Running payroll is one of the most important responsibilities for any small business owner. It’s not just about paying your employees; it’s about staying compliant with HMRC regulations, correctly calculating taxes, National Insurance contributions, and pension deductions, and keeping accurate records. Payroll mistakes can lead to penalties, interest charges, or employee disputes.
Whether you’re paying your first employee or managing payroll as a director of a limited company, properly setting up payroll ensures smooth operations and peace of mind. You will also need to comply with automatic enrolment duties by setting up a workplace pension scheme for eligible employees.
Register as an Employer
Before you start paying your employees, you must register your business with HMRC as an employer. This registration provides you with your PAYE reference number, which is required on all employee payslips and for reporting purposes. It’s an essential step to ensure your payroll is compliant from the very first payday. On registration, HMRC issues two separate references:
(1) the Employer PAYE Reference (e.g. 123/A456) used for tax and NIC reporting, and
(2) the Accounts Office Reference (e.g. 123PA00012345) used specifically for making payments to HMRC.
You must register before the first payday to get your employer’s PAYE reference number. PAYE registration is specifically required when you expect to pay any employee at or above the Lower Earnings Limit (LEL), or if you are providing employee benefits or expenses, or engaging subcontractors under CIS. Not all payments to workers trigger a PAYE obligation (e.g. if all employees earn below the LEL). This will be sent to you in a letter. You cannot register more than 2 months before you start paying people. HMRC typically processes online registrations within 5 working days, though receiving your reference by post may take longer.
Set Up PAYE Online
After registering as an employer with HMRC, the next step is to set up PAYE online. This system allows you to report income tax, National Insurance, and other deductions directly to HMRC, ensuring compliance with the law.
When you register as an employer, HMRC usually provides login details for your PAYE account. If you don’t receive them automatically, you can enrol for PAYE online separately. This gives you full access to submit payroll information and manage your reporting efficiently.
In practice, most employers will use their payroll software (not PAYE Online directly) to submit RTI returns. PAYE Online is primarily used to view liabilities, access correspondence, and manage the employer account. The current wording implies it is the main submission tool, which is slightly misleading. Payroll software handles the RTI submissions, while PAYE Online is used for account management.
The payroll software we offer will submit Real-Time Information (RTI) reports directly to HMRC each time you pay your employees. You can then use PAYE Online to review your submissions and check your account
Choose Payroll Software
Once your PAYE system is ready, the next step is to decide how you will manage payroll going forward. Many small businesses choose to use payroll software because it automates calculations, handles deductions, and submits information directly to HMRC. This can save significant time and reduce the risk of errors.
When selecting software, it’s important to consider the size and complexity of your business. Think about the number of employees you have, how often you plan to run payroll, and any special pay types such as bonuses or statutory payments. Choosing the right software ensures that all payroll tasks, from calculating wages to generating payslips and reporting to HMRC, are handled accurately and efficiently. However, Basic PAYE Tools is a free option suitable for employers with fewer than 10 employees.
For businesses with very simple payroll needs, HMRC also offers Basic PAYE Tools, a free option suitable for small employers. For more complex payrolls, professional payroll software or outsourcing to a payroll provider may be the best solution. Selecting the right method from the start makes the entire payroll process much smoother. Payroll software selection should also consider security, access control and backup arrangements because payroll data is highly sensitive.
Note: The payroll software used should be HMRC-recognised for RTI filing.
Record Employee Data
Accurate employee records are the foundation of any smooth payroll system. Before you process your first payroll, make sure you collect and record essential information for each employee. This includes their full name, address, date of birth, and National Insurance number. You’ll also need details about their pay, tax code, and any deductions, such as student loan repayments or pension contributions.
It’s equally important to track sick leave, statutory payments, and any other pay adjustments. Keeping all employee data up to date ensures that your payroll calculations are accurate and compliant with HMRC requirements. HMRC requires employers to keep payroll records for at least 3 years after the end of the tax year to which they relate. This is a specific legal requirement under the Income Tax (PAYE) Regulations 2003, which lends the content greater authority.
Having a structured system for recording employee information also makes it easier to generate payslips, submit RTI reports, and manage year-end tasks efficiently.
Calculate Pay and Deductions
Once all employee information is recorded, the next step is to calculate pay and make the necessary deductions. Payroll involves calculating each employee’s gross pay, deducting income tax and National Insurance contributions, and making workplace pension contributions in line with your auto-enrolment duties under the Pensions Act 2008. You may also need to account for student loan repayments, unpaid leave, and statutory payments such as Statutory Sick Pay or Statutory Maternity and Paternity Pay.
For employers with directors on the payroll, it is worth noting that NICs for directors are calculated differently from those of regular employees. Directors are subject to an annual earnings period for NIC purposes, meaning their NIC liability is calculated by reference to the whole tax year rather than each pay period. This can result in no NICs being due in early pay periods and a larger deduction later in the year once the annual threshold is reached. Employers may alternatively use the cumulative method, which spreads the liability more evenly across the year. This is a common area of confusion for small limited companies, particularly those in which the director receives a low salary topped up with dividends.
Using payroll software can make this process much easier, as it automatically calculates deductions based on each employee’s tax code and National Insurance category. After calculating pay, all deductions and payments must be reported to HMRC through a Full Payment Submission (FPS) each pay period. Ensuring these calculations are accurate is critical, as mistakes can lead to penalties or delays in employee payments.
Accurate calculations not only keep your payroll compliant but also help maintain employee trust and satisfaction by ensuring staff are paid correctly and on time. Moreover, National Minimum Wage interactions where deductions or salary sacrifice arrangements could affect compliance.
Pay HMRC
After processing payroll and submitting your Full Payment Submission (FPS) to HMRC, the next step is to pay the tax and National Insurance contributions you owe. The payment deadline depends on how you pay: electronic payments must reach HMRC by the 22nd of the month following the end of the tax month, while non-electronic payments, such as cheques, must reach HMRC by the 19th. It is important to schedule payments with enough time for the funds to clear and reach HMRC by the relevant deadline, as the date HMRC receives the payment counts — not the date you initiate it.
HMRC accepts payment by several methods, including Direct Debit, Faster Payments, CHAPS, Bacs, and debit or corporate credit card through the HMRC online service. Direct Debit is particularly useful for employers who want to automate payments and reduce the risk of missed deadlines. Faster Payments usually reach HMRC the same or next day, including weekends and bank holidays, while Bacs and cheques typically take up to 3 working days.
If payment is late, HMRC charges both penalties and interest. Late payment interest runs from the day after the due date at the current HMRC rate. Penalties follow a default-based structure, with percentage charges applied from the second default in a tax year, and additional 5% surcharges applied at 6 months and 12 months on any amount that remains outstanding. Staying on top of payment deadlines is therefore not just a matter of good practice — it has a direct financial consequence if not managed correctly.
Prepare for the Next Tax Year
At the end of each tax year, several important compliance steps must be completed before the new tax year begins on 6 April.
The final payroll submission requires you to send your last Full Payment Submission on or before your employees’ last payday of the tax year, with the “Final submission for year” indicator ticked in your payroll software. If your software does not support this on an FPS, or if you forgot to tick the indicator, you must send a final Employer Payment Summary with the indicator ticked instead. If you did not pay anyone in the final pay period, an EPS with the final submission indicator is also required to close out the year with HMRC.
You must give a P60 to every employee who is on your payroll on 5 April — the last day of the tax year. The P60 summarises their total pay and deductions for the year and must be provided to employees by 31 May.
Before the new tax year begins, you should also check for new tax code notices from HMRC and update your payroll software to reflect any changes to income tax bands, National Insurance thresholds, and the new National Minimum Wage and National Living Wage rates, which typically take effect from 1 April. Updating employee records with any changes in pay or personal information at this stage helps avoid errors from the first payroll run of the new year.
Preparing for year-end and the new tax year in advance reduces the risk of missed deadlines, incorrect submissions, and the penalties that can follow.
Conclusion
Setting up payroll correctly is essential for any small business in the UK. It ensures that employees are paid accurately, taxes and National Insurance contributions are reported on time, and your business remains fully compliant with HMRC regulations.
Whether you choose to manage payroll in-house using software or outsource it to a professional provider, following the proper steps from registering as an employer to preparing for the next tax year will help you avoid mistakes, save time, and maintain a smooth payroll process. A well-organised payroll system not only protects your business from penalties but also gives employees confidence that they will be paid correctly and on schedule.
By taking payroll seriously and staying proactive, you can focus on growing your business while keeping compliance and employee satisfaction a top priority.
