PAYE explained simply means understanding how employers deal with Income Tax, National Insurance and certain other deductions through payroll before an employee receives their wages.

Whether you employ staff or your employer pays you through PAYE, the system works quietly in the background every payday.

It has also been around for more than 80 years.

In this episode, we look at what PAYE is, why the government introduced it, what employers need to do, what employees should check and why good payroll management matters to the wider finances of a business.

About this episode

PAYE stands for Pay As You Earn.

Employers use the system through payroll so HMRC can collect Income Tax and National Insurance from employees.

Payroll can also deal with other deductions, including student and postgraduate loan repayments where they apply.

For an employee, the payroll process deals with much of the tax calculation connected with wages before the net pay reaches the bank account.

For an employer, PAYE is not optional administration that you can simply ignore. If the rules require you to operate PAYE, you need to calculate the deductions correctly, report the payroll and pay HMRC on time.

“PAYE – pay as you earn – is the official translation or pain as you earn if I’ve heard some people say.”

What does PAYE actually do?

The basic idea is straightforward.

An employer calculates an employee’s gross pay and then uses payroll to work out the correct deductions.

Those can include:

Income Tax
employee National Insurance
student or postgraduate loan repayments where applicable
other payroll deductions that apply to the employee

Those deductions leave the employee with their net pay.

The employer reports the payroll information to HMRC and pays over the relevant tax and National Insurance.

That is why PAYE sits at the centre of the relationship between an employee, their employer and HMRC.

Why was PAYE introduced?

The history takes us back to the Second World War.

The government introduced PAYE in 1944 to collect Income Tax from employment more regularly and efficiently.

Before PAYE, the tax system collected money from employees much less frequently. The government needed a system that brought tax in as people earned their wages rather than relying on larger payments later.

There is one useful historical distinction to make.

PAYE started collecting Income Tax in 1944. HMRC’s own historical timeline shows National Insurance contributions joining the system from 1948.

The system has changed enormously since then, particularly with digital payroll and Real Time Information, but the central idea remains much the same: calculate what somebody owes as they earn their pay.

Why has PAYE lasted for more than 80 years?

Quite simply, the basic model works.

For employees, employers normally deduct tax throughout the year, so workers do not face one large tax bill at the end.

For government, PAYE provides a regular flow of tax receipts.

For employers, it provides a structured payroll system, although it also makes the employer responsible for calculating, reporting and paying over those deductions.

“It’s a very efficient system, certainly for the government of an army of unpaid tax collectors.”

That line sums up one side of PAYE rather nicely.

The employer does a significant amount of the collection work on HMRC’s behalf.

Employer responsibilities under PAYE

If you take on employees, PAYE brings several practical responsibilities.

First, register as an employer with HMRC before the first payday where the rules require you to do so. HMRC normally lets you register up to two months before you start paying people.

You then need payroll software or a payroll service that can record employee details, calculate pay and deductions, and report the required information to HMRC.

For each payroll, the main process includes:

calculating the employee’s gross pay
using the correct tax code
calculating Income Tax and National Insurance
processing student or postgraduate loan deductions where applicable
calculating the employee’s net pay
reporting the payroll to HMRC
paying the employee
paying the relevant PAYE and National Insurance to HMRC

You also need to keep appropriate payroll records and give employees the documents they are entitled to receive.

Reporting payroll to HMRC

Under Real Time Information, employers normally report employee pay and deductions using a Full Payment Submission, or FPS.

Employers normally send the FPS to HMRC on or before the employee’s payday.

This gives HMRC payroll information throughout the tax year rather than leaving everything until one annual return.

When you take on a new employee, you include their details in the payroll reporting process too.

This is one reason accurate information at the beginning of employment matters.

When do employers pay PAYE to HMRC?

Employers also need to pay the payroll deductions to HMRC on time.

Employers normally need to pay PAYE and National Insurance by the 22nd of the following tax month when paying electronically, or by the 19th when using certain non-electronic methods.

Some smaller employers can pay quarterly where their average monthly PAYE and National Insurance liability is less than £1,500.

This creates an important cash-flow point.

The Income Tax and employee National Insurance you deduct from wages are not spare cash for the business. You need to pass those amounts to HMRC.

If you use that money to plug another cash gap, you can create a much bigger problem when the PAYE payment date arrives.

Payslips, P45s and P60s

Payroll is not only about sending numbers to HMRC.

Employees need information too.

A payslip should show the employee what they have earned and the deductions from their pay.

When somebody leaves employment, the employer gives them a P45 showing the relevant pay and tax information.

If an employee still works for you on 5 April, you normally need to give them a P60 showing their pay and tax for the tax year.

Employers must provide the P60 by 31 May.

Employees have responsibilities too

The employer may operate the payroll, but employees should not assume that every figure is automatically correct.

If you are an employee, make sure your employer has the right personal information.

When you start a new job, your employer normally uses your P45 to help establish your payroll details and tax code.

If you do not have a P45, HMRC’s starter checklist can provide the information your new employer needs.

You should also check your payslips and your tax code.

A wrong tax code can mean paying too much tax or not enough.

If the employer deducts too little, the employee may eventually face an additional tax bill.

“Whether you are paying somebody or being paid yourself, it pays to pay attention.”

PAYE is more than Income Tax

One reason payroll can feel complicated is that PAYE sits alongside several other employer responsibilities.

National Insurance is an obvious example.

For 2026/27, employers generally pay standard Class 1 National Insurance at 15% on relevant earnings above the standard Secondary Threshold of £5,000 a year, subject to the employee’s National Insurance category and any relief that applies.

Employees in the standard category generally pay Class 1 National Insurance at 8% between the Primary Threshold and Upper Earnings Limit, then 2% above the Upper Earnings Limit.

For a broader explanation, see National Insurance Easily Explained.

Company directors also follow particular National Insurance calculation rules, which we cover in Director National Insurance.

The full cost of employing somebody

The episode makes another important point: salary is only one part of the cost of employing somebody.

When planning your staffing budget, think about the wider package, including:

gross salary or wages
employer National Insurance
workplace pension contributions where applicable
holiday pay
statutory payments and other employment costs
payroll software or payroll-service costs

That matters particularly when you are thinking about hiring your first employee.

A salary that looks affordable on its own can produce a noticeably higher total employment cost once you include the other obligations.

Our guide to holiday pay obligations for employers looks at one part of that wider cost.

Why PAYE matters for cash flow

Payroll is one of the most important recurring cash commitments in many organisations.

Employees expect you to pay them correctly and on time.

HMRC expects employers to report and pay PAYE liabilities correctly and on time.

You also need to fund pensions and other employment costs.

That means your cash-flow planning should not stop at the headline wage figure.

You need to know when payroll leaves the bank, when PAYE falls due to HMRC and what other employment costs fall around those dates.

Good payroll therefore contributes to good financial control.

What happens when PAYE goes wrong?

Mistakes can happen, but ignoring them can make matters worse.

Late payroll reports, incorrect deductions and late PAYE payments can lead to interest, penalties or extra correction work.

There is also an employee impact.

An incorrect tax code or deduction can leave somebody with the wrong net pay or a later underpayment of tax.

Good payroll software helps, and an experienced payroll provider can remove much of the administrative burden. However, the employer still needs to make sure the payroll information they provide is accurate.

A practical PAYE checklist for employers

Check employment status. Make sure the person is genuinely an employee rather than assuming everyone working for you belongs on payroll.
Register with HMRC. Do this before the first payday where PAYE registration is required.
Set up payroll properly. Use suitable payroll software or a payroll provider.
Collect the right employee information. Use the P45 or starter checklist where appropriate.
Use the correct tax code. Follow HMRC’s current instructions and code notices.
Calculate all deductions. Include Income Tax, National Insurance and other applicable payroll deductions.
Submit the FPS on time. Normally report on or before payday.
Pay HMRC on time. Keep PAYE money available for the payment deadline.
Give employees their documents. Provide payslips and the relevant P45 or P60.
Budget for the full employment cost. Include employer National Insurance, pensions, holiday pay and other obligations.

FAQs

What does PAYE stand for?

PAYE stands for Pay As You Earn. Employers use the system through payroll to deduct Income Tax and National Insurance from employees’ earnings.

When was PAYE introduced?

The government introduced PAYE in 1944 to collect Income Tax. HMRC’s historical timeline shows National Insurance contributions joining the system from 1948.

When must an employer register for PAYE?

Employers normally need to register with HMRC before the first payday where PAYE registration is required. HMRC normally allows registration up to two months before you start paying people.

When does an employer report payroll to HMRC?

Employers normally send a Full Payment Submission on or before the employee’s payday.

When is PAYE paid to HMRC?

Employers normally pay monthly PAYE by the 22nd after the end of the tax month when paying electronically, or by the 19th using certain non-electronic methods. Eligible smaller employers may pay quarterly.

Does PAYE mean employees never need a tax return?

No. PAYE deals with tax on employment income, but an employee may still need Self Assessment because of other income or circumstances.

What should an employee do if their tax code looks wrong?

Check the tax code and employment details and contact HMRC where necessary. A wrong code can make you pay too much or too little tax.

When must employers provide a P60?

If an employee still works for you on 5 April, you normally need to give them their P60 by 31 May.

Episode Timecodes

00:00 – PAYE, how it started and why it matters
00:28 – What the episode covers
01:06 – What PAYE means
01:30 – Why PAYE still matters
01:58 – PAYE for employees
02:20 – PAYE as an employer responsibility
02:39 – Why PAYE was introduced in 1944
03:02 – Collecting tax directly from wages
03:29 – Why the PAYE model lasted
03:52 – Benefits for employees and government
04:13 – PAYE as a legal obligation
04:33 – Employer responsibilities
04:58 – Tax, National Insurance and other deductions
05:17 – Paying HMRC, payslips and P60s
05:44 – Payroll software and employer responsibility
06:02 – Mistakes, late payments and penalties
06:23 – Employee responsibilities
06:42 – Starter checklist, payslips and tax codes
07:02 – Overpaying and underpaying tax
07:23 – Why PAYE matters to small businesses
07:39 – Paying people correctly and managing cash flow
07:58 – The full cost of employing somebody
08:28 – Why PAYE still matters today
08:54 – Reviewing your payroll processes

Related episodes and guides

Key takeaway

PAYE explained simply comes down to collecting the right payroll information, calculating the right deductions, reporting them to HMRC and paying everybody at the right time.

For employees, employers deal with most tax on wages as they pay them.

For employers, PAYE creates a legal and financial responsibility that affects payroll, cash flow and the relationship with the team.

The government may have introduced the system in 1944, but the basic principle still works today.

Whether you are paying somebody or being paid yourself, keep an eye on the numbers.

Plan it. Do it. Profit.

Further Support

If you are taking on your first employee, reviewing your payroll or want help making sure your PAYE process works properly, you can contact us for an initial chat.

We can help with payroll, employer taxes, accounting systems, cash-flow planning and understanding the full financial cost of employing people.

You can also use our free online business calculators to support your wider financial planning.

For more practical finance and tax guidance, visit the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

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PAYE Explained: How It Works and Why It Matters