What Does the Term "Pay As You Earn PAYE" Mean in Accounting - More Than Accountants

Welcome to our Support Center

What Does the Term “Pay As You Earn PAYE” Mean in Accounting

If you’re an employer or an employee, PAYE has an impact on how you collect and pay taxes.

What is PAYE (Pay As You Earn)?

A pay-as-you-earn system is one in which an employer deducts income tax from an employee’s compensation each pay period and remits it to the government on the employee’s behalf. You may have spotted these deductions on pay stubs from previous jobs; it’s a mechanism for employees to pay income tax over the course of the year rather than all at once when taxes are assessed. Even though the employee’s taxes are being paid, it is your job as the employer to deduct the taxes appropriately and pay them on time.

The PAYE system is used in several nations, including the United Kingdom, South Africa, New Zealand, and Australia. Similar systems exist in North America as well, however there are minor differences. It’s a good idea to get guidance with payroll taxes until you’re confident in your understanding of the law, but it’s also a good idea to familiarise yourself with the procedure so you can notice any problems that develop.

Want to switch to More Than Accountants? You can get an instant quote online by using the form below. In a like for like comparison for services we are up to 70% cheaper than a high street accountant.

We provide accountancy services to small businesses. The experts at More Than Accountants can take care of your self-assessment accounts and company tax requirements, ensuring that you do not incur any penalties or fines as a result of any mistakes or delays.

How Does PAYE Work?

When it’s time to hire someone, you’ll need to register with the government as an employer. In the United Kingdom, you’ll need your employee’s national insurance number and tax code to figure out how much to withhold from their pay. On top of federal taxes, PAYE can include other deductions such as benefit programmes, employer-provided insurance, and student loan payments.

If the tax office doesn’t have enough information to assess deductions for the entire year in the United Kingdom, they may issue you an emergency tax code that simply utilises the basic personal allowance to determine how much tax to deduct. You’ll be able to make appropriate adjustments after you have a suitable PAYE code, such as paying the employee back for overpaid tax or deducting additional tax, depending on the circumstances. If your employee believes they overpaid taxes during the year, they can file a return to get the money back – but be as exact as possible, since huge tax refunds will reflect poorly on your ability to handle payroll effectively.

Each time you pay an employee, you’ll also need to create a pay slip as an official record of the earnings received and deductions made from those wages — the pay slip should include the employee’s gross income, a list of deductions, and their net income (take home pay). Pay stubs are crucial records for both employees and employers, and you’ll need them if your company is audited.

RELATED: What Does the Term “Financial Year” Mean in Accounting

Making a report to your tax authority

Employee earnings and withholding amounts must be reported to the UK Revenue Authority when they occur — on or before each payday. If you own a small business, you will need to calculate how much tax and national insurance you owe each month and pay these taxes monthly or quarterly.

Employers must also disclose changes in an employee’s circumstances that may affect their taxable income – for example, if an employee marries or develops a disability, you must update your records. Make sure you or your HR department follows up with long-term employees to update this information on a regular basis. It’s a good idea to include this checkup as part of their annual performance assessment so that all of their information is current.

PAYE exemptions

All income, including bonuses, maternity leave, and sick leave payments, must be deducted through PAYE, but it’s crucial to understand that there are situations when you won’t need to deduct tax. This varies by country, but in most cases, a person must earn a certain amount of money each year in order to be taxed.

Even though they work for you on a regular basis, independent contractors and freelancers aren’t technically your employees and must pay their own taxes, so there’s no need to withhold taxes from their bills. If you’re unclear, do some online research to see if the person in question qualifies as an independent contractor or freelancer, as the definition of these terms can be a little hazy. If you hire someone as a contractor but hold them to the same standards as an employee, you may be misclassifying them and exposing yourself to tax fines in the future.

How can I set up a PAYE account as an employer?

When you register as an employer with HMRC, you will be registered for PAYE. Before hiring new employees or subcontractors, you need first register!

What is the purpose of PAYE deduction?

PAYE allows employees to pay tax and National Insurance on their income in instalments rather than receiving a large tax bill at the end of the year. The instalments are computed using an employee’s estimated earnings over the course of a tax year, minus their personal allowance.

RELATED: What Does the Term “Bank Reconciliation” Mean in Accounting

Table of Contents