Payroll Guide 2025/26
Pay As You Earn (PAYE) is the system HMRC uses to collect Income Tax and National Insurance Contributions from employees’ wages before they receive their pay. If you are an employee, your employer deducts tax and NI automatically every payday. If you are an employer, you are legally responsible for operating PAYE correctly. This complete guide explains exactly how it works for both.
What is PAYE?
PAYE — Pay As You Earn — was introduced in 1944 and remains the UK’s primary method of collecting Income Tax and National Insurance from people in employment. Rather than employees paying their own tax at the end of the year, PAYE requires employers to deduct the right amount of tax and NI from each salary payment and send it directly to HMRC.
Almost all employees in the UK pay tax through PAYE. It covers full-time employees, part-time workers, casual workers, and company directors who receive a salary.
How PAYE Works — Step by Step
📊 The PAYE Process
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Gross Pay
Employee earns their full salary before deductions
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Tax Code
HMRC assigns a code telling employer how much tax-free pay to allow
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Deductions
Income Tax + National Insurance calculated and deducted
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HMRC Payment
Employer sends deductions to HMRC each month
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Net Pay
Employee receives take-home pay after all deductions
Income Tax Rates and Bands 2025/26
The amount of Income Tax deducted through PAYE depends on how much an employee earns and which tax band their income falls into:
| Band | Taxable Income | Tax Rate |
|---|---|---|
| Personal Allowance | Up to £12,570 | 0% — Tax Free |
| Basic Rate | £12,571 – £50,270 | 20% |
| Higher Rate | £50,271 – £125,140 | 40% |
| Additional Rate | Over £125,140 | 45% |
Tax is not charged on your entire salary at one rate!
You only pay each rate on the income that falls within that band. On a £60,000 salary: the first £12,570 is tax-free, the next £37,700 is taxed at 20%, and only the remaining £9,730 is taxed at 40%. Many people misunderstand this — your effective tax rate is always lower than your highest band rate.
National Insurance Contributions (NIC) 2025/26
In addition to Income Tax, PAYE also deducts National Insurance Contributions. Both employees and employers pay NI — but at different rates:
| Type | Who Pays | Rate | On Earnings |
|---|---|---|---|
| Class 1 Employee NI | Employee | 8% | £12,570 – £50,270 |
| Class 1 Employee NI | Employee | 2% | Above £50,270 |
| Class 1 Employer NI | Employer | 15% | Above £96/week (£5,000/year) |
Employer NI increased from April 2025
The employer NI rate rose from 13.8% to 15% and the secondary threshold dropped from £9,100 to £5,000 per year from 6 April 2025. This significantly increases the cost of employment for UK businesses. The Employment Allowance increased to £10,500 to partially offset this for smaller employers.
Understanding Tax Codes
Your tax code tells your employer how much of your income is tax-free. It is set by HMRC and appears on your payslip, P60, and P45. The most common tax code is 1257L — meaning you have a tax-free personal allowance of £12,570.
1257L
Standard Code 2025/26
You get the full £12,570 personal allowance. Most employees have this code.
BR
Basic Rate — No Allowance
All income taxed at 20%. Used for second jobs or when your allowance is used elsewhere.
0T
No Personal Allowance
Tax deducted on all earnings. Used when no P45 is provided to a new employer.
K
Negative Allowance
You owe tax from a previous year or have untaxed income reducing your allowance.
NT
No Tax
No tax to be deducted — used in specific circumstances approved by HMRC.
W1/M1
Emergency Code
Non-cumulative — tax calculated week by week or month by month without reference to the full year.
6 million UK workers have the wrong tax code!
An incorrect tax code means you are either overpaying or underpaying tax. Always check your tax code on your payslip or via your HMRC Personal Tax Account at gov.uk. If your code is wrong, contact HMRC immediately — you can reclaim overpaid tax going back 4 years.
Reading Your Payslip
Every employee must receive a payslip on or before their pay date. Here is what a typical PAYE payslip looks like:
BRITVEX LTD — Payslip
April 2025 | Tax Code: 1257LEarnings
Basic Salary£3,500.00
Gross Pay£3,500.00
Deductions
Income Tax (20%)– £387.40
Employee NI (8%)– £215.12
Pension (auto-enrolment 5%)– £175.00
Net Take-Home Pay£2,722.48
Employer PAYE Obligations
If you employ anyone who earns above the Lower Earnings Limit (£123/week in 2025/26), you must operate PAYE. As an employer your key obligations are:
1
Register as an Employer with HMRC
Before making your first payroll run, register at gov.uk/register-employer. HMRC will send you a PAYE reference number.
2
Use Payroll Software
You must use HMRC-recognised payroll software to calculate deductions and submit Real Time Information (RTI) reports. Popular options: Xero, Sage, QuickBooks, FreeAgent.
3
Submit RTI (Full Payment Submission) Each Payday
Every time you pay an employee, you must submit a Full Payment Submission (FPS) to HMRC on or before the payment date — even if no tax is due.
4
Pay HMRC Monthly
Pay the total Tax and NI deducted to HMRC by the 19th of the following month (or 22nd if paying electronically). For example, April payroll must be paid to HMRC by 19 May.
5
Issue P60 After Each Tax Year
By 31 May, give every employee who was on your payroll on 5 April a P60 showing their total pay and deductions for the year.
6
Issue P45 When Employment Ends
When an employee leaves, immediately give them a P45 showing their pay and tax to date so their new employer can set the right tax code.
Key PAYE Documents Explained
| Document | What It Is | When Issued | Why Important |
|---|---|---|---|
| P60 | Annual summary of pay and tax | By 31 May each year | Evidence of earnings for mortgages, benefits, Self Assessment |
| P45 | Pay and tax when leaving a job | When employment ends | New employer uses to set correct tax code |
| P11D | Benefits in kind report | By 6 July each year | Reports taxable benefits (company car, health insurance) |
| P800 | Tax calculation from HMRC | After tax year ends | Shows if you’ve paid too much or too little tax |
Auto-Enrolment Pensions
Employers must also automatically enrol eligible employees into a workplace pension scheme. In 2025/26 the minimum contributions are:
- Employee minimum contribution: 5% of qualifying earnings (including tax relief)
- Employer minimum contribution: 3% of qualifying earnings
- Total minimum: 8% of qualifying earnings
Qualifying earnings are calculated on income between £6,240 and £50,270 per year. Employees can opt out but must be re-enrolled every 3 years.
Frequently Asked Questions
What does PAYE stand for?
PAYE stands for Pay As You Earn. It is HMRC’s system for collecting Income Tax and National Insurance from employees through their employer, deducted directly from wages before the employee receives their pay.
What is the standard tax code for 2025/26?
The standard tax code for 2025/26 is 1257L, reflecting the personal allowance of £12,570. If you have this code you can earn up to £12,570 before paying any Income Tax.
How do I know if I’m on the wrong tax code?
Check your payslip, P60, or HMRC Personal Tax Account at gov.uk. If your code doesn’t match your circumstances — for example if you have one job but are on BR code — contact HMRC immediately. You can reclaim any overpaid tax going back 4 years.
Do self-employed people pay PAYE?
No. Self-employed sole traders pay Income Tax and National Insurance through Self Assessment — not PAYE. However, if a sole trader also has employment income from a separate employer, that employment income will go through PAYE.