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What Is PAYE?

PAYE (pay as you earn) is a system that enables employers to deduct National Insurance and income tax from employees before paying them their wages (including adoption pay, sick pay, maternity/paternity pay and pension payments). Employers are responsible for sending deductions through PAYE to HMRC (HM Revenue and Customs).

Legally, employers must note the full details of an employee's pay and deductions made in their payslips. When the tax year ends, workers receive a P60 form that explains the total amounts that have been paid to them and taxes paid to HMRC through PAYE during the previous tax year. The tax years run from April 6th to April 5th.

If an individual pays tax on their pensions and wages under the PAYE system, PAYE can also be used to collect tax on other forms of income. For instance, if a worker pays tax using PAYE on a pension, the tax that is due on their state pension can also be collected through PAYE. PAYE can also be used to pay tax on interest and rental income, self-employed National Insurance contributions and other tax debts.

UK taxpayers are allowed to earn a certain amount without paying tax every year. This is known as their “personal allowance”. If a worker's income is over a certain amount, the amount they can take home tax-free is reduced in proportion to their earnings. HMRC will only charge a worker tax on everything they earn that is above their personal allowance . For example, if you earn £20,000 a year, and you are entitled to a personal allowance of £12,500, then HMRC will only collect tax on everything above that £12,500. This means that only the remaining £7,500 of your salary will be taxed. Using PAYE, employers must deduct tax and National Insurance on a monthly basis in line with worker's wages.

You must earn over £12,500 to start paying income tax. After this amount, tax will be deducted in the following ways:

  • 20% on everything earned between £12,500 and £50,000.
  • 40% on everything earned between £50,000 and £150,000.
  • 45% on everything earned over £150,000.

PAYE Tax Codes

HMRC uses tax codes to inform employers of how much to deduct from workers' wages using the PAYE system. If there isn't enough information on the worker and HMRC cannot issue a tax code, employers can use an emergency tax code until more information becomes available. PAYE tax codes typically consist of a number followed by a letter. The number refers to the amount of income and allowances a worker has, while the letter indicates the type of allowances a worker is receiving. Tax codes are found on workers' payslips and pension statements.

Emergency Tax Codes

If an employer cannot be given an accurate tax code for a worker by HMRC, they will receive an emergency tax code. This tax code automatically assumes that a worker is only entitled to the most basic form of personal allowance (before tax). The PAYE tax code will contain the letter L if it is an emergency tax code. If a worker is on an emergency tax code, they may not receive all of the reliefs and benefits they are entitled to, and HMRC may owe them a tax refund later down the line. This can take several years to materialise, especially if a worker has changed jobs multiple times and HMRC has had to keep up. Likewise, moving to the correct tax code may also mean that a worker has paid too little in tax and, therefore, owes HMRC more in taxes. These will be deducted via PAYE and their current employer.

A worker stops paying emergency tax when the correct PAYE tax code information is given to their employer by HMRC. This enables an employer to make the correct tax deductions in future.

What Are the Differences between PAYE and Self Assessment?

If a person earns an income and does not have National Insurance or tax deducted via the PAYE scheme, they will need to provide HMRC with a completed self-assessment tax return to pay their taxes. Income not taxed under PAYE includes rental income or income from those that are self-employed. It is a legal obligation to inform HMRC of any taxable income that is received in addition to income earned and taxed through PAYE.

Starting a New Job and PAYE

If a worker begins a new role with an employer, they will be given a form called a P45 by their previous employer, or they will be asked to fill in a P46 form if they do not have a P45. This will help HMRC to calculate the correct tax code so that, when the worker starts their new job, their new employer deducts the right amount of tax from their wages. Keep in mind that any additional financial bonuses received from an employer are also eligible for National Insurance and tax deductions if they are paid through PAYE.

The PAYE system uses various forms including:

  • P60: This notifies a worker how much tax they have paid in a full tax year.
  • P45: This is given to a worker when they leave a PAYE job. It is an important document if you have paid too much tax and need to prove that HMRC owes you money.
  • P11D: If extra benefits are given through an employer such as a company car, mobile phone or health insurance, an employer will use this form to declare these benefits to HMRC.

Need to set up your business for PAYE? Follow our easy step-by-step process , and we'll do it for you, taking the hassle out of notifying HMRC. Set up your payroll the easy way!

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