Small Business Accountants

What is PAYE? How does Pay As You Earn Tax Work?

PAYE (Pay As You Earn) is the UK system through which employers deduct income tax and National Insurance from employees' wages before paying them. HMRC assigns each employee a tax code, currently 1257L for the standard £12,570 personal allowance, which determines how much can be earned tax-free. Employers report deductions each pay period through Real Time Information (RTI) using Full Payment Submissions and Employer Payment Summaries.

By Jordan Macey MAAT Reviewed by Noor Fiaz Updated 16 Apr 2026 6

Key takeaways

PAYE collects income tax and National Insurance at source, so employees pay the correct tax each payday rather than settling a lump sum at year end.
The standard 2025/26 tax code is 1257L, reflecting the £12,570 personal allowance. Income above that threshold is taxed at 20%, 40% or 45% depending on the band.
Employers must report PAYE deductions to HMRC every pay period via Real Time Information, submitting a Full Payment Submission (FPS) on or before each payday.
Employee National Insurance for 2025/26 is 8% on earnings between £12,570 and £50,270, then 2% above. Employer NIC is 15% on earnings above the £5,000 secondary threshold.
When an employee leaves, the employer issues a P45. By 31 May each year, every current employee receives a P60 summarising total pay and tax for the year.

Introduction to PAYE

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.

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What is PAYE

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.

How Do I Set Up PAYE Payroll

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:

Register as an employer with HMRC. After registering, you'll receive a PAYE Online login credentials within five working days.
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:

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

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PAYE Tax Deadlines

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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PAYE on Your Pension

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:

If your only income is from the state pension, you have to send a self-assessment tax return to HMRC.
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.
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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PAYE When You're Self-Employed

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:

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

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GoForma can Solve Your PAYE Problems

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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Frequently asked questions

What is PAYE and how does it work?

PAYE stands for Pay As You Earn. It is the UK system through which employers deduct income tax and National Insurance contributions from employees' gross pay before issuing wages. HMRC assigns each employee a tax code that tells the employer how much tax-free income to allow. The employer calculates deductions each pay period and sends the amounts to HMRC, so tax is collected throughout the year rather than as a single annual bill.

What is a PAYE tax code and what does 1257L mean?

A PAYE tax code tells your employer how much income you can earn before tax is deducted. The most common code for 2025/26 is 1257L, which reflects the £12,570 personal allowance. HMRC may adjust your code if you receive benefits in kind, owe tax from a previous year, or have multiple income sources. You can check your tax code on your payslip, P60, or through your HMRC online account.

What are P45, P60 and P11D forms?

A P45 is issued when an employee leaves a job and shows earnings and tax paid during that employment. A P60 is an annual summary of total pay and deductions for the tax year, which employers must provide to each employee by 31 May. A P11D reports benefits in kind and expenses provided to employees, and must be submitted to HMRC by 6 July following the end of the tax year.

What are employers' PAYE responsibilities?

Employers must register with HMRC as an employer, operate PAYE on each employee's pay, and report deductions through Real Time Information (RTI). This means submitting a Full Payment Submission (FPS) on or before every payday and an Employer Payment Summary (EPS) where needed. Employers must also issue P45s to leavers, provide P60s by 31 May, and pay PAYE liabilities to HMRC by the 22nd of the following tax month for electronic payments.

What is a PAYE Settlement Agreement?

A PAYE Settlement Agreement (PSA) lets employers pay income tax and National Insurance on minor, irregular or impractical benefits on behalf of their employees. Common examples include staff entertaining, small gifts and incentive awards. Employers must apply to HMRC before the start of the tax year the PSA covers. Once agreed, the employer settles the tax and Class 1B NIC by 22 October following the end of that tax year.

What is an emergency tax code and when does it apply?

An emergency tax code is a temporary code HMRC assigns when it does not have enough information to issue the correct one. This typically happens when an employee starts a new job without a P45 from a previous employer. The most common emergency codes for 2025/26 are 1257L W1 (weekly) and 1257L M1 (monthly), which apply the personal allowance on a non-cumulative basis. Once HMRC receives the correct details, it issues a revised code.

Does PAYE apply if you are self-employed?

Self-employed individuals do not use PAYE on their trading income. Instead, they report earnings and pay income tax and National Insurance through Self Assessment. However, HMRC can collect small Self Assessment debts of under £3,000 through a PAYE tax code adjustment if the individual also has PAYE income. To qualify, the online tax return must be filed by 30 December following the end of the relevant tax year.

What are the 2025/26 PAYE income tax and NIC rates?

For 2025/26, income tax rates are 20% basic rate on earnings from £12,571 to £50,270, 40% higher rate from £50,271 to £125,140, and 45% additional rate above £125,140. Employee National Insurance is 8% on earnings between £12,570 and £50,270, then 2% above that. Employer NIC is 15% on earnings above the £5,000 secondary threshold, with an Employment Allowance of up to £10,500 available to eligible employers.