What is PAYE?
PAYE is the framework HMRC uses to collect Income Tax and National Insurance from employment income at source. As the employer you calculate and deduct the right amounts every payday, report them to HMRC in real time and pay the money over monthly. Your employee simply receives their net pay and a payslip.
How Income Tax is deducted
Each employee has a tax code that tells your payroll software how much tax free pay they get. The standard code for 2026/27 is 1257L, reflecting the £12,570 personal allowance. Above that, tax is deducted at 20% up to £50,270, 40% up to £125,140 and 45% beyond. Because these thresholds are frozen until 2031, pay rises quietly pull more people into higher bands each year, a process known as fiscal drag.
Tax is normally calculated cumulatively across the tax year, so the system self corrects if pay varies month to month. Emergency codes with W1 or M1 endings calculate each period in isolation until HMRC issues the correct code.
Employee National Insurance
Employees pay Class 1 National Insurance at 8% on earnings between the primary threshold of £12,570 and £50,270 a year, and 2% on anything above. Unlike Income Tax, NI is worked out on each pay period by itself rather than cumulatively, except for directors who use an annual method.
Employer National Insurance
On top of gross wages, you pay employer (secondary) Class 1 NI at 15% on each employee's earnings above £5,000 a year in 2026/27. There is a valuable exemption for young workers: no employer NI is due on earnings up to £50,270 for employees under 21 or apprentices under 25. Most small employers can also claim the £10,500 Employment Allowance, which is set against the employer NI bill as the year progresses. Our guide to employer National Insurance and the Employment Allowance runs through the numbers with examples.
Other deductions that run through PAYE
PAYE also handles student loan repayments once income passes the relevant plan threshold, workplace pension contributions under auto enrolment, and from April 2027 most benefits in kind will be taxed through payroll too. Court orders and childcare scheme deductions can also flow through the payslip. Each of these has its own rules, thresholds and priority order, which good software applies automatically.
What you must do as an employer
Your legal responsibilities are to operate the correct tax codes, calculate deductions accurately, give itemised payslips, file a Full Payment Submission on or before each payday, and pay HMRC by the 22nd of the following month electronically. Errors usually surface as employee complaints about wrong tax or HMRC compliance letters, and correcting them late can involve penalties and interest. If you would rather hand the whole cycle to a specialist, our fixed fee payroll service covers everything from payslips to pension filings.
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 directly from wages and salaries each payday, rather than through an annual tax bill.
How much can an employee earn before paying tax in 2026/27?
The standard personal allowance is £12,570, giving the common tax code 1257L. Income Tax is deducted at 20% between £12,570 and £50,270, 40% up to £125,140 and 45% above that. These thresholds are frozen until 2031.
Who pays employer National Insurance?
The employer pays it on top of gross wages. In 2026/27 it is 15% on each employee's earnings above £5,000 a year, although the £10,500 Employment Allowance reduces the bill for most eligible employers.