How To Work Out PAYE For A Small Business
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- Pay, Tax, Employees, Payroll, Benefits
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Find out more about how to work out PAYE for a small business. We look at how is PAYE calculated and why employers PAYE.
What is PAYE?
PAYE (Pay As You Earn) is a financial system that large and small businesses use to ensure the people they employ pay the correct amount of Income Tax and National Insurance Contributions.
It's become a crucial part of payroll for companies, given its ease and efficiency of use, ensuring your employees pay quarterly or annually. All taxes and contributions, including student loan repayments, are deducted from employees' wages before they are then paid. This means your employees won't have to pay any further tax once they've received their net pay.
Do I need to use PAYE?
Not every employer feels as though they need to use the PAYE system. However, if your employees meet one or more of the following criteria, it may be best to pay them through the PAYE system:
- Claim expenses
- Receive employee benefits
- Receive other taxable benefits
- Have a second job
- Receive pension payments from you
- Earn £116 per week or more
As soon as your business or company hires an employee, you need to register yourself with HMRC as an employee, which you can do online through the government website.
Even if your employees don't fall into any of the above categories for PAYE, you'll still need an accurate payroll system to generate and keep track of your payroll records.
What are the benefits of PAYE?
The main benefit of using the PAYE system is that it ensures all of your employees pay tax at the right rate throughout the tax year. Other benefits include accurately arranging your payroll taxes.
As an employer, you'll need to pay these taxes for most employee benefits, such as employee health insurance, the costs of uniforms, company cars, travel expenses and any number of other expenses your employees will cost your business.
Why do employers pay PAYE?
Employers use the PAYE system to pay their employees because it is their duty to ensure they pay the right amount of tax to HMRC, and the PAYE system is the best way to ensure this is done accurately. Of course, these employers don't handle their payroll themselves unless their business is still small.
Most growing and larger companies will outsource their payroll, and therefore their PAYE payments, to professional accountants or payroll services. Using these services puts your employees' tax obligations in the hands of experts who will ensure your full payment submissions are accurate and timely throughout the tax year. If you want to pay tax in a way that keeps you in HMRC's good books, hiring an accountant is the best way to do this.
How do you work out PAYE tax?
If you are going to manage your employees' PAYE as an employer, it's vital that you know how it all works. In the following section, we'll take you through the most important things you need to know to ensure your PAYE payments to your employees are accurate. After all, this is the entire purpose of the PAYE system, and if you're determined to do this yourself with payroll software or other financial tools, it's best to do it properly.
How is PAYE calculated?
Essentially, the amount of tax you pay through the PAYE system is determined by your earnings, with any personal allowances you and your employees are eligible for deducted.
It's important to remember that the tax collected through PAYE is an estimate based on your employee's tax codes. Therefore, the amount paid may not be exact when calculating PAYE, so you should account for additional charges just in case there is an error.
Regarding your personal allowances, everyone living in the UK is entitled to earn up to £12,570 per year before having to pay a penny in Income Tax. This is the current rate for the 2022/23 tax year. This tax-free allowance is gradually reduced once someone starts earning over £100,000 per year.
You may also have your Personal Allowance reduced if you have any unpaid taxes. Conversely, if you have paid too much in Income Tax, you can be granted a higher Personal Allowance to account for the tax overpaid.
All your earnings above the Personal Allowance threshold will be charged at the appropriate tax rate. How much Income Tax you pay is determined by how much you earn per year, with three different rates for different income levels. For the 2022/23 tax year, the different tax rates are as follows:
- Basic Rate: For those with annual earnings between £12,571 - ££37,700. All earnings within this range will be taxed at 20%.
- Higher Rate: For those with annual earnings between £37,701 - £150,000. All earnings within this range will be taxed at 40%.
- Additional Rate: For those with annual earnings above the £150,000 threshold. All earnings above this threshold will be taxed at 45%.
HMRC determines which tax bracket someone will be placed in by providing them with a tax code. This tells you, as an employer, and whatever pension provider you select, how much tax needs to be deducted from your employee's statutory pay or pensions.
If HMRC doesn't have the necessary information to provide your employee's tax code, they will be placed on an emergency tax code until this is rectified. These can often not be accurate according to your employee's earnings, so you should inform HMRC of the proper information as soon as possible.
Paying HMRC through PAYE
Again, you need the appropriate tax code to ensure your employees pay the right amount of tax through PAYE. You can usually find their respective tax codes through the government website.
Alternatively, it will usually be noted on a P45 that a previous employer issued, so long as your employee has had a previous employer. National Insurance Contributions are a little trickier to determine, but they also use codes to place people into specific categories.
These are based on age and employment status, with most employees in the UK being category A for NI Contributions. Everyone in the UK will also have a National Insurance Number to determine their category.
What do I need to watch out for with PAYE?
As you can imagine, there are a few tricky things to look out for when using the PAYE system. These difficulties can lead to issues with HMRC, so it is always best to avoid them.
Adjustments: This is when you don't calculate and note down changes in pay, such as raises, overtime or employee bonuses.
Incorrect Details: Not properly separating your expenses, pension contributions and sick pay.
Tax Codes: Using the wrong tax code for your employees. This means they will be paying inaccurate tax contributions for their salaries.
Employees Leaving: Forgetting to remove employees from the payroll after they have left your company.