What is PAYE? How it works for employers in the UK

Published Monday 15 June 2026

Table of contents

• What is PAYE?
• How PAYE works
• PAYE tax codes explained
• UK income tax rates and bands
• When to register for PAYE
• PAYE deductions
• National Insurance under PAYE
• PAYE deadlines
• How to set up PAYE payroll
• Reporting to HMRC
• What does a PAYE payslip look like?
• How to pay HMRC through PAYE
• Common PAYE mistakes to avoid
• PAYE and the self-employed
• Simplify your payroll with Xero
• FAQs on PAYE

Key takeaways

• Register for PAYE before your first payday if any employee earns £129 or more per week, receives benefits, has another job, or receives certain government allowances. It can take up to 30 days to get your employer reference number from HMRC, so register early.
• You deduct Income Tax and National Insurance from employee wages using their tax codes, then submit these payments to HMRC by the 22nd of the following month for online payments or by the 19th for postal payments.
• Use HMRC-recognised payroll software to calculate deductions and submit Real Time Information (RTI) reports to HMRC on or before each payday. The software also generates compliant payslips for your employees.
• Late PAYE payments trigger escalating penalties from 1% to 4% of the unpaid amount, plus interest at 8.5% per year, so staying on top of deadlines protects your cash flow.

What is PAYE?

PAYE (Pay As You Earn) is HMRC's system for collecting Income Tax, National Insurance, and other deductions directly from employee wages before they receive their pay. As an employer, you deduct the required amounts each pay period and send them to HMRC using payroll software.

The system means your employees pay tax gradually throughout the year, rather than facing 1 large bill. It's your responsibility to get the amounts right, report them to HMRC, and pay on time.

Your core PAYE duties as an employer are to:

• keep accurate records of all payments and deductions for each employee
• notify HMRC when employees join or leave your business
• forward all deducted amounts to HMRC by the required deadlines
• give every employee a payslip on or before each payday

How PAYE works

PAYE spreads each employee's annual tax bill across every pay period. Instead of your employees calculating and paying tax themselves at the end of the year, you collect it from their wages each time you run payroll.

HMRC assigns each employee a tax code that tells you how much tax-free pay they're entitled to. You apply that code to their earnings each pay period, deduct the correct Income Tax and National Insurance, and pay them the remainder.

The system works on a cumulative basis. Each time you run payroll, the calculation accounts for all the pay and tax from earlier in the tax year. If an employee's circumstances change mid-year, the cumulative method adjusts future pay periods so they end up paying the right total by April.

PAYE tax codes explained

Tax codes tell you how much tax-free income an employee can earn before you start deducting Income Tax. HMRC issues them, and you apply them every time you run payroll.

The most common tax code for 2026/27 is 1257L. The numbers represent the employee's tax-free Personal Allowance divided by 10, so 1257 means £12,570 of tax-free income. The letter L confirms they're entitled to the standard Personal Allowance.

Other letters you'll see include:

• BR: all income taxed at the basic rate (20%), typically used for a second job
• D0: all income taxed at the higher rate (40%)
• NT: no tax deducted
• K: the employee owes more tax than their allowance covers, so extra tax is collected through their wages
• M: the employee receives a transfer of 10% of their partner's Personal Allowance

If HMRC sends you a new tax code for an employee, apply it from the next pay period. Using the wrong code is 1 of the most common PAYE errors and can result in your employees overpaying or underpaying tax.

UK income tax rates and bands

Income Tax is calculated on earnings above the Personal Allowance. The rates and bands for the 2026/27 tax year are frozen at the same levels as previous years.

The current bands are:

• Personal Allowance: up to £12,570 per year (0% tax)
• basic rate: £12,571 to £50,270 (20%)
• higher rate: £50,271 to £125,140 (40%)
• additional rate: over £125,140 (45%)

Employees earning more than £100,000 per year lose £1 of their Personal Allowance for every £2 earned above that threshold. By £125,140 their Personal Allowance is reduced to zero.

When to register for PAYE

You need to register for PAYE with HMRC before your first payday if any of the following apply to your employees in the current tax year.

Registration is required when an employee:

• is paid at or above the lower earnings limit (£129 or more per week for 2026/27)
• receives expenses or company benefits
• receives a pension
• has had another job
• has received Jobseeker's Allowance, Employment and Support Allowance, or Incapacity Benefit

Register no earlier than 2 months before your first payday. HMRC will send you an employer reference number, which you'll use to report payroll and communicate with HMRC. It can take up to 30 days to arrive, so don't leave it until the last minute.

If you're taking on your first employee, the hiring employees checklist covers everything you need alongside PAYE registration.

PAYE deductions

PAYE deductions are the amounts you take from employee wages before paying them. The exact deductions depend on each employee's tax code, earnings, and personal circumstances.

Standard deductions for most employees:

• income tax: calculated using their tax code and the income tax bands
• National Insurance: calculated on earnings above the primary threshold

Additional deductions when they apply:

• student loan repayments: for employees with outstanding student loans (plan type determines the threshold and rate)
• attachment of earnings orders: court-ordered deductions for debts
• workplace pension contributions: auto-enrolment pension deductions

Payroll software calculates these amounts automatically, but you're responsible for making sure the inputs are correct. With wages across UK small businesses growing by 2.7% year-on-year, and even faster in sectors like hospitality at 3.6%, staying on top of changing pay rates and the PAYE thresholds they trigger is increasingly important (Xero Small Business Insights, based on data from 440,000 UK small businesses).

National Insurance under PAYE

National Insurance contributions (NICs) are collected through PAYE alongside Income Tax. Both you and your employees pay NICs, but at different rates and thresholds.

For 2026/27, the key employee thresholds are:

• lower earnings limit: £129 per week (£6,708 per year)
• primary threshold (where employee NICs start): £242 per week (£12,570 per year)
• employee NIC rate: 8% on earnings between the primary threshold and £50,270, then 2% above that

As an employer, you also pay NICs on your employees' earnings. The secondary threshold, where employer NICs begin, is £96 per week. The employer NIC rate is 15% on earnings above that threshold.

The employment allowance lets eligible employers reduce their employer NICs bill by up to £10,500 per year. You can claim it if your total employer NICs were below £100,000 in the previous tax year. For detailed rates and thresholds, see the National Insurance rates guide.

PAYE deadlines

PAYE payment deadlines depend on your business size and your expected annual PAYE bill. Missing them triggers penalties and interest charges, so it's worth building these dates into your calendar.

Monthly payments (most businesses):

• due by the 22nd of the following month for online payments
• postal payments must reach HMRC by the 19th

Quarterly payments (smaller businesses):

• available if your total annual PAYE bill is expected to be less than £1,500
• due by the 22nd of the month after each quarter ends
• contact HMRC's PAYE helpline to request quarterly payment arrangements

Meeting these deadlines matters. HMRC's late payment penalties escalate from 1% of the unpaid amount for up to 3 missed payments to 4% for 10 or more in a single tax year. The interest rate on overdue PAYE payments is 8.5% per year, which adds up quickly on larger bills.

How to set up PAYE payroll

Setting up PAYE payroll involves registering with HMRC and choosing the right software to handle calculations and submissions.

1. Register as an employer with HMRC

Tell HMRC you're hiring by registering as an employer on their website. You'll get a PAYE reference number to access your online PAYE account, where you can check what you owe, pay your bill, and receive notices.

If you run a limited company, register for PAYE online. Other business types may need a different registration method; check the HMRC registration page for details. Allow 30 days to receive your PAYE reference number.

2. Choose payroll software

Choose payroll software that fits your business needs. HMRC-recognised software calculates deductions automatically, sends Real Time Information (RTI) reports to HMRC, and produces payslips you can distribute to employees.

Look for software that handles auto-enrolment pensions, student loan deductions, and statutory pay (such as sick pay and maternity pay) alongside standard PAYE calculations.

Reporting to HMRC

You must report payroll information to HMRC each time you pay your employees, using Real Time Information (RTI). This means submitting reports on or before each payday, not at the end of the month or year.

There are 2 main RTI submissions:

• Full Payment Submission (FPS): sent on or before each payday, containing details of each employee's pay, tax, and National Insurance for that pay period
• Employer Payment Summary (EPS): sent by the 19th of each month if you need to report items that reduce your PAYE bill, such as statutory pay reclaims or the employment allowance

You also need to report to HMRC when an employee joins or leaves. New starters require their details on the next FPS. For leavers, you enter their leaving date on the FPS and provide them with a P45.

HMRC-recognised payroll software sends these submissions automatically as part of the payroll process. If you miss a report or submit late, HMRC may issue a penalty.

What does a PAYE payslip look like?

You must give every employee a payslip on or before each payday. Payslips show exactly how you calculated their take-home pay after deductions.

Required payslip information:

• gross wages: total pay before any deductions
• all PAYE deductions: Income Tax, National Insurance, and any other deductions itemised separately
• net wages: final take-home pay after all deductions
• hours worked: required if pay varies by hours

Helpful additions that give your employees a clearer picture:

• tax code: shows their current tax status
• National Insurance number: for the employee's own reference
• year-to-date totals: running totals for the tax year

Modern payroll software generates compliant payslips automatically and can email them directly to employees, saving you the time of printing and distributing paper copies.

How to pay HMRC through PAYE

Paying HMRC through PAYE means sending the total of all deductions you've collected from your employees' wages, plus your employer National Insurance contributions, by the deadline for each pay period.

1. Calculate deductions through payroll

Your payroll software uses each employee's tax code to calculate their Income Tax. It also calculates National Insurance contributions for both the employee and you as the employer. The tax collected through PAYE can't exceed 50% of an employee's income in any pay period.

2. Add employer contributions

On top of employee deductions, add your employer National Insurance contributions and any Apprenticeship Levy payments if they apply. Your PAYE bill may also include Construction Industry Scheme (CIS) deductions.

3. Submit payment to HMRC

Monthly payments are due by the 22nd of the following month if you pay online. If you pay by cheque, your payment must reach HMRC by the 19th. Direct Debit is the simplest option; it collects the amount automatically after you've submitted your RTI report.

If you pay by Direct Debit, you may see a temporary interest charge while the payment clears. HMRC reverses this once the payment is confirmed. A payment is considered late if it arrives on or after the 5th of the tax month after it was due.

Common PAYE mistakes to avoid

Even small PAYE errors can lead to penalties, employee complaints, or extra admin to put things right. Here are the mistakes that catch employers out most often.

• Using the wrong tax code: always apply the most recent code HMRC has issued. If you use an outdated code, your employee will overpay or underpay tax, and you'll need to correct it.
• Missing RTI deadlines: FPS submissions are due on or before payday, not after. Late submissions trigger automatic penalties from HMRC.
• Paying HMRC late: even a few days past the deadline counts as late. Penalties start at 1% and escalate with each missed payment in the tax year.
• Not reporting starters and leavers: new employees must appear on the next FPS. Leavers need their leaving date recorded and a P45 issued.
• Forgetting auto-enrolment: you must enrol eligible employees into a workplace pension and deduct contributions through payroll. Missing this is a separate compliance obligation with its own penalties.
• Running payroll manually without proper records: if you're not using HMRC-recognised software, calculation errors and reporting gaps are much more likely.

PAYE and the self-employed

If you're self-employed, you don't pay tax through PAYE. Instead, you report your income and pay Income Tax and National Insurance through Self Assessment, filing a tax return each year.

PAYE only applies when you employ other people. If you're a sole trader who takes on staff, you'll need to register as an employer and run PAYE for those employees, even though your own income goes through Self Assessment. The same applies if you're a company director paying yourself a salary: the salary runs through PAYE, while dividends are reported on your Self Assessment return.

Simplify your payroll with Xero

Running PAYE doesn't have to mean hours of manual calculations and chasing deadlines. Xero's payroll tools calculate deductions and submit your RTI reports directly to HMRC, so you can keep everything in 1 place and stay on top of your PAYE obligations without the stress. Get one month free.

FAQs on PAYE

Here are answers to some frequently asked questions about PAYE.

What is the difference between PAYE and Self Assessment?

PAYE is managed entirely by the employer, with no action needed from the employee at tax time. Self Assessment requires individuals to file a tax return each year, calculate what they owe, and pay HMRC directly by 31 January.

Do all employers need to register for PAYE?

Not always. If none of your workers meet the earnings or benefit criteria, you don't need to register, but you still must keep payroll records. If you engage self-employed contractors, check their employment status carefully; HMRC can reclassify them as employees and charge you unpaid PAYE, NICs, and penalties.

What happens if you pay PAYE late?

You can appeal a penalty if you have a "reasonable excuse," such as a serious illness, bereavement, or an HMRC system outage that prevented payment. Submit your appeal through your HMRC online account or in writing within 30 days of the penalty notice.

Can you run PAYE without software?

Technically, HMRC offers Basic PAYE Tools for free if you have fewer than 10 employees. For most businesses, dedicated payroll software is faster, reduces errors, and handles RTI submissions, payslips, and auto-enrolment pensions in 1 place.

What is a P45 and when do you need one?

A P45 is a document you give an employee when they leave your business. It shows their total pay and tax for the current tax year, and their new employer uses it to set up the correct tax code from their first payday.