PAYE for Small Business Owners: A Plain-English Guide
PAYE is how HMRC collects Income Tax and National Insurance from employees as they’re paid. If you have employees — or pay yourself a salary as a limited company director — here’s what you need to know, including the significant changes that took effect in April 2026.
What is PAYE and when does it apply?
PAYE is HMRC’s mechanism for collecting income tax and employee National Insurance at source — deducted from each pay packet before the employee receives it, rather than collected later through self-assessment. As an employer, you calculate and deduct the right amounts, pay them to HMRC, and report every payment in real time.
PAYE applies as soon as you have employees — even one, even part-time, even if they earn below the tax threshold. It also applies to limited company directors who pay themselves a salary, even if the company has no other employees.
PAYE rates and thresholds for 2026/27
Income Tax
The personal allowance for 2026/27 is £12,570 per year (£1,048 per month / £242 per week). Employees pay no income tax on earnings below this threshold.
| Tax rate | Rate | Applies to earnings above personal allowance |
|---|---|---|
| Basic rate | 20% | Up to £37,700 |
| Higher rate | 40% | £37,701 to £125,140 |
| Additional rate | 45% | Above £125,140 |
Scottish employees pay different income tax rates — your payroll software handles this automatically based on their tax code.
National Insurance — employee contributions
Employees pay Class 1 National Insurance on earnings above the Primary Threshold (£12,570 per year): 8% on earnings up to £50,270, and 2% above that.
National Insurance — employer contributions
Employers pay 15% on earnings above the Secondary Threshold of £5,000 per year. This is a business cost — not deducted from the employee’s pay. The threshold was reduced from £9,100 to £5,000 in April 2025, meaning employers now pay NIC on a larger portion of each employee’s earnings.
Employment Allowance
Eligible businesses can reduce their employer NIC bill by up to £10,500 per year. Most small businesses qualify — the main exclusion is companies where the director is the sole employee. For many small employers, Employment Allowance eliminates the employer NIC bill entirely. Claim it through your payroll software at the start of each tax year.
National Minimum Wage (from 1 April 2026)
| Worker category | Rate per hour |
|---|---|
| Aged 21 and over (National Living Wage) | £12.71 |
| Aged 18–20 | £10.85 |
| Under 18 | £8.00 |
| Apprentice rate | £8.00 |
Statutory Sick Pay — major changes from 6 April 2026
| What’s changed | Old rule (pre-6 April 2026) | New rule (from 6 April 2026) |
|---|---|---|
| When SSP starts | Day 4 of absence (3 unpaid waiting days) | Day 1 of absence — waiting days abolished |
| Earnings threshold | Employees needed to earn ≥£125/week to qualify | No minimum earnings — all employees qualify |
| Rate | £116.75 per week (flat rate) | £123.25 per week, or 80% of average weekly earnings — whichever is lower |
In practice, any absence by any employee now triggers an SSP liability from day one — including short absences that previously went unrecorded. Review your sickness absence policies and confirm with your payroll provider that the changes are reflected in your system.
How PAYE works in practice
Setting up payroll
Register as an employer with HMRC before you run your first payroll — online at gov.uk, taking up to five working days. You’ll receive a PAYE reference number and an Accounts Office reference, both needed for submitting payments.
You’ll also need payroll software. HMRC maintains a list of approved software at gov.uk/payroll-software, including some free options for businesses with fewer than ten employees. Most small businesses use Xero, QuickBooks, FreeAgent, or Sage, which handle PAYE calculations automatically.
Running payroll
Each time you pay employees, your payroll software calculates income tax, employee NIC, and employer NIC; produces payslips; and submits a Full Payment Submission (FPS) to HMRC. The FPS must be submitted on or before the payment date — not after. Most software does this automatically when you run payroll.
Paying HMRC
You pay HMRC the combined total of income tax deducted, employee NIC, and employer NIC. For most small businesses this is monthly — on or before the 22nd of the following month. If your total PAYE bill is less than £1,500 per month, you can pay quarterly instead.
New starters and leavers
| Situation | What you need | What you do |
|---|---|---|
| New starter with a P45 | P45 from previous employer, plus name, address, DOB, NI number | Use P45 to set the correct tax code from day one |
| New starter without a P45 | Starter checklist completed by the employee | Apply the appropriate emergency tax code until HMRC issues the correct one |
| Employee leaving | Their earnings and tax paid in the current tax year | Produce a P45 via payroll software; submit to HMRC and give copy to employee |
End of year obligations
- P60 — Issue to every employee still employed on 5 April, showing total earnings and deductions for the year. Deadline: 31 May.
- P11D — If you provide benefits in kind (company cars, private medical insurance, interest-free loans), report these by 6 July after the tax year end. Class 1A NIC (15%) is payable on the value of those benefits.
- Final Employer Payment Summary — Confirm final figures for the year through your payroll software to close off the tax year with HMRC.
PAYE as a limited company director
If you run a limited company and pay yourself a salary, the company operates PAYE on that salary in exactly the same way as for any other employee. The most tax-efficient approach for many director-shareholders is a salary up to or around the personal allowance (£12,570), with additional income taken as dividends — though the optimal split depends on your circumstances and should be discussed with your accountant.
Common mistakes small employers make
The Full Payment Submission must be made on or before the payment date. Late submissions generate automatic penalties. Configure your payroll software to submit automatically when you run payroll.
Many small businesses miss out simply by not activating the claim in their payroll software. Check it’s enabled at the start of each tax year — it can eliminate your employer NIC bill entirely.
From 6 April 2026, SSP applies from the first day of absence to all employees, regardless of earnings. If your payroll software hasn’t been updated to reflect the day-one eligibility and the 80%-of-earnings calculation, your SSP figures will be wrong.
Register with HMRC as an employer before your first payroll — not after. Retroactive registration creates complications. As soon as you know you’re hiring, register.
The amount due is income tax plus employee NIC plus employer NIC — not just income tax. Underpaying creates reconciliation problems. Use the payment schedule your payroll software generates to make sure you’re paying the right total.
Useful resources
- HMRC PAYE for employers — gov.uk/paye-for-employers
- Approved payroll software — including free options for smaller employers at gov.uk/payroll-software
- Employment Allowance — eligibility and how to claim at gov.uk/claim-employment-allowance
- 2026/27 rates and thresholds — gov.uk/guidance/rates-and-thresholds-for-employers-2026-to-2027
- Your accountant — a one-off session when setting up payroll for the first time pays for itself. Getting it right from the start costs far less than fixing errors later.
More guides for UK small business owners
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