliance.

How do I know when to outsource payroll?

Consider outsourcing when payroll takes too much of your time, your team is growing, or you're worried about staying compliant. If you're spending hours each month on payroll admin or struggling to keep up with rule changes, a payroll service or accountant can take that burden off your plate.