A Quick Guide to PAYE (Pay As You Earn) and Employment Allowance

When you run a business and hire your first employee, you step into a new world of responsibilities — and one of the most important is managing PAYE (Pay As You Earn).

This system, run by HMRC in the UK, ensures that income tax and National Insurance contributions are collected from employees' earnings before they’re paid.

Here’s what business owners need to know to stay compliant and run a smooth payroll process:

What Is PAYE?

PAYE is HMRC’s system for collecting Income Tax and National Insurance from employment. As an employer, it’s your legal duty to calculate and deduct the right amounts from your employees’ wages and pay them to HMRC on time.

PAYE typically applies if your employee earns more than:

• £242 a week (£1,048 a month / £12,570 a year) – the personal allowance threshold (2025/26)

• Or they get benefits such as a company car, private medical insurance, interest free loans, etc

PAYE is collected from employees' earnings before they're paid

When Does a Small Business Need to Register for PAYE?

You must register as an employer with HMRC before your first payday if you:

• Hire employees

• Pay yourself as a director via payroll

• Provide employee benefits or expenses

You should register at least 5 working days before your first payday to give HMRC time to process your registration.

How to Set Up PAYE

1. Register with HMRC as an employer online

2. Get a PAYE reference number and an Accounts Office reference

3. Choose payroll software that can report to HMRC (Xero, QuickBooks, FreeAgent, etc.)

4. Collect employee information (e.g. P45s, National Insurance number)

5. Run payroll and submit a Full Payment Submission (FPS) to HMRC on or before each payday

   
   
   
   

What Are Your PAYE Responsibilities?

As an employer, you are required to:

• Calculate deductions: income tax, employee National Insurance, student loans, and pension contributions

• Contribute employer National Insurance: this is in addition to the deductions from employee pay

• Submit reports to HMRC: FPS each payday, and possibly an Employer Payment Summary (EPS) if adjustments are needed

• Pay HMRC: usually by the 22nd of each month (if paying electronically), or by the 19th if paying by post

Common PAYE Mistakes to Avoid

• Missing deadlines: Late FPS filings can trigger penalties

• Incorrect deductions: Use up-to-date tax codes and check software accuracy

• Not keeping records: Employers must keep PAYE records for at least 3 years

• Failing to provide payslips: Employees are legally entitled to a written payslip showing earnings and deductions

Common mistakes include failing to keep proper records and not providing payslips

PAYE and Sole Directors

If you’re a sole director and the only employee, PAYE might still apply if you pay yourself above the personal allowance or draw a salary in addition to dividends. It’s often tax-efficient to run a small salary through PAYE while taking the rest as dividends — but this must be set up and recorded properly.

What is the Employment Allowance?

The Employment Allowance is a valuable relief for small businesses in the UK, designed to help reduce their National Insurance (NI) liability. It has been increased from £5,000 in 2024/25 to £10,500 in 2025/26 to help offset some of the increase in employer NIC costs from April 2025.

To be eligible, generally, you must be:

• A registered employer

• A business or charity (including Community Amateur Sports Clubs) with employees

• Paying Class 1 National Insurance contributions for your employees or directors

Key changes from April 2025 regarding eligibility:

• Removal of the £100,000 previous year's NI liability limit: Previously, employers were only eligible if their total secondary Class 1 NI liabilities were less than £100,000 in the previous tax year. This restriction has been removed from 6 April 2025, opening up the allowance to more businesses.

• Single-director companies: If your company has only one director who is also the sole employee earning above the secondary NICs threshold, you generally cannot claim the allowance. However, if you have two or more directors, or a single director and at least one other employee earning above the secondary threshold, you might be eligible.

• Public sector bodies: Generally, public sector bodies or businesses where more than 50% of their work is in the public sector are not eligible, unless they are a registered charity.

• Domestic employees: You cannot claim for employees who do personal, household, or domestic work (e.g., nannies, gardeners), unless they are care or support workers.

• Connected companies/charities: If your business is part of a group of companies or charities, only one entity in the group can claim the allowance, and it can only be claimed against one PAYE scheme.

How does the employment allowance relate to PAYE?

Reduces your NI bill	The allowance is used to reduce your employer's Class 1 NICs liability as it arises throughout the tax year, typically on a month-by-month basis, until the £10,500 limit is reached or the tax year ends.
Claim through payroll software	You claim the Employment Allowance as part of your Real Time Information (RTI) submission to HMRC. Most payroll software has an option to indicate that you are claiming the allowance, often by ticking a box in the "Employment Allowance indicator" field when sending an Employment Payment Summary (EPS).
HMRC Basic PAYE Tools	If you use HMRC's free Basic PAYE Tools, you can also claim through this.
Not automatic	You need to claim the Employment Allowance every tax year to ensure you're still eligible. It's not an automatic carry-over.
Early claim is better	The earlier you claim in the tax year, the sooner you'll benefit from the reduction in your NIC payments.
Unused allowance	If you don't use the full allowance by the end of the tax year, and you have no other PAYE debts, HMRC may either set the remaining balance against future tax liabilities or issue a refund.
Backdating claims	You can backdate claims for the previous four tax years if you were eligible but didn't claim. You'll need to submit an EPS for each year you are claiming.

Final Thoughts

PAYE can seem daunting at first, but with the right setup and tools, it becomes a routine part of running your business. Cloud payroll software and the support of a professional accountant can simplify the process and ensure you stay compliant.

The Employment Allowance can significantly reduce employer costs for small businesses - excluding sole director companies - by reducing Class 1 NIC liabilities. The allowance can be claimed each tax year through payroll software or HMRC's Basic PAYE Tools, but it is not automatic and should be claimed as early as possible.

Still unsure? It’s always wise to seek expert advice tailored to your business.

Need Help with PAYE?

Our accounting team at Verifiable Accounts can help you register for PAYE, run payroll, and keep HMRC happy — so you can focus on growing your business.

Please note that this is a simplified helpsheet and further research should be performed if you are still unsure.