PAYE means Pay As You Earn and it’s a UK tax system that deducts tax and national insurance from peoples payslips before they get paid. Chances are that if you are employed by someone in the UK, then you are part of this tax system.
Find out how PAYE works, why it is put in place and how it impacts what happens to your gross pay before it ends up in your bank account.
Table of contents
- 1. What is PAYE Tax and How Does it Work?
- 2. How Does Your Employer Know How Much PAYE Your Should Pay?
- 3. Who Has to Pay PAYE Tax
- 4. Why Do I Pay PAYE?
- 5. Can You Claim Back PAYE Tax?
1. What is PAYE Tax and How Does it Work?
PAYE stands for ‘Pay As You Earn’ which is HMRC’s system in the UK that makes employers who run payroll responsible for collecting income tax and national insurance from people who are employed by them every time they pay them. In other words, you pay tax are you earn income.
Take a look at this example payslip below, you’ll see that Amy Wright earns a salary of £2,500 for the month of May 2021 but receives a net pay of £1,926.04. Deductions have happened to her gross pay before the money hits her bank account for:
- Income tax
- National insurance
- Pension contributions
These deductions have been made by her employer on her behalf and paid over to the appropriate authorities under what is known as PAYE.
2. How Does Your Employer Know How Much PAYE Your Should Pay?
Employers know how much of each deduction to make in the above payslip because there are rules laid out by HMRC attached to each one of them, dictating how much people pay, usually depending on how much they earn.
2.1 Income Tax Deductions
Your employer knows how much income tax your need to pay because HMRC issues everyone employed in a job with a tax code. They will find this on your P45 or starter checklist if they don’t have a P45 (previously called a P46).
A tax code is a numerical number, followed by a letter, that is issued by HMRC. Tax codes tell employers not just how much tax to deduct but also how much personal allowance (or free pay) you are entitled to. For 2021/2022 the most common tax code is 1257L (previously 1250L). You can find out more about how tax code work in this guide, as well as how HMRC works them out for you and sends them to your employer.
The amount of tax you pay, depends on how much you earn – with those earning more paying more tax in higher tax bands. PAYE tax rates are paid on a sliding scale and change every tax year on the 6 April each year. The current income tax rates are:
|Personal allowance 0%||£12,570||£1,047.50|
|Basic rate 20%||£12,570 to £50,270||£1,047.50 to £4,189.17|
|Higher rate 40%||£50,271 to £150,000||£4,189.17 to £12,500|
|Additional rate 45%||over £150,000||over £12,500|
So say you are paid £3,000 each month, you will receive your annual personal allowance monthly in arrears too so that it matches how you get paid. By looking at the monthly rates in the table above your PAYE tax is worked out as follows:
|Personal Allowance 0% £1,047.50||£0.00|
|Basic rate 20% (£3,000 – £1,047.50 = £1,952.50)||£390.50|
|Total PAYE income tax||£390.50|
2.2 National Insurance
National insurance is calculated based on the gross salary that you receive every time you are paid and is not related to your tax code. When you are employed by someone, you’ll pay Class 1 national insurance through the PAYE system.
The amount of national insurance you pay again depends on how much you earn and you are taxed at different NI rates. The current rates are:
|Employees Class 1 National Insurance 2021/2022||Weekly||Monthly||Annually|
|Lower Earnings Limit (LEL)|
Employees do not pay National Insurance but
get the benefits of paying
|Primary Threshold (PT)|
Employees start paying National Insurance
|Secondary Threshold (ST)|
Employers start paying National Insurance
|Upper Earnings Limit (UEL)|
All employees pay a lower rate of National Insurance
above this point
|Employee Rates||12%||Between the Primary Threshold and Upper Earnings Limit|
|2%||Above Upper Earnings Limit|
|Employer Rates||13.8%||Above the Secondary Threshold|
So in the example payslip above, Amy earns £2,500 per month so pays national insurance of £204.36 calculated as £2,500 – £797 x 12%.
2.3 Pension Contributions
Both you and your employer are legally obligated to contribute directly into an approved workplace pension scheme every time you get paid – it’s the Governments way of forcing us to save for our retirement.
As part of the PAYE scheme, you’ll need to put away a percentage of your salary (known as ‘qualifying earnings’) and your employer must add some in too. The current workplace contributions are 5% from the employee and 3% from the employer. In addition, you’ll receive income tax relief on you the amount you put away.
|Qualifying Earnings 2021/2022||Annual Thresholds||Monthly Thresholds|
|Lower Earnings Limit||£6,240||£520|
|Upper Earnings Limit||£50,270||£4,189|
In the example above, Amy earns £2,500 per month, so her own pension contribution is £99.00 (£2,500 – £520 = £1,980 x 5%).
3. Who Has to Pay PAYE Tax
Most people who are employed by someone in a job will pay PAYE tax. Some may work for people and be responsible for their own taxes, these people are usually registered as self-employed. Being self-employed means you are responsible for working out your own taxes and paying them twice a year under the rules of self-assessment instead of the PAYE system.
4. Why Do I Pay PAYE?
The PAYE system is designed to help people stay on top of the tax they owe and ensure everyone within the system pays the right amount of tax. Under the rules of PAYE, you are given your personal allowance periodically each time you are paid to avoid people finding themselves in a position where they owe tax back to HMRC should their circumstances change.
5. Can You Claim Back PAYE Tax?
When you are employed, your tax code should be set correctly by HMRC so that you pay the right amount of tax. In some circumstances however, this tax code isn’t necessarily correct because HMRC are missing information on you or HMRC set your tax code based on certain assumptions which are no longer true.
5.1 Claiming Back PAYE When You Are Employed
If you in employment and are on the wrong tax code, then your first step to claiming back PAYE overpaid is to contact HMRC to correct your tax code. They will send your employer a P6 coding notice to change your tax code which should mean you get a tax rebate for the amount you have overpaid in your future pay packet.
If you have left your job part way through the year and have not started a new job then you may have overpaid on your tax because you haven’t received sufficient personal allowance for the tax year. In this case, HMRC will automatically recheck your income/tax calculation once the tax year has finished on 5 April each year and send you a tax refund if you are owed one, along with a statement as to how they calculated it called a P800. You may also be able to call HMRC to see if they can arrange a tax refund quicker, although this is not always possible.
5.2 Claiming Back PAYE When You Are Self-Employed
If you are employed and self employed then you’ll be able to claim back PAYE when you fill in your tax return. You’ll need to fill out the employment section declaring your earnings from your job, along with any tax deducted. Once you have entered details of all your other income, HMRC will calculate your tax based on all your earnings and you’ll receive credit for any unused personal allowance and overpaid PAYE.