Pay As You Earn (PAYE) is HMRC's system for collecting Income Tax and National Insurance from employees before their wages are paid. For most employees, it means tax is deducted automatically every pay period with no action required on their part. For employers, PAYE creates a monthly reporting and payment obligation to HMRC that must be met precisely and on time.
What is PAYE?
Under PAYE, employers calculate and deduct Income Tax and employee National Insurance Contributions (NICs) from each employee's pay, then forward the amounts to HMRC. PAYE is triggered once an employee's earnings exceed the PAYE threshold: £242 per week (£1,048 per month) for 2026/27.
PAYE eliminates the need for most employees to file a Self Assessment tax return, as their tax obligations are settled automatically through their employer. However, employees with complex tax affairs — multiple jobs, benefits in kind, income over £100,000, or other untaxed income — may still need to file Self Assessment in addition to being taxed through PAYE.
Tax codes 2026/27
A tax code tells your employer how much of your income is tax-free. The standard tax code for 2026/27 is 1257L, which gives an employee a Personal Allowance of £12,570. HMRC sends updated tax codes to employers each April through the P9X notification. Employers must use the new codes from 6 April each year.
How to read a tax code
The number in your tax code is your tax-free allowance with the last digit removed. Code 1257L means your annual tax-free allowance is £12,570. Your employer applies this monthly (£1,047.50) or weekly (£241.73) before calculating PAYE.
Common tax code suffixes:
| Suffix | Meaning |
|---|---|
| L | Standard Personal Allowance — the most common code |
| M | Receiving the Marriage Allowance from a partner |
| N | Transferring the Marriage Allowance to a partner |
| T | HMRC needs to review your allowances (e.g. income over £100,000) |
| K | Negative allowance — your untaxed income or deductions exceed your allowances |
| 0T | No Personal Allowance — used in emergency situations or when the allowance is fully withdrawn |
| BR | All income taxed at basic rate — commonly used for second jobs |
| D0 | All income taxed at higher rate — used for second or third jobs |
How PAYE tax is calculated
The calculation for each pay period follows these steps:
- Determine the employee's gross pay for the period (salary, overtime, bonus, etc.).
- Apply the PAYE free pay — the tax-free amount for this period based on the tax code.
- Calculate taxable pay = gross pay minus free pay.
- Apply the income tax rates to the taxable pay: 20% basic rate, 40% higher rate, 45% additional rate.
- Calculate employee National Insurance on earnings between the Primary Threshold (£12,570/year) and the Upper Earnings Limit (£50,270/year) at 8%, and 2% above the UEL.
- Deduct these amounts from the employee's gross pay before payment.
Most payroll software calculates these amounts automatically using HMRC's published tax tables and the employee's tax code. Employers do not manually calculate PAYE for each employee — the software does it.
Employer National Insurance
In addition to employee NI, employers pay their own NI contributions on employee earnings above the Secondary Threshold. For 2026/27, this is charged at 15% on earnings above £5,000 per year (£96.15 per week).
Employer NI is a cost to the business — it is not deducted from the employee's wages. For a full-time employee on £35,000, employer NI costs the business approximately £4,500 per year, on top of the salary itself. This is a significant consideration when budgeting for new hires.
Employer NI is fully deductible as a business expense for Corporation Tax purposes (or as a self-employed expense for sole traders who employ staff).
Employment Allowance
The Employment Allowance reduces the amount of employer NI a business pays each tax year. For 2026/27, the allowance is £10,500. This means eligible businesses do not pay employer NI until their total annual employer NI bill exceeds £10,500.
Most small and medium-sized businesses qualify. You cannot claim the Employment Allowance if:
- Your employer NI bill was £100,000 or more in the previous tax year
- You employ only one person and that person is also a director
- You are a public authority
Claim the Employment Allowance through your payroll software or HMRC's Basic PAYE Tools. You must claim it each tax year — it does not carry over automatically.
Real Time Information (RTI)
Since April 2013, all employers must report PAYE information to HMRC in real time using Real Time Information (RTI). This means you cannot wait until the end of the year to report payroll — you must submit a Full Payment Submission (FPS) to HMRC on or before every payday.
If you make changes between paydays — for example, correcting an error — you use an Employer Payment Summary (EPS) to notify HMRC. The EPS is also used to claim the Employment Allowance, report SSP reclaimable amounts, and notify HMRC of periods of inactivity.
RTI submissions must be made on time. Late FPS submissions attract penalties (except for the first submission in any tax year, where a one-month grace period applies for new employers).
Payslips, P60, and P45
Payslips
Every employee has a legal right to a payslip on or before each payday. The payslip must show: gross pay, all deductions (with amounts) including tax, NI, and pension contributions, and net pay. The payslip can be provided electronically.
P60
A P60 is the annual summary of an employee's pay, tax, and NI contributions for the tax year. You must provide a P60 to all employees who are still employed at 5 April by 31 May each year. Employees use their P60 to complete Self Assessment returns, claim tax refunds, apply for mortgages, and prove their income.
P45
A P45 is issued when an employee leaves your employment. It shows their total pay and tax deducted to date in the current tax year. The leaving employee takes the P45 to their new employer (or to the Jobcentre if claiming benefits). You must provide a P45 on or before the employee's last day.
Benefits in kind and P11D
If you provide employees with benefits (anything non-cash with monetary value), these are taxable as benefits in kind. Common examples include company cars, private health insurance, interest-free loans over £10,000, accommodation, and non-trivial gifts.
Benefits in kind are reported to HMRC on the P11D form, due by 6 July after the end of each tax year. You must also submit a P11D(b) to declare and pay employer Class 1A NI on the benefits (at 13.8% on the taxable value, payable by 22 July).
As an alternative to P11Ds, you can operate a PAYE Settlement Agreement (PSA) for minor or irregular benefits, paying tax and NI on your employees' behalf under a single annual calculation. Many employers prefer PSAs for items like staff parties and Christmas gifts.
Salary sacrifice arrangements (such as company cars under an Optional Remuneration Arrangement) can reduce the taxable benefit but have their own rules and tax implications.
Setting up PAYE as an employer
If you take on an employee for the first time (including paying yourself as a company director through payroll), you must register as an employer with HMRC before the first payday. Do this at GOV.UK — HMRC will issue you an employer PAYE reference and accounts office reference number, which you need to make submissions and payments.
Steps to set up PAYE:
- Register as an employer at GOV.UK (allow up to 5 working days for your registration to process).
- Set up payroll software (or sign up for HMRC's free Basic PAYE Tools for small employers with fewer than 10 employees).
- Collect each employee's full name, date of birth, NI number, and starter declaration (previous employment details).
- Submit a Full Payment Submission (FPS) on or before the first payday.
- Pay tax and NI to HMRC by the 19th of each month (22nd if paying electronically).
Key takeaways
- PAYE automatically deducts Income Tax and employee NI from wages before payment, using a tax code to determine each employee's tax-free allowance.
- The standard tax code for 2026/27 is 1257L, giving a Personal Allowance of £12,570. From April 2026, HMRC sends tax code updates digitally rather than by post.
- Employer NI is charged at 15% on employee earnings above £5,000 per year — a significant additional cost on top of salary.
- The Employment Allowance reduces employer NI by up to £10,500 per year for most eligible businesses.
- Under RTI, employers must submit a Full Payment Submission on or before every payday. Benefits in kind are reported annually on P11Ds by 6 July.
Frequently asked questions
How do I know if my tax code is correct?
Check your tax code on your payslip and compare it to what you expect based on your circumstances. If you have one job and the standard Personal Allowance, your code should be 1257L. Log into your HMRC Personal Tax Account at gov.uk to see your current code and request a change if it is wrong. HMRC can update your code and notify your employer automatically through their PAYE systems.
What is the PAYE payment deadline?
Most employers pay PAYE and NI monthly by the 19th of the month following the tax month end. If you pay electronically, the deadline is the 22nd. Tax months run from the 6th of one month to the 5th of the next. For example, for the tax month 6 March to 5 April, PAYE must reach HMRC by 19 April (or 22 April electronically). Large employers making quarterly PAYE payments have different deadlines.
Do company directors have to go through payroll?
Not automatically, but it is very common for directors to put their salary through payroll to create a deductible expense for the company and ensure NI contributions are recorded. Directors who receive employment income through the company must be registered on the payroll and PAYE applied through RTI, even if their salary is low (for example, set at the NI threshold). Dividends are not salary and are not processed through payroll.
What happens if I pay PAYE late?
HMRC charges automatic penalties for late PAYE payments. For most employers, a penalty of 1% to 4% of the amount owed applies, depending on how many late payments you make in a tax year. Interest also accrues on unpaid amounts. There is a 12-month exception for the first late payment of a new employer, but this applies only once and HMRC must be notified promptly.
Can an employee opt out of PAYE?
No. PAYE is a legal requirement — neither the employer nor the employee can opt out of it. Employers must deduct and remit PAYE regardless of the employment contract. Attempting to pay employees in a way that avoids PAYE (for example, through loans, gifts, or disguised remuneration schemes) can result in significant penalties under HMRC's anti-avoidance rules.