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How Does PAYE Work And How It Is Calculated?

PAYE or Pay As You Earn is a type of income tax that your employees need to pay, or it is directly deducted from their salaries. It is basically HMRC’s way of collecting taxes from your employees.

As an employer, you’re responsible for ensuring that the PAYE system in your organization is running systematically and the employees are paying their share of taxes to the government.

In this article, we’ll help you break down the concept of PAYE, how it works, and how you can calculate it. So, let’s get started.

What is PAYE Again?

Let’s explain the concept of PAYE once and for all. PAYE is a tax collection system. It is all about ensuring that the government is generating tax revenue from the citizens of the country. It is deducted directly from the employees’ salary. As an employer, you should make sure that you’re obeying the PAYE system.

If you go by the rules of PAYE, you’ll have to deduct income tax and national insurance contributions from each employee’s monthly salary/wage and pay it to the HMRC. This should be a monthly practice. So, it is better that you understand the concept of PAYE and how PAYE works.

How is PAYE Calculated?

How much PAYE an employee should pay is dependent on their earnings. Here’s an example of how you can calculate PAYE for the employees:

For every employee earning in 2021-22, the tax-free personal allowance limit is £12,570, on a yearly basis. Beyond the personal allowance, you will be subject to different tax rates depending on the tax-paying group you belong to.

Here’s the table for you to refer to:

Tax rate Tax paying bracket
The basic rate of 20% £12,571-£50,270
The higher rate of 40% £50,271-£150,000
Additional rate of 45% Over £150,001

Now let’s find out how an  employer should pay employees:

  • You may need to make statutory payments that include sick, maternity, adoption, etc.
  • You need to report some expenses and benefits separately at the end of a financial year. This includes uniforms, company vehicle policies, etc.
  • Bonuses, incentives, holiday payments, medical suspension payments, cash prizes, etc., will fall under the normal pay category. However, it can be otherwise if a tip or commission is paid to your employees directly by a customer.

An employer should take into account the deductions too when calculating the PAYE. Here are the details:

  • Does your employee require you to make any student loan repayments? That will be considered as a deduction.
  • Pension deductions are also essential to consider. This deduction should be made before calculating the tax.
  • You should also give the “Payroll Giving” option to your employees. That way, they can make charity from their salaries. You need to deduct this before making the tax deductions.
  • You may need to deduct the child care amount from their salaries for paying parents before the tax.

So, How Does PAYE Work?

You already know that the tax year for 2021 runs from the 6th of April 2021 to the 5th of April 2022. You will need to identify the taxable incomes of your employees and deduct the necessary allowances to reach the taxable amount. Then , you can place an employee in their respective tax-paying group. Next, the only thing left will be to pay the PAYE amount. That’s it.

As an employer, if you’re trying to understand the concept of PAYE, it is a must that you comprehend the concepts of NIC properly.

NIC stands for National Insurance Contributions of an employee. It is a type of tax that you receive on your earnings, and these go straight to the National Insurance Fund. In fact, employees get many benefits from this contribution.

How do the National Insurance Under PAYE System Work?

Collecting and sending the NIC to HRMC is a crucial responsibility of the employers. The contributions made for NIC is based on the individual’s earning percentages.

Generally, the employee, as well as the employer, make their shares of payments. As an employer, your payment is called secondary class 1 contributions, while your employee’s contribution is known as primary class 1 contribution.

Note that for the 2021-22 tax year, an employee doesn’t need to pay NIC contributions up to a threshold of £797 per month. Anything over and beyond is taxable. Alternatively, as an employer, you need to pay NIC on a particular employee’s pay of over £737 per month.

Does all these sound confusing? Well, that’s natural.

However, as an employer,  it is your responsibility to report the NIC.So, the best way out is to maintain a record of all these details under the PAYE system.

Also, remember that NIC is different from tax. You can cumulatively calculate tax. However, NIC calculation depends on an employee’s earnings. This could mean their weekly, monthly, bi-weekly, or even pay-day specific payments.

A Quick Sneak Peek into an Employer’s Responsibilities

Does it all sound too overwhelming for you? Go through these quick pointers to note your responsibilities as an employer under the PAYE system:

  • Follow the PAYE guidelines and ensure that all PAYE deductions and calculations have been made successfully
  • Keep record for each employee and their respective deductions
  • Don’t forget to maintain a record of employee-specific perks and benefits
  • Add all payment and deduction related details to HRMC
  • Make a note of your and employees’ National Insurance Contributions
  • Provide payslip to the employees so that they can also maintain their records

Does it all still seem too hard? Switch to Multiplier

Does it all seem too challenging for you? Still can’t figure out what is PAYE and how does PAYE works? No worries! Switch to Multiplier.

Here’s what it can help you with:

  • Prompt management of your global hiring needs
  • Seamless payroll management
  • Easier employee retention schemes and policies
  • Handling of tax, insurance, and other major administrative factors

Want to explore further? Book a demo now!

Binita Gajjar
Binita Gajjar

Content Marketing Lead

Binita is a Content Marketing Lead at Multiplier

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