An Employer's Guide to Payroll: Pay As You Earn (PAYE)
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Running a business comes with various responsibilities, and one of the key aspects is managing your employees' payroll efficiently. The Pay As You Earn (PAYE) system is the mechanism through which income tax and National Insurance contributions are collected from employees' wages. This system ensures that the government can fund essential services like education, healthcare, and state benefits like the State Pension.
In this comprehensive guide, we will delve into the intricacies of the PAYE system, helping employers understand how it works, tax codes, National Insurance, and much more. Whether you are using payroll software or managing payroll manually, having a fundamental understanding of the PAYE system is vital for ensuring accuracy and compliance.
Understanding 'Pay' for Tax and National Insurance Purposes
The PAYE system requires employers to deduct tax and National Insurance contributions from most payments made to employees. To operate PAYE correctly, it's essential to comprehend what constitutes 'pay' for tax and National Insurance purposes. Pay for National Insurance aligns closely with pay for tax, although there are some distinctions. For more in-depth information on pay and deductions, please get in touch with KRIS London Accountant .
The Role of Tax in the PAYE System
When a person is employed, their employer deducts income tax from their wages and pays it to HMRC under the PAYE system. The tax code plays a crucial role in determining the amount of tax to be deducted from an employee's pay. Tax codes typically consist of numbers and letters, such as 1257L or K396.
Under the PAYE system, an employee's personal allowance (the amount they can earn before paying tax) is distributed evenly throughout the year. HMRC employs the tax code to inform an employer of an employee's tax-free earnings for a specific pay period. This tax-free amount could be the standard personal allowance of ￡12,570, but it may vary based on individual circumstances.
It's important to note that as a person's income increases, so does the amount of income tax they pay. The key rates of income tax and personal allowances can be found on the GOV.UK website. PAYE evenly spreads an employee's income tax liability throughout the tax year, making it an estimate rather than an exact measurement of the employee's tax liability.
How Tax Codes Work
Collecting income tax is based on an employee's tax code. The tax code signifies the amount of tax-free pay an employee is entitled to in a given pay period. Be sure to subscribe to our newsletter to gain access to a more detailed explanation of how tax codes work in our upcoming article.
National Insurance Contributions Under PAYE
In addition to collecting and sending the correct amount of tax to HMRC, employers are also responsible for collecting and sending National Insurance contributions (NICs) to HMRC. NICs are essential for building entitlement to various state benefits, including the State Pension. Both employees and employers usually contribute to NICs.
NIC Rates for 2023/24
For the tax year 2023/24, employees do not pay NIC on earnings up to the primary threshold of ￡242 per week (￡1,048 per month). However, between the lower earnings limit (LEL) of ￡123 per week (￡533 per month) and the primary threshold, employees are treated as if they have paid NIC, helping protect their entitlement to state benefits.
Employers are liable to pay NIC on any employee's pay exceeding ￡175 per week (￡758 per month). However, most small employers can claim up to ￡5,000 a year as an Employment Allowance, effectively reducing or eliminating their employer NIC payments.
National Insurance for Specific Groups
To support these schemes, different National Insurance category letters are used.
Benefits of Freeports
Employers in UK Freeport tax sites can claim relief from employer Class 1 National Insurance contributions. The government created Freeports to boost economic activity and employment opportunities in disadvantaged communities. Employers in Freeport locations can benefit from reduced employer NIC payments, thanks to the Freeport Upper Secondary Threshold (FUST).
Details about the Freeports and how the scheme operates can be found on the GOV.UK website.
Employing Family Members and National Insurance Treatment
When employing family members, it's crucial to note that there are no special tax rules that apply to them. Family members are subject to the same tax rules as any other employees. However, for NIC purposes, if you employ someone you usually live with in the same 'dwelling house,' their NICs are disregarded, and no NIC is payable. More information on this can be found in our guidance on employing family members.
National Insurance Employment Allowance for Employers
In the tax year 2023/24, employers may be eligible to claim the Employment Allowance, which can provide relief of up to ￡5,000 from their National Insurance bill. This allowance is aimed at smaller employers with Class 1 NIC liabilities less than ￡100,000 in the previous tax year.
The Function of Tax Codes
A tax code is a crucial element in calculating the amount of tax to deduct from an employee's pay. It is typically a combination of numbers and letters, such as 1257L or K396. The tax code is used to determine an employee's tax-free earnings for a specific pay period, enabling accurate tax calculations.
How Tax Codes Work
Tax codes reflect a person's entitlement to a personal allowance, which, in 2023/24, is ￡12,570. The personal allowance is distributed evenly throughout the tax year, ensuring that the employee's income tax bill is spread across the year rather than being paid in a lump sum.
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Cumulative Tax Codes
PAYE is usually calculated on a cumulative basis, meaning that an employee's income tax liability is assessed throughout the tax year. This method ensures that employees do not overpay or underpay tax. For example, if an employee starts working in September, they are allowed a portion of their personal allowance for that month.
Emergency Tax Codes
Emergency tax codes, denoted by codes like 1257L W1 or 1257L M1, are used when an employee's pay period is not aligned with the tax year. In such cases, only one week's or month's worth of tax allowances is granted against the wages for that specific period.
Additional Tax Code Variations
There are various other tax codes, each signifying different tax treatment:
Employees with Multiple Jobs
In cases where an employee has multiple jobs, employers might be advised to use a BR code, especially if the employee's total income surpasses their personal allowance. However, employees can contact HMRC to split their allowances and avoid tax deductions from both employers if their combined income remains below the personal allowance.
Managing Tax Code Changes
Most tax codes change at the beginning of each tax year to account for increases in the personal allowance. HMRC provides guidance on the necessary actions before the start of each new tax year. Employers must ensure they are using the latest tax codes to avoid errors in their payroll.
Reporting Payroll Information to HMRC
Under the PAYE system, employers are legally required to report payroll information to HMRC accurately and on time. There are various payroll processes, and you can choose the one that best suits your business. The two primary methods for reporting payroll information are:
Late Reporting and Penalties
Failing to report payroll information accurately and on time can result in penalties from HMRC. The severity of the penalties depends on the number of employees and the length of the delay. To avoid penalties, it's essential to ensure your payroll reporting is both accurate and timely.
Real-Time Information (RTI)
The PAYE system operates on Real-Time Information (RTI), which means employers must report payroll information to HMRC in real-time. RTI has revolutionised the PAYE system, making it more accurate and efficient.
Real-time reporting helps HMRC stay updated on an employee's financial situation, ensuring they receive the correct tax credits and benefits. It also reduces the need for end-of-year reconciliations and ensures that an employee's tax record is up-to-date.
PAYE Settlement Agreements (PSAs)
In some cases, employers might need to deal with expenses and benefits for their employees. To simplify the process, employers can use PAYE Settlement Agreements (PSAs) to pay the tax and National Insurance on the employees' behalf.
PSAs are particularly useful when there are non-cash benefits, such as company cars or health insurance, involved. By using a PSA, employers can save time and administrative effort.
Support for Employers
Managing payroll and the PAYE system can be complex and time-consuming. To help businesses navigate these challenges, there are various resources available, including:
Something to keep in mind
The PAYE system is a fundamental aspect of employing staff in the UK. Understanding how it works, including tax codes, National Insurance, and reporting requirements, is crucial for ensuring compliance and efficiency in managing your employees' payroll.
As an employer, your responsibility is not only to pay your employees but also to ensure that the correct tax and National Insurance contributions are deducted and reported to HMRC. Staying up-to-date with changes in tax legislation and payroll reporting requirements is essential to avoid penalties and ensure a smooth payroll process.
LOYALS Accountants & Business Consultants, based near King's Cross and serving the entire London area, are here to take care of your tax considerations and ensure your tax accuracy and compliance. By outsourcing your payroll to us, you gain access to the best tax-optimising strategies that are not only legal but also incredibly smart.
We hope this guide has provided you with valuable insights into the PAYE system and how it impacts your business. By mastering the PAYE system, you can ensure that your employees are paid accurately and on time, and your business remains in compliance with HMRC regulations. For more in-depth information and assistance, consider consulting with LOYALS Accountants & Business Consultants.