Business Advice · 15 June 2021

How does payroll work? Here’s what you need to know

How does payroll work? Here’s what you need to know

Being an employer is a significant role to undertake. You will need to come up with contracts for your employees and ensure that they are treated fairly within their working environment.

While you have the benefit of employees working for you and creating jobs, all employers in the UK are responsible for the payment of their employees and need to use PAYE when it comes to their payroll. They’ll also need to pay payroll tax to the HMRC. The process may appear daunting at first, but it is fairly easy and simple once you are set up and get the ball rolling.

In this article, we aim to shed some light on the payroll process for new employers.

When do you need to set up an employee payroll?

As an employer, you need to set up employee payroll as soon as you hire your very first employee. Payroll will need to be set up before you pay them their first wages or salary. It’s important not to leave it to the last minute in case you run into unexpected issues.

How to set up employee payroll

Before you get started with paying your employee through PAYE, you’ll need to do the following:

  • Register as an employer with the HMRC- Once you have done this, you’ll receive a PAYE reference number in your welcome package from them. Please allow 5 working days for the HMRC to get back to you.
  • Request your employee’s tax code and National Insurance number. These will be necessary when it comes to processing their pay.
  • Ask for your employee’s P45 from their previous employer. This will bring you up to date with what they currently owe for the tax year. If they don’t have one or don’t have access to one, the HMRC provides a checklist that helps you calculate what they may owe.
Now you have everything you need to process your first employee’s pay through PAYE and the HMRC.

What is a payroll tax deduction?

National Insurance Contributions should be your biggest concern when it comes to a payroll tax deduction, as you’ll need to pay NICs for both yourself and your employees. The NICs thresholds are also much lower than formal taxes, which means that you’re more likely to have to pay it.

Once employees start earning over a certain amount, you’ll also need to calculate what they owe in terms of income tax. Student loans and pensions are other contributions that you’ll have to withhold.

What you need to remember is that each employee’s situation will be different depending on their income, and you should ensure that you have all the necessary information for each employee.

What you need to do every time you pay your employees

On the day that you pay your employees, or a few days before, you’ll need to do the following.

  • Ensure that their pay is recorded- This includes their wages, salary, any bonuses or commission that was earned.
  • Record any deductions that were made from their pay- deductions typically include things like tax, National Insurance Contributions, pensions, and student loans.
  • Create payslips- payslips act as formal proof of payment.
  • Report pay and deductions to the HMRC by using a Full Payment Submission Form.

What you need to do after you’ve paid your employees

In the UK, you usually need to pay your employees by the 5th. From the 6th, you can start the processes that you’ll need to do after you have paid your employees, but keep in mind that you’ll only have access to what you owe from your Full Payment Submission on the 12th. And this information will be available online.

What you’ll need to do in the month following paying your employees, you’ll need to:

  • Send an Employer Payment Summary to the HMRC by the 19th of the month- in this summary; you will be able to claim any reductions on what you owe.
  • You’ll be able to view the full balance of what you owe within two days of submitting your Employer Payment Summary.
  • Ensure that you pay the HMRC in full by the 22nd if you are paying online. If you’re paying by post, you’ll need to pay by the 19th.
You need to ensure that you pay on time; otherwise, you may be met with a penalty by the HMRC. However, if you end up usually paying less than £1, 500 per month (which is common if you don’t have many employees), you may be able to pay the HMRC quarterly instead of monthly, which may make things easier for you.

What happens if I report late to the HMRC?

If you don’t send a Full Payment Summary or send one late, you can expect to receive a late filing notice from the HMRC. If you don’t have a valid reason for not sending a summary or sending one late, you will probably have to pay the penalty.

You should make an effort to send complete Full Payment summaries before the cut off date as if you don’t or if you send incomplete payrolls, you could negatively affect your employee’s benefits.

Please note that if you are a new employer, you could risk having your PAYE scheme closed if you don’t send a Full Payment Summary within 120 days. So when applying to be an employer, make sure that you actually plan on employing someone and paying them soon. Otherwise, you’ll have to go through the entire process of applying to be an employer all over again.

When do my employees need to start paying tax?

If your employees earn under £120 a week, you will only need to record and report their pay as they won’t need to pay tax. But if they are receiving a pension, you’ll need to record this. And if they have another job, this may push them into a tax bracket, so this will also need to be taken into consideration.

How do I pay payroll taxes?

You actually have quite a few different options when it comes to how you’re able to pay your payroll taxes. As you know by now, you need to send regular updates to the HMRC and report and pay your employees taxes every month. Most businesses are encouraged to pay these taxes online, and paying online is probably the most convenient route, but you are also able to pay your taxes through the mail by sending a cheque, as well as by cash at your local bank or even through telephone banking.

Calculating payroll taxes

Calculating payroll taxes can get quite confusing as each employee will require their own separate calculations. But the HMRC provides a very helpful calculator tool that helps you calculate the right amount. The site also provides many other helpful tools that you’ll find handy as a new employer.

Investing in specialised payroll software is also highly recommended as it will make the entire process of PAYE so much simpler and more cohesive and ensure that you are completely compliant.

How much do I need to pay my employees? And what should their working hours be?

Being a new employer definitely comes with its challenges as you’ll have to make a lot of decisions around pay and working hours. While each employee role is different, you’ll need to ensure that you are treating your employees fairly.

In the UK, the minimum wage is usually updated every April. On top of a minimum wage, you’ll also need to consider that the UK has a National Living Wage, which applies to employees who are 25 years old and older. It is important that you are paying your employees at least the minimum wage according to their age.

When it comes to working hours, employees should not work more than 48 hours a week. Typical working days are 8 hours long, but this will also depend on the type of job.

It is definitely worth doing some research into standard industry rates for the job you want to fill. You don’t want to be paying your employees less than they would make at a competitor’s business, as you could risk losing them. Having a high employee turnover will mean that you have to dedicate more time doing admin and training new staff.

Employee contracts

If you’re an employer in the UK, you’ll need to create a contact for each and every employee. In each contract, you’ll need to stipulate working hours, pay, roles and responsibilities. Employees will need to provide you with their tax number and provide a P45 form.

What about statutory pay?

Statutory payments, such as statutory maternity pay, statutory adoption pay and statutory sick pay, are all processed through payroll and PAYE and need to be reported to the HMRC.

If you’re an employer that has had to make statutory payments, you will be able to recover some of these payments. However, the exact amount that is recoverable will entirely depend on National Insurance Contributions each year.

Employees are eligible for statutory sick pay for up to 28 weeks at least. In the UK, new mothers are offered as many as 52 weeks of maternity leave. This timeframe also applies to adoption leave. Paternity leave is currently set at one or two consecutive weeks.

What about pensions?

In the UK, employers need to enrol their employees in a pension scheme if they are not already enrolled in one. However, if your employees don’t earn more than £120 a week, you are not obliged to enrol them in a pension scheme.

Once you’ve enrolled your employees in a pension scheme, you’ll need to:

  • Pay the minimum contributions by the 22nd of each month.
  • Allow your employees to leave the pension scheme and pay them out what they’re owed.
  • Allow employees to rejoin the scheme at least once a year even if they’ve opted out.
In most cases, the pension amount will come out of the employees’ salaries, but in certain contracts, the employer will be solely responsible for these payments.

What is Real-Time Information?

Real-Time Information (or RTI) is the innovative online system used by the HMRC to keep track of all payroll information. Once the information has been submitted, it cannot be revoked, so errors can prove to be costly. All the usual payment reporting can be done through RTI, and employers will need to inform HMRC if they hire a new employee, fire an employee if an employee quits. Or if certain employee circumstances change.

Your year-end reporting

In addition to your monthly reports to the HMRC, you’ll also need to do a year-end report which needs to be submitted by the end of the tax year (5 April). That being said, you should definitely not leave this process to the last minute as it can be quite time-consuming. Your year-end report consists of:

  • Providing each of your employees with a Form P60, This form is essentially a summary of all of their pay and relevant deductions for the year.
  • Reporting all of your benefits, tax deductions and pay for each employee to the HMRC
At the beginning of the new tax year, you may also want to :

  • Update employee payroll records
  • Update all of your specialised payroll software
If you’re an employer that is struggling with the process of PAYE and payroll taxes, you can always look into employing an accountant or tax professional to handle your PAYE for you. This way, you can rest assured that everything is above board, and you won’t run into any trouble with the HMRC. If employing an additional is an expense that your business cannot afford, you can always look at hiring a freelancer that will charge you per hour or taking the time to learn how PAYE works yourself. Either way, having an in-depth understanding of how PAYE works will only prove to be beneficial for you as an employer. If there is anything you don’t understand, you can always call the HMRC’s payment helpline.

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