Payroll taxes and deductions explained

When you run payroll, money is deducted from an employee’s gross pay before they receive their net pay. Some deductions go to HMRC, some go to pension providers, and some may go elsewhere depending on the employee’s circumstances.

There are also costs that the employer pays on top of an employee’s salary.

Below is a simple breakdown of the main payroll taxes and deductions in the UK.

PAYE Income Tax

PAYE stands for Pay As You Earn. It is the system HMRC uses to collect Income Tax through payroll.

Income Tax is deducted from an employee’s wages based on:

• Their tax code

• How much they earn

• The current Income Tax rates and thresholds

The tax code tells payroll how much of someone’s pay is tax free and which tax rates apply. We will cover tax codes in more detail in the next article.

More information about PAYE is available here:
https://www.gov.uk/income-tax

Employee National Insurance

National Insurance is another deduction taken from most employees’ pay.

The amount depends on:

• How much the employee earns

• Their National Insurance category

Employees pay National Insurance once their earnings go above a certain threshold. The rate increases once they pass higher earnings limits.

National Insurance helps fund things such as the State Pension and certain benefits.

Details of current rates and thresholds are available here:
https://www.gov.uk/national-insurance

Employer National Insurance

In addition to the employee’s deductions, the employer usually pays Employer National Insurance.

This is not taken from the employee’s pay. It is an extra cost to the business, calculated based on the employee’s earnings above a set threshold.

Employer National Insurance must be paid to HMRC along with the Income Tax and Employee National Insurance that has been deducted.

Pension contributions

Under workplace pension rules, eligible employees must be automatically enrolled into a pension scheme.

Both the employee and the employer usually contribute a percentage of qualifying earnings.

• The employee’s contribution is deducted from their pay

• The employer’s contribution is paid on top of their salary

These contributions must be paid to the pension provider by the required deadline.

We will cover workplace pensions and NEST in more detail in a separate article.

Student loan repayments

If an employee has a student loan and earns above a certain threshold, payroll must deduct student loan repayments.

The amount deducted depends on:

• Which repayment plan the employee is on

• How much they earn

HMRC tells employers when to start or stop deducting student loan repayments.

Postgraduate loan repayments

Some employees also have postgraduate loans. These are separate from standard student loans and have their own thresholds and deduction rates.

If applicable, these are also deducted through payroll.

Other possible deductions

Other deductions may include:

• Attachment of earnings orders

• Child maintenance payments

• Salary sacrifice arrangements

• Private medical or other agreed deductions

Some deductions are required by law, while others are agreed between the employer and employee.

What the employer must pay to HMRC

Each pay period, payroll calculates:

• Income Tax deducted

• Employee National Insurance

• Employer National Insurance

• Student or postgraduate loan deductions

These amounts are reported to HMRC and must be paid over, usually by the 22nd of the following month if paying electronically.

If payments are late, HMRC can charge interest and penalties.

Understanding these deductions helps explain why an employee’s net pay is lower than their gross salary, and why employing staff costs more than just the salary agreed.