How Much is PAYE Tax in the UK?

As a startup founder, its important to understand the different taxes, as much as it is for employees. One such tax to take note of is PAYE tax. In this guide, we will familiarise ourselves with PAYE tax and particularly, how much the national rates are.

Companies that offer payroll software in the UK include:

1. Rippling
2. Pento
3. Deel

What is PAYE?

In simple words, PAYE is a direct deduction of income tax from employees’ salaries before they receive their pay.

These deductions are automatically withdrawn before the salary reaches the employee’s bank account, ensuring the convenience and efficiency of the system. This automatic deduction process alleviates the need for employees to manually manage their tax payments.

The PAYE system is widely adopted across the UK. Employers use a PAYE payroll system to calculate precise income tax and National Insurance contributions. These deductions are influenced by factors such as tax codes, National Insurance category letters, pension contributions, student loan repayments, and, in some cases, child maintenance payments. PAYE becomes essential for any UK employer with employees earning the equivalent of £118 or more per week.

If you receive state benefits or pensions, PAYE makes it easy by automatically factoring in taxable state benefits in your tax code. This simplifies the tax process for people with different sources of income, making sure the right amount of tax is taken out promptly. And if your financial situation is a bit more complicated, like being self-employed or having a high income, PAYE smoothly shifts into the Self Assessment system. This adaptability means a personalised approach to tax collection, fitting various individual circumstances and income sources.

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How Do I Calculate PAYE?

Calculating PAYE involves a straightforward yet crucial process, ensuring employees pay the correct amount of income tax. PAYE is based on an employee’s earnings during a time over a month, generally.

Workers can earn a certain salary every year before they begin to pay income tax. The current tax year’s salary is at £12,570. Anything below wouldn’t be taxed.

Workers can earn a certain salary every year before they begin to pay income tax. The current tax year’s salary is at £12,570. Anything below wouldn’t be taxed. For earnings between £12,571 and £50,270, the basic income tax rate is 20%. If your earnings surpass £50,270, the rate increases to 40%. Those with earnings exceeding £125,140 have an additional rate of 45%. It’s important to note that the initial £12,570 falls under the category of Personal Allowance, making it tax-free. But, individuals earning over £100,000 will see a reduction in this allowance by £1 for every £2 earned beyond this threshold.

The employer uses a provided tax code to calculate deductions and makes use of tools such as the HMRC PAYE payment calculator for accuracy.

Tax is deducted when workers get paid, which is generally on a monthly basis, dividing it into equal payments throughout the year.

On top of income tax, the PAYE system also includes National Insurance contributions. NI contributions are for social care benefits and the NHS. The standard NI deduction for the current tax year sits at around 13.25%, and then 16.5% for those earning over £4,189 a month or £50,271 annually. Employers are also required to make a secondary contribution, known as Employers NI, at 15.05% for the same tax year.

The process becomes more intricate with off-payroll working, especially under the IR35 Directive. The UK government has implemented stricter regulations to prevent tax avoidance through disguised employment. Medium to large employers must correctly classify workers under IR35, and fines are imposed for errors. The HMRC provides an online employment status checker to help employers ensure accurate payments to independent contractors.

Understanding an employee’s tax code is integral to the PAYE process. A tax code is a combination of numbers and letters used by employers to calculate tax deductions. The basic personal allowance is allocated evenly throughout the tax year, enabling the spreading of income tax over the year. Tax codes can be adjusted based on various factors, such as additional allowances or deductions, resulting in a specific tax-free amount for each pay period.

Employers may encounter situations like emergency tax codes, typically denoted as W1 or M1, used in specific circumstances to prevent significant over or underpayments. Other codes, such as BR (basic rate) or NT (no tax), may also be encountered based on individual circumstances.Employers need to make sure they’re using the right tax code, as errors can lead to underpayments, resulting in potential penalties.

There are a few online calculators, such as the HMRC PAYE/NI calculator online for an easier way to understand where you stand tax wise. These tools help determine tax bands and provide accurate information for effective PAYE calculations.

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What Happens with Late Payments?

Employers must stick to to specific schedules and procedures for paying PAYE bills to HMRC. Failure to make timely and complete PAYE deductions results in late payment penalties. The penalty percentage varies based on the number of defaults in a tax year.

With PAYE taxation in the UK, recent government reforms aim to streamline and make the system fairer. The changes, effective for VAT and Income Tax Self Assessment (ITSA), introduce late payment penalties to encourage timely payments. As per the new regulations starting from January 1, 2023, VAT customers are now subject to these penalties. For ITSA customers, the changes kick in as they transition into Making Tax Digital (MTD), beginning with the tax year starting April 6, 2026, for those earning over £50,000 per year and April 6, 2027, for those with income exceeding £30,000 annually.

The penalty structure consists of a first penalty, triggered after the initial 15 days after the due date, and a second penalty, which accrues daily at 4% per annum from day 31 onwards. The government allows for Time-to-Pay (TTP) arrangements, providing taxpayers an option to halt penalty accrual by proposing and adhering to a payment schedule. Importantly, taxpayers can approach HMRC for TTP within the first 30 days to avoid the full penalty.

HMRC acknowledges the transition’s challenges and adopts a considerate approach in the first year. Taxpayers making a genuine effort to comply have a 30-day window to approach HMRC before facing the first penalty. The discretion extends to situations where a taxpayer has a reasonable excuse for late payment, and HMRC maintains discretionary power to reduce or waive penalties based on individual circumstances.

In contrast, the HMRC has introduced penalties for late PAYE/NIC payments, affecting businesses failing to meet their obligations. The penalties range from 1% to 4% for payments delayed up to six months, with a 5% penalty for amounts overdue for more than six months.

However, businesses under the Business Payment Support Service, adhering to Time to Pay Deals, are exempt from payment penalties. The HMRC guide suggests using Company Voluntary Arrangements (CVAs) for companies facing financial challenges. A CVA allows for delayed tax and creditor payments, with potential benefits such as zero interest and penalties over a specified period, providing a viable alternative to insolvency.

Here is a summarised list of the penalties:

1 to 3 defaults: 1% penalty
4 to 6 defaults: 2% penalty
7 to 9 defaults: 3% penalty
10 or more defaults: 4% penalty

Additionally, a further late filing penalty of 5% is charged if full payment is not made after three months, increasing to 10% after 12 months.