Whether you’re a sole trader or the director of a limited company, taking on your first employee is a big moment for your business. Becoming an employer can seem like a daunting step as there is a lot to do, from finding the right person to work for you, to creating contacts, and making sure your payment process is in order.
If you own a small business and you are thinking of recruiting your first employee, then this article is very important for you. It’s vital that you have a strong understanding of your responsibilities as an employer, to ensure that your business is compliant with HMRC rules and regulations. This straightforward guide will take you through the essentials of operating payroll and staff benefits in line with PAYE regulations.
Payroll is the backbone of a company. If anything goes wrong with your payroll system, it can cause serious problems for your business. Most employees in the UK have a fixed income and outgoing direct debit, so if they do not get paid on time this can cause serious complications. This can create mistrust within your company and ultimately affect your image, therefore it is essential to revise your payroll system to prevent any errors with your monthly sales target. Paying your employees correctly and on time is a significant principle for a sustainable business.
A lot of important financial decisions regarding your employees depend on the payroll and payslips. For instance, a decision about a mortgage application approval depends on the affordability of the applicant. Mortgage underwriters analyse applicants’ payslips in order to make the decision.
How to register as an employer?
Once you have hired an employee and agreed upon a contact, you need to register as an employer with HMRC. You will need to use HMRC Online Services to send mandatory payroll reports to HMRC, access tax codes for your employees, receive email reminders and alerts, and pay any penalties that you may receive. Whether you take on one staff member or ten, this is a system you will have to become familiar with.
You must register two days before your employee is due to be paid, but you can do this any time in the two months beforehand. It can take up to five days to receive your PAYE reference number, so it’s best to register early if you can. You will also need to register your employee.
Upon hiring someone, you need to alert HMRC and send them details about the new employee in order to work out their tax code. If they have a recent P45, the information will be on there. If not, they will have to fill in a Starter Checklist for you to send to HMRC.
Once you have this information, you can enter it into your payroll system to correctly work out PAYE deductions.
Understanding PAYE as an employer
Paying your staff for their contracted hours is just one of many payments you will manage as an employer. PAYE is a method of paying income tax and national insurance contributions. You have a legal obligation to apply PAYE to the payments you make to your employees if their earnings reach the National Insurance Lower Earnings Limit (LEL). For the tax year 2020-2021 the LEL is £120 a week, £520 a month or £6,240 a year.
Even if your employee doesn’t earn £120 per week, you will still need to maintain payroll records for them. In this case, you will generally only need to record and report their pay, unless they have another job or receive a pension.
Through PAYE, you will make deductions for National Insurance and Income Tax from your employee’s pay. The PAYE system is also used to deduct other payments from your employees, such as:
- Student loan repayments
- Employees’ pension contributions
- Payments under an attachment of earnings order
- Repayment of a loan you’ve made to an employee
What is PAYE applied to?
PAYE is applied to any payment that an employee receives through working for you. According to smallbusiness.co.uk, this includes:
- Salary and wages
- Overtime, shift pay and tips – unless these are paid directly to your employee or they come out of an independent ‘tronc’
- Bonuses and commission
- Certain expenses allowances paid in cash
- Statutory sick pay
- Statutory maternity, paternity or adoption pay
- Lump sum and compensation payments – like redundancy payments – unless they’re exempt from tax
- Non-cash items like vouchers, shares or premium bonds – you apply PAYE to the cash value of items like this
Understanding payroll as an employer
The second thing you must do when you employ someone is set up a payroll system. Not only will you use it to pay your staff, but it is also used to calculate any PAYE deductions, generate payslips, make payments and submit information to HMRC in line with their rules and regulations.
There are three options when it comes to handling payroll. You can:
- Operate payroll yourself with special software,
- Hire someone to do it for you in-house, or
- Fully outsource your payroll to an accountant.
Whatever option you choose, the software must be approved by HMRC. HMRC provides its own software, including a free version for organisations with less than 10 employees as well as other software packages that you can pay for.
Why payroll health check?
HMRC carries out health checks on employers every year to detect and prevent risk factors associated with payroll to prevent any serious issues arising. This is done by:
- Ensuring employees are only paid for the actual work done.
- Ensuring you are paying to right employee at the right time.
- Implement a system where payroll is under your control.
- Ensuring payroll is correctly calculated.
- Ensuring tax, pension and other third-party deduction paid correctly.
Your monthly obligations
Your payroll system is crucial to ensuring that you meet your obligations as an employer. Every time you pay your employees, there are certain things you have to do via your payroll software.
The government lists the following five key payroll obligations:
1. Make a record of your employees’ pay
You must make a record of how much every employee was paid each month, even if they get paid less than £120 per week. All taxable payments must be included, such as Statutory Sick Pay etc. See Gov.uk for more on recording employees’ pay.
2. Calculate deductions
Your payroll software will calculate out how much you need to pay by using your employee’s tax code and national insurance category letter.
3. Calculate your employer’s National Insurance contribution
If your employee earns more than £183 per week, you will need to pay Employer’s Class 1 NICs. The rate that you will have to pay depends on their earnings and their National Insurance category letter.
4. Produce payslips
By law, each employee is entitled to a payslip for each payment they receive (Employment Rights Act 1999 section 8).
Your employee’s payslip must show all the deductions taken from their pay. These are:
- Income Tax
- Employee National Insurance Contributions
- Student loan deductions (if applicable)
- Pensions contributions (unless they have opted out or are ineligible).
- Gross pay
- Amount of deductions (tax, NI, pensions, student loan payments)
- Net pay
- Method of payment
Whether or not your employee pays Income Tax, you will need to submit a payroll report to HMRC which can be done by entering your PAYE Online login details into your payroll software. It’s important that you send your FPS on time, otherwise you can be fined between £100 to £400 depending on how many staff members you employ.
5. Report their pay and deductions to HMRC in a Full Payment Submission (FPS).
Whether or not your employee pays Income Tax, you will need to submit a payroll report to HMRC. This can be done by entering your PAYE Online login details into your payroll software. It’s important that you send your FPS on time, otherwise, you could be fined between £100 to £400 depending on how many staff members you employ. For more see Gov.uk here.
The tax month after paying staff
In the month following payment (beginning on the 6th) you can log into your HMRC Online account to:
* View what you owe for the previous month.
* Reclaim reductions on statutory payments such as maternity and paternity leave.
* Make payments to HMRC.
Once you have paid your employees, you need to pay the deductions to HMRC by the 22nd of the following month if you pay online, or the 19th if you pay by post. If the average monthly payments are less than £1,500 each month, you can make quarterly payments.
Making payments to HMRC
When paying HMRC, you will need to know the PAYE Accounts Office Reference number that you received after you registered as an employer.
As well as paying the monthly deductions and National Insurance Contributions each month, there are annual payments to be made. At the end of the tax year, you will need to send HMRC a final Full Payment Submission (FPS) on or before your employees’ last payday of the tax year on their P60. It’s important to always pay on time, otherwise, you could have to pay interest or face a fine.
Another deduction that you may need to make are student loan repayments. You will need to ask your employee if they have a student loan and record the answer in your payroll software. However, you won’t have to calculate the deductions as your software will do this for you. The amount that your employee will need to repay is based on which plan they are on which will be either:
- 9% of their income above £19,390 a year for Plan 1
- 9% of their income above £26,575 a year for Plan 2
- 6% of their income above £21,000 a year for Postgraduate loans
All employees now benefit from a pension plan. The new auto-enrolment pension rules mean that as an employer, you must enrol all employees aged between 22 and the state pension age who earn over £10,000 in a company pension scheme.
Each month, you will have to deduct pension contributions from your employees pay and make an employer contribution. You normally make pension deductions before you take off tax. The government recommend that you use The Pensions Regulator’s tool for employers to find out what you need to do and when you need to do it. You will need to do your research to decide on the best scheme for your business. You may also need to deduct child maintenance directly from a paying parent’s earnings or pension.
Payroll Giving and dealing with employee expenses
You can give your employees the option to donate to charity directly from their pay before tax is deducted by registering with Payroll Giving. Once you register, they will let you know how to make deductions.
If your employee claims work-related expenses, you will have to record these on your payroll system and reimburse the employee through their pay. Business expenses are anything that your employee needs to do their job. They are not typically treated as gross pay and are not subject to tax and NI. For example, train travel to a meeting is a business expense. If the expense is personal, then it will be considered gross pay and it will be taxable.
Managing employee benefits
Employee benefits are a brilliant way to promote employee satisfaction and wellbeing. Research carried out by Glassdoor found that 34% of employees say benefits and perks would attract them to a new job. There are many employee benefits to choose from which can be free or paid for services. Free benefits include things like flexible working or skills training, both of which are very popular with employees.
How to manage benefits through payroll
Like expenses, different tax and NIC rules apply to employee benefits. HMRC maintains a list of the different types of benefits and expenses you can provide, and what sort of payments apply to them.
In some cases, PAYE is applied to the value of the benefit in the same way as it is applied to an employee’s salary or statutory payments e.g., maternity pay. However, in many cases you will need to report benefits to HMRC at the end of the tax year and make a one-off payment of Class 1A NICs on the value. Instead of using PAYE, a P11D form must be filled in and submitted every year detailing the relevant benefits. This usually alters the employee’s tax code for the following year.
Some of the benefits that you could consider are:
- Interest-free travel loans – you could provide employees with an interest-free loan of up to £10,000 in any tax year for the purchase of an annual travel card or season ticket. These are cheaper if bought annually rather than daily, weekly or monthly.
- Gym memberships – giving employees a free or discounted gym membership is a good way of maintaining employee health and wellbeing.
- Salary Sacrifice – Some benefits can be provided through salary sacrifice, which means the employee agrees to receive a lower salary in exchange for them (this makes the benefits cheaper as no income tax is paid on that money). These deductions will also have to be calculated through the payroll.
Other types of employee benefits include dental insurance, private medical costs, professional body membership fees and sick pay. There is no limit to what you could offer, and there are plenty of employee benefit schemes that offer a range of packages and manage them for you.
What is a payroll bureau?
A payroll bureau company offers payroll outsourcing solutions for businesses. One of the key benefits you will get from outsourcing payroll to a payroll bureau company are expertise payroll skills and knowledge.
Finding the right payroll bureau company can be challenging, especially if you want them to offer the fully managed payroll services. The key factors you need to contemplate before choosing a payroll outsourcing company are experience, knowledge, cost, and location.
What is the cost of outsourcing payroll?
Outsourcing your payroll to a payroll bureau company can be more expensive than in-house payroll. The cost of outsourcing your payroll is dependent upon what is included in your package, and it will cost you more if you include pension in your payroll package. If you outsource your payroll to Tax Care, it will cost you around £3 per payslip.
This guide has given you a comprehensive and straightforward overview of what you need to know about operating a payroll system when you first become an employer. Despite the daunting feelings surrounding the move from sole-trader or director of a limited company, it becomes much easier than you think once the processes are up and running. Seeing your business grow and expand is exciting and achieving these things right from the outset will save you time and stress in the long run.