PAYE and National Insurance are central to an employer’s payroll responsibilities. Each pay period, the employer must calculate gross pay, apply the employee’s tax code, deduct Income Tax and employee National Insurance where due, calculate employer National Insurance and report the payment to HMRC through payroll software.
The obligation is not limited to larger employers. A business taking on its first employee must establish a dependable payroll process, collect the correct starter information and understand when submissions and payments are due. Errors can affect the employee’s pay and tax record while creating unexplained balances in the employer’s bookkeeping.
Payroll software performs many calculations automatically, but it depends on the employer entering the correct employee details, tax code, National Insurance category, payment date and earnings. The resulting payroll reports must then be reconciled with the bank payments and accounting records.
How PAYE and National Insurance work together
PAYE is the system employers use to deduct Income Tax and certain other amounts from employees’ pay. National Insurance is calculated separately using the employee’s earnings, National Insurance category and the thresholds applying to the pay period.
Employee National Insurance is deducted from gross pay where applicable. Employer National Insurance is an additional employment cost paid by the employer and must not be deducted from the employee’s wages.
The payroll calculation may also include student or postgraduate loan deductions, pension contributions, statutory payments, attachment orders and other authorised deductions. These amounts must be reported and recorded according to their actual nature.
HMRC’s PAYE guidance for employers explains the main responsibilities involved in registering, running payroll, reporting employee payments and paying HMRC.
Registering as an employer
A business will normally need to register as an employer with HMRC before its first payday, even where the only person being paid is a company director. Registration creates the employer PAYE reference and Accounts Office reference needed for payroll submissions and payments.
The employer should allow enough time for these details to arrive before running the first payroll. Paying an employee first and attempting to register afterwards can make it harder to submit the required information on time.
Registration does not establish whether someone is genuinely an employee. Employment status depends on the actual contractual and working arrangement. A business should confirm this before deciding whether to process someone through payroll or treat them as self-employed.
Once the PAYE scheme has been established, it remains open until HMRC is told that the employer has stopped paying staff and the final payroll reports have been submitted correctly.
Collecting information for a new employee
Before processing the first payment, the employer needs the employee’s full name, address, date of birth, gender for payroll reporting, National Insurance number where available and employment start date.
The employer should also obtain the employee’s P45 from their previous employment. Where no P45 is available, the employee should complete HMRC’s starter checklist so the payroll software can apply the appropriate starter declaration and initial tax code.
Entering incomplete or incorrect information can create duplicate employment records at HMRC or cause the wrong tax basis to be used. The employer should not guess a National Insurance number or reuse details belonging to another employee.
Payroll records contain sensitive personal information and should be stored securely. Access should be restricted to people who need the information to perform their role.
How PAYE Income Tax is calculated
PAYE Income Tax is calculated using the employee’s taxable pay, tax code, pay frequency and the tax basis attached to that code. The tax code indicates how much tax-free pay may be available or whether an adjustment needs to be collected through payroll.
The employer must use the tax code supplied through the employee’s P45, starter process or HMRC notification. A new code issued by HMRC should be applied from the appropriate payroll according to the instructions received.
For the 2026 to 2027 tax year, the standard Personal Allowance remains £12,570, although an individual employee’s tax code may reflect a different allowance or adjustment. Scottish taxpayers are subject to Scottish Income Tax bands, while Welsh taxpayers may have a Welsh tax code.
The employer should not amend an employee’s tax code merely because the employee believes it is wrong. The employee should contact HMRC where their code needs to be reviewed.
Employee National Insurance for 2026 to 2027
For most employees using National Insurance category A, employee National Insurance for 2026 to 2027 is charged at 8 per cent on earnings above the primary threshold and up to the upper earnings limit. Earnings above the upper earnings limit are generally charged at 2 per cent.
The annual primary threshold is £12,570 and the annual upper earnings limit is £50,270, although payroll normally applies the relevant weekly, monthly or other pay-period thresholds.
Different National Insurance category letters and rates can apply to employees who are under 21, apprentices under 25, employees over State Pension age, married women with a valid reduced-rate election and certain other groups.
HMRC publishes the current figures in its employer rates and thresholds for 2026 to 2027. Payroll settings should be reviewed at the beginning of every tax year rather than relying on rates retained from an earlier period.
Employer National Insurance
Employer National Insurance is paid by the employer in addition to the employee’s gross salary. For most employees, the standard employer rate for 2026 to 2027 is 15 per cent on earnings above the applicable secondary threshold.
The standard annual secondary threshold remains £5,000 for 2026 to 2027. Different thresholds and reliefs can apply to qualifying employees, including some employees under 21, apprentices under 25 and eligible veterans.
Employer National Insurance should be included when assessing the total cost of employing someone. A salary figure alone does not represent the employer’s complete payroll cost because pension contributions, holiday pay and other employment costs may also apply.
The bookkeeping should record employer National Insurance separately from the deductions taken from employees. Combining the two can make the PAYE liability and employment cost difficult to reconcile.
Employment Allowance
Employment Allowance allows eligible employers to reduce their employer Class 1 National Insurance liability. The maximum allowance for the 2026 to 2027 tax year is £10,500.
The allowance is normally claimed through payroll software using an Employer Payment Summary. It reduces eligible employer National Insurance until the allowance has been fully used or the tax year ends.
Not every employer qualifies. A company where the only employee paid above the secondary threshold is also a director cannot generally claim. Special restrictions can also affect public bodies, employers of domestic staff and businesses carrying out work subject to state-aid or subsidy-control considerations.
The employer should confirm eligibility each tax year rather than allowing software to carry the claim forward automatically. Where connected companies exist, only one may normally claim the allowance.
Submitting the Full Payment Submission
The Full Payment Submission reports each employee’s pay and deductions to HMRC. It must normally be submitted on or before the date the employee is paid.
The FPS includes taxable pay, Income Tax, National Insurance, student loan deductions, statutory payments, pension information and the employee’s payment date. New starters and leavers also require additional information.
The payment date entered should normally be the employee’s usual contractual payday. Where employees are paid early because the normal date falls on a weekend or bank holiday, HMRC generally expects the regular payday to be reported.
HMRC’s guidance on reporting payroll through an FPS explains when the submission is due and how corrections should be handled.
When an Employer Payment Summary is required
An Employer Payment Summary is used to report information that is not included in the ordinary FPS. This may include statutory-payment recovery, Employment Allowance and periods when no employees were paid.
If no employees are paid during a tax month, the employer should generally send an EPS by the nineteenth day following that tax month. Without the submission, HMRC may estimate a PAYE liability because it has not been told that no payment was made.
An employer expecting a longer period without staff payments can report a period of inactivity through the EPS, subject to HMRC’s rules.
The EPS may also reduce the amount shown as payable to HMRC. The payroll records and bookkeeping should therefore reflect both the FPS liability and any valid reductions reported through the EPS.
Paying PAYE and National Insurance to HMRC
The employer’s PAYE bill can include Income Tax deducted from employees, employee National Insurance, employer National Insurance, student loan deductions and other payroll liabilities.
Monthly electronic payments are normally due by the twenty-second day following the end of the tax month. Payment by post is generally due by the nineteenth. Different arrangements may apply to employers authorised to pay quarterly.
The payment should use the correct Accounts Office reference and payment-period suffix where required. An incorrect reference can cause HMRC to allocate the payment to the wrong period, leaving one month appearing unpaid.
The amount shown by payroll should be reconciled with the employer’s HMRC account and the payment recorded in the bank. Differences should be investigated rather than carried forward from one month to the next.
Reconciling payroll with the bookkeeping records
The payroll journal should record gross wages, employee deductions, employer National Insurance, employer pension contributions, net pay and the liabilities owed to HMRC and pension providers.
The net wages recorded should agree with the payments made to employees. The PAYE control account should agree with the amount reported and payable to HMRC after allowing for valid EPS adjustments.
Posting only the net amount paid to staff as wages understates the employment cost and omits the liabilities deducted from employees. Posting the later payment to HMRC as a second expense then duplicates part of the cost.
Regular bank reconciliation helps confirm that wage payments and payments to HMRC have been captured. The payroll reports are still needed to divide those cash movements correctly between expenses and liabilities.
Workplace pension duties
Employers must assess their staff for automatic enrolment and enrol workers who meet the applicable age and earnings conditions. Employers also need to contribute to the pension scheme and provide required information to workers.
The duties begin when the first member of staff starts work. Postponement may be available in some circumstances, but it does not remove the need to assess staff and issue the correct communications.
Pension deductions and employer contributions should be reconciled with the pension-provider schedule and payments made. Amounts deducted from employees remain liabilities until they have been paid to the scheme.
The Pensions Regulator’s guidance on automatic-enrolment duties for new employers explains the initial and continuing responsibilities.
Statutory payments through payroll
Employers may need to administer Statutory Maternity Pay, Statutory Paternity Pay, Statutory Adoption Pay, Shared Parental Pay, Parental Bereavement Pay, Neonatal Care Pay and Statutory Sick Pay where the relevant conditions are met.
Entitlement, qualifying earnings, evidence and payment periods differ between the schemes. Payroll software can calculate amounts, but the employer still needs to enter the correct dates and supporting information.
Eligible employers can generally recover specified statutory family-related payments through the PAYE system. Small employers meeting the National Insurance liability test can receive enhanced recovery, while the ordinary recovery rate applies to other eligible employers.
The 2026 to 2027 employer rates and thresholds guidance includes current statutory-payment rates and recovery provisions. Difficult entitlement questions should be referred to HMRC or an appropriately qualified payroll professional.
Student and postgraduate loan deductions
Student loan and postgraduate loan deductions may begin when HMRC issues a start notice or the employee provides information indicating that deductions are required.
The correct loan plan must be selected because different earnings thresholds apply. The employer should not choose a plan based on the employee’s age or where they currently live.
Deductions must be included in the FPS and paid to HMRC as part of the employer’s PAYE bill. They should also be recorded as payroll liabilities in the bookkeeping system.
When HMRC issues a stop notice, the employer should apply it promptly. Refunds should not be made outside payroll unless HMRC’s rules permit the employer to do so.
Directors and National Insurance
Company directors are employees for National Insurance purposes, but their contributions are normally calculated using an annual earnings period. This can produce a different pattern from the calculation used for ordinary employees.
Payroll software may offer an annual method or an alternative method that calculates contributions during the year and performs a final adjustment. The method should be set correctly when the director is added.
Changes to a director’s appointment date, pay frequency or National Insurance category can affect the calculation. The employer should not process a director as an ordinary monthly employee without confirming the correct payroll settings.
Salary and dividend planning is a tax matter and depends on the company’s circumstances and the shareholder’s wider position. A bookkeeper can process an authorised salary but should not prescribe a tax strategy without appropriate professional advice.
Setting up payroll software correctly
Payroll software needs the employer’s PAYE references, payment schedule, employee records, tax codes, National Insurance categories and pension settings. Opening year-to-date figures may also be needed where the payroll is transferred during the tax year.
An incorrect setup can cause every later submission to contain the same problem. Before the first live pay run, the employer should check the pay date, tax period, employee details and expected deductions.
Businesses using Xero can review our guide to setting up payroll in Xero. The page explains the software foundations required before PAYE and RTI processing begins.
The payroll system should not be treated as separate from the bookkeeping. Payroll reports, pension schedules, bank payments and HMRC liabilities must all flow into the accounting records consistently.
Correcting payroll errors
When an FPS contains incorrect information, the correction should normally be made through payroll software and reported to HMRC as soon as possible. Changing only the bank payment or bookkeeping journal does not correct the employee’s HMRC record.
The appropriate method depends on whether the error relates to the current tax year or an earlier year. Modern RTI corrections are generally reported through a corrected FPS rather than the former Earlier Year Update process.
Overpayments and underpayments of wages also need to be handled carefully. Recovering money from an employee may involve employment-law and minimum-wage considerations as well as payroll calculations.
The correction should be documented so that the revised payroll report, HMRC submission, employee payment and bookkeeping entry can be reconciled.
Payroll records that employers should retain
Employers should retain records showing employee pay, deductions, tax codes, National Insurance categories, statutory payments, workplace pension information, expenses and benefits where relevant.
Records should also include payroll submissions, HMRC notices, employee starter and leaving information and evidence supporting statutory-payment calculations.
The business should use a consistent filing system by tax year and pay period. Payroll information should not be stored only in the personal email account of the person who processes it.
The beginning of a new tax year is a useful point to review tax codes, thresholds, employee details and outstanding payroll balances. Our new tax year bookkeeping checklist covers the wider records and settings worth checking each April.
When outsourced payroll support becomes useful
Some employers can run a straightforward payroll successfully using suitable software. External support becomes more useful when the payroll includes variable hours, statutory payments, pensions, directors, attachments or frequent employee changes.
The service scope should identify responsibility for calculations, FPS and EPS submissions, payslips, pension uploads, HMRC payments and bookkeeping journals. A general promise to handle payroll may not include all these tasks.
Bookkeeping Packages Ltd provides payroll services for UK employers according to an agreed schedule and scope. Payroll information can also be incorporated into our wider bookkeeping services so wages and liabilities remain visible in the accounts.
To discuss your payroll frequency, number of employees and current software, use the Bookkeeping Packages enquiry form.
About the Author
Stuart Kerr is Managing Director of Bookkeeping Packages Ltd, an outsourced bookkeeping service supporting UK small businesses and accountancy practices. With over 20 years of bookkeeping experience, Stuart specialises in helping businesses maintain reliable financial records and useful management information.
This article is provided for general information only. Stuart Kerr is a professional bookkeeper, not an employment lawyer, tax adviser or regulated financial adviser. Nothing in this article constitutes tax, legal, employment or financial advice. Advice specific to your circumstances should be obtained from an appropriately qualified professional.