What is PAYE in the UK? – A Complete Guide

What is PAYE in UK A Complete Guide


Pay as you earn, or PAYE refers to income tax that is withdrawn from your paycheck before you receive it. This system, which was first used in 1944, is today used by most employees to pay their income taxes.

Your company sends the money to HMRC ‘at source,’ which means it comes immediately from your salary before it reaches your account. This method can also deduct National Insurance and student loan installments.

Self-assessment is an alternative method of paying income tax, in which individuals file a self-assessment federal return and pay tax once or twice a year.

How is PAYE calculated?

How is PAYE Calculated

The amount of PAYE you pay is determined by your earnings and whether you are qualified for the annual allowance. The personal allowance is the amount of money you can earn each tax-free year. It will be £12,570 in 2021-22, which will be £12,500 in 2020-21.

If you earn more than the personal allowance, you’ll pay 20%, 40%, or 45% in taxes, depending on whether you’re a basic rate, higher percentage, or additional rate taxpayer. Your income will decide the rate you pay.

The PAYE tax rates and thresholds for 2021-22 apply throughout the United Kingdom except for Scotland.

How is PAYE calculated on a pension?

PAYE is also used to collect taxes from people who get a pension. The money you earn is paid net, which means it is not taxed.

Your pension provider (usually a retirement fund or insurance firm) will collect the tax you owe and send it to HMRC. Your pension provider will deduct the tax you owe on your government pension.

If you get payments from multiple sources, such as a pension scheme and a private pension, HMRC will only ask one of them to deduct the tax from your state pension instalments. The frequency with which tax is deducted is determined by how frequently you are paid.

How is PAYE calculated when you are self-employed?

Self-employed individuals usually engage in filing their self-assessment tax returns annually, meeting the self assessment deadline set by HMRC. In this process, they are required to make two ‘payment on account’ installments, one in January and the other in July. Adhering to the self-assessment deadline ensures compliance with tax regulations and facilitates the timely fulfillment of financial obligations to HMRC.

However, in some instances, you may be able to pay tax through PAYE, which ensures your tax is paid automatically and you won’t miss a deadline. You can pay your self-assessment fee through PAYE if you meet the following criteria. Your tax bill owes you less than £3,000.

If you’re an employee or receive a corporate pension in addition to receiving income through self-employment, you already pay tax through PAYE. Your paper tax return was due on October 31st, and your online tax return was due on December 30th.

PAYE and your P60

Your employer or pension provider will send you a P60 statement at the end of each tax year (5 April) that shows the total gross amount you’ve been paid, how much tax has been deducted, and how much net income you’ve earned after that.

If you have more than one, each of your employers or pension providers should send you a different P60 End of Year Credential.

PAYE income tax is charged at 20% in the case above, minus a personal allowance of £12,570. (for the 2021-22 tax year). The tax code 1257L denotes this.

A £100 business pension contribution is also included in the payment.

PAYE in National Insurance

PAYE in National Insurance

If your earnings are above a specific threshold, National Insurance is withheld each pay period. The 2021-22 is £9,568, up from £9,500 in 2020-21.

Despite the fact that some payments, such as pension contributions, are tax-deductible, you will still have to pay National Insurance. Expenses that are not subject to income tax are not automatically exempt from National Insurance.

The basic rule is that if the reimbursement is a separate payment intended exclusively at reimbursing or contributing to expenses you have incurred, it should be National Insurance-free. However, some expenditures are never covered by National Insurance.

For members of the Armed Forces, this includes a mileage budget up to HMRC-approved rates if you can use your car to get to work, as well as operational mess allowances and council tax relief payments.

Pension contributions

Payments to your employer’s pension plan (including any optional contributions) or donations to a private pension provider are examples of this.

Because these donations are deducted ‘at source,’ you do not have to pay tax on them.

Student loan repayment

Depending on when you graduated from university, you’ll be on Plan 1 or Plan 2.

Plan 1: If you began university before September 1, 2012, you’d start repaying your student loans after earning £19,895 per year (or £1,658 per month). At the start of each new tax year, this level tends to rise.

Plan 2: If you began university in England or Wales after September 1, 2012, the annual repayment threshold for student loans is presently £ £27,295 (or £2,275 per month).

Repayments are calculated by rounding down to the nearest pound 9% of your income above the threshold.

Tax-free pay

Tax Free Pay

Although most of your wages (including overtime, bonuses, commissions, tips, and holiday pay) are subject to income tax, some contributions from your company are tax-free.

These do not contribute to your taxable income and do not need to be reported if you receive a tax return.

They are as follows:

HMRC has a formal arrangement (a ‘dispensation’) with your employer for reimbursement expenditures.

Mileage reimbursement up to HMRC-approved rate (45p per mile for the first 10,000 work miles and 25p per mile afterwards) if you drive your car for work if your employer enters a voluntary agreement with HMRC to pay tax on your behalf. 

How to Solve your PAYE Problems?

If the error occurred during the tax year 2020-2021, Send an FPS, including the amount that should have been deducted.

If both of the following apply, you must write to HMRC

You still owe your employee a refund if the difference is harmful because you deducted or reported too much National Insurance, for example, because they’ve left your employment.

You must include the following information in your letter

Your employee’s name, date of birth, and National Insurance number, why you overpaid National Insurance contributions, which tax years you overpaid in how much National Insurance you overpaid, and why you cannot make the payment to the employee. 

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