Pay As You Earn (PAYE) is the system HMRC uses to collect income tax from employees. As an employer, you're legally required to deduct the correct amount from every employee's salary and pay it over to HMRC each month. Getting it wrong means penalties — getting it right means peace of mind for you and your staff.
This guide walks you through exactly how PAYE is calculated for the 2025/2026 tax year (1 March 2025 — 28 February 2026).
What Is PAYE?
PAYE stands for Pay As You Earn. It's not a separate tax — it's the method of collecting income tax at source. Every time you pay an employee, you withhold PAYE and pay it to HMRC on their behalf. Employees then receive credit for these payments when they file their annual tax return.
Step 1: Determine Taxable Income
Start with the employee's gross monthly salary, then subtract allowable deductions to arrive at taxable income:
- Pension/provident fund contributions — deductible up to 27.5% of the greater of remuneration or taxable income, capped at £35,000 per year
- Medical aid — not deducted from taxable income directly, but a tax credit is applied later
For most employees, taxable income = gross salary minus pension fund contribution.
Step 2: Annualise the Income
HMRC tax tables are annual, so multiply the monthly taxable income by 12 to get the annual equivalent. For example, if an employee earns £2,500 per month after pension deductions, the annual taxable income is £30,000.
Step 3: Apply the Tax Brackets
Use the 2025/2026 HMRC tax brackets to calculate the annual tax. the United Kingdom uses a progressive tax system — you pay a higher rate on each successive bracket, not on your entire income.
| Taxable Income (Annual) | Tax Rate |
|---|---|
| £12,571 — £50,270 | 20% |
| £50,271 — £125,140 | 40% |
| £125,141 and above | 45% |
Example: £60,000 Annual Taxable Income
Taxable income = £60,000 − £12,570 allowance = £47,430
Tax on the first £37,700 at 20% = £7,540
Tax on the remaining £9,730 at 40% = £3,892
Total annual Income Tax = £11,432
Step 4: Subtract Rebates
HMRC provides tax rebates based on age:
- Personal Allowance (most taxpayers): £12,570, via tax code 1257L
- Tapered away above £100,000 — £1 lost for every £2 earned
- Fully withdrawn at £125,140, creating a 60% effective band
For our example: £60,000 − £12,570 allowance = £47,430 taxable. That gives £7,540 at the basic rate plus £3,892 at the higher rate = £11,432 annual tax.
Step 5: Apply Medical Tax Credits
If the employee belongs to a medical aid, subtract the monthly medical tax credits:
- Employee: 5% of qualifying earnings
- Employer: at least 3% of qualifying earnings
- Qualifying earnings band: £6,240 to £50,270
For a member with one dependant: £36 + £36 = £73/month = £870/year. Final annual tax = £4,200 − £870 = £3,300.
Step 6: Divide by 12 for Monthly PAYE
Monthly PAYE = £3,300 ÷ 12 = £280. This is the amount you deduct from the employee's salary each month and pay to HMRC.
Tip: Our free PAYE calculator does all of this automatically. Enter a salary and get instant monthly and annual PAYE breakdowns — no spreadsheet required.
When to Pay PAYE to HMRC
PAYE must be paid to HMRC by the 7th of the following month. For example, PAYE deducted from January salaries must be paid by 7 February. You submit the payment via HMRC PAYE Online using an P32 return.
Common Mistakes to Avoid
- Applying the rate to total income — remember, each bracket only applies to the income within that bracket.
- Forgetting the allowance taper — above £100,000 the effective marginal rate hits 60%, not 40%.
- Not annualising — applying monthly income directly to annual tables gives the wrong result.
- Ignoring pension deductions — contributions reduce taxable income and therefore PAYE.
Automate Your Payroll
Manually calculating PAYE for every employee each month is time-consuming and error-prone. With SmartSheets's free payslip generator, PAYE, National Insurance, and Apprenticeship Levy are calculated automatically. Generate compliant payslips in minutes and focus on running your business.