How to Calculate Pay As You Earn Tax​​​ (PAYE)?

Pay As You Earn, commonly known as PAYE, is a part and parcel of running a payroll, which entails calculating and distributing due wages among the employees. Therefore, it is significant to learn how to calculate pay as you earn if you are a business owner, a director of a limited company, or an employee. In this regard, this blog will delve into a stepwise discussion of how to calculate pay as you earn tax so that you stay compliant with HMRC in fulfilling your PAYE obligations.

 

Take a Look at PAYE:

A salary is a fixed amount of money that an employee is paid as compensation for their services in a company or business. Likewise, a limited company director is also classed as an employee for tax purposes, and they take a salary for their role of managing the company’s routine operations. A salary is paid at regular intervals, usually every month. Now, whether you are a director or an employee, you are liable to pay income tax and National Insurance contributions (NICs) on your salary, which are deducted beforehand under the PAYE tax. You receive your salary through the PAYE scheme, under which all employees, including directors, directly pay their income tax and NICs from their earnings before they are paid wages.
For greater clarity, it is a tax system governed by HMRC in the UK to streamline and smooth the tax collection process, wherein the employer first deducts applicable amounts of income tax and NICs before distributing the salaries to employees. Thereafter, employers pay the salaries to the staff. In the end, the employers send the deducted amounts to HMRC on behalf of the employees.

How to Calculate Pay As You Earn Tax?

To get an insight into how to calculate pay as you earn tax for employees and company directors, you must take into account the following steps:

Determine the Employee’s Income Source:

First and foremost, you must determine the source the employee is receiving the salary to calculate how to pay as you earn tax. To illustrate, a company director receives their income in two ways:
Through salary or dividends.
Now, the salaries of both the employees and directors are subject to PAYE and NICs payments and can be deducted accordingly under PAYE. However, in the case where a director is also a shareholder of a company, they are also entitled to receive the dividend income. Dividends are the portion of the company’s retained profits that it distributes among the shareholders. Notably, since dividends are taxed separately from the income tax and NICs, they are not subject to PAYE. Consequently, you must consider the director’s salary for the calculation of PAYE.

Register for PAYE:

It is worth mentioning that the current tax year is from 6 April 2024 to 5 April 2025. Thus, it is obligatory for limited company members must to register for PAYE if any of the following conditions apply to the directors in the ongoing tax year:

• If the director is paid £123 or more a week.
• If they are obtaining expenses and company benefits.
• They secure pension benefits.
• They have been employed at another job.

Furthermore, to register for PAYE, a limited company will need to set up as an employer with HMRC. This can be done online through the HMRC website by submitting the details like the company name, address, and start date of employing staff or directors. After completing the registration, HMRC will provide you with a PAYE reference number and login credentials to manage your payroll processes. Alternatively, you can appoint a competent and well-versed accountant to manage your payroll tasks on your behalf.
For more information, visit the government website:

Calculate the Income Subject to Tax:

This step involves calculating all the director’s earnings subject to PAYE. For this, you must consider all the sources a director is drawing their earnings from, like their basic salary, bonuses, and benefits in kind (which include the company car or private health insurance).

Apply the Current Income Tax Rates:

Another significant step in learning how to calculate pay as you earn tax includes knowing the tax band your taxable income falls within. To go into detail, if a company’s director’s income exceeds the personal allowance threshold of £12,570 (which is tax-exempt, meaning no tax is paid on it), it will be subject to different tax rates based on the income. It means that your applicable PAYE rate will be determined by your income.
More specifically, the following are the current income tax rates according to HMRC:

PAYE Tax Rate	Rate percentage (%)	Annual Income
Personal Allowance	0	Up to £12,570
Basic Rate	20	£12,571 to £50,270
Higher rate	40	£50,271 to £125,140
Additional rate	45	over £125,140

Also, you can check on the Government Website:

Calculate National Insurance Contributions (NICs)

Fortunately, if your salary is within your tax-free personal allowance (£12,570) bracket, you will not have to deduct Class 1 employee NIC from your salary for the purpose of calculating PAYE.
On the contrary, for a salary above the tax-free threshold, the limited company will have to deduct NI (National Insurance) from your earnings, which will be sent to HMRC via PAYE. More specifically, the company will also pay Class 1 employer’s NI on your salary that surpasses the current NIC secondary threshold of £9,100 annually.
Additionally, directors’ NICs are calculated differently from ordinary employees due to the annual earnings method, such as for the current tax year:

• Primary Threshold =  £12,570.
• Lower Earnings Limit £6,396.
• Employee NIC Rate =12% (on income between £12,570 and £50,270)
• Employee NIC Rate = 2% (on income above £50,270).
• Employer NIC Rate: 13.8% (on income above £9,100).

To learn more about the NIC rates, visit the government website:

Deduct PAYE Tax and NICs for PAYE:

Once you have determined the correct income and NIC rates, you have now almost accomplished the process of implementing how to calculate pay as you earn tax. Now, you can simply deduct the correct PAYE from your salary.

Submit Your PAYE Bill to HMRC:

After the deduction of appropriate income tax and NICs from your salary, it comes under the ambit of your legal responsibilities as a director to submit your PAYE bill to HMRC by the 22nd of the next tax month, considering you are paying it online. Alternatively, if you are paying your PAYE bill by cheque and posting it, it must arrive at HMRC by the 19th of the month.

Fulfil Your Filing and Reporting Requirements with HMRC:

The last step in learning how to calculate pay as you earn tax includes meeting your filing and reporting obligations. Further explaining, these obligations include the filing of monthly PAYE submissions, such as Full Payment Submissions (FPS) and Employer Payment Summaries (EPS).
Take note that these must be sent through the Real Time Information (RTI) system.
Finally, it is mandatory for the shareholders to provide P60s forms to directors and issue P11D forms at the end of the year to show and document any benefits in kind that the directors might have secured from the company.
To know further about P60 and P11D forms, visit the government website.

 

Conclusion:

Ultimately, the paramount objective of the PAYE system is to reduce the possibility of tax evasion and simplify the process of tax collection by ensuring all employees directly pay their income tax and National Insurance (NI) contributions from their earnings before they receive their salaries. Moreover, with payroll services, you can simplify the cumbersome payroll process of implementing how to calculate pay as you earn tax to save your time and effort. We specialise in delivering reliable payroll solutions for UK businesses with our extensive experience and by combining advanced technology with personalised service. Hence, be it pay slips or pensions, we handle them with precision and care with our seamless payroll management.
Disclaimer: Please note that the information provided in this blog on Payroll Services Accountants is exclusively for informational purposes and should not be considered financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.