Pay As You Earn (PAYE) is the system HMRC uses to collect income tax and National Insurance from employees. As an employer, you're legally required to deduct the right amount each payday, report it to HMRC in real time, and pay it over. Getting it wrong means penalties — getting it right means peace of mind for you and your staff.
This guide walks you through how PAYE is calculated for the 2026/2027 tax year (6 April 2026 — 5 April 2027).
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 deduct tax using their tax code, report it on a Full Payment Submission (FPS), and pay HMRC. Most employees never need to file a tax return.
Step 1: Work Out Taxable Pay
Start with the employee's gross pay for the period, then take off anything deducted before tax:
- Pension contributions under a net pay arrangement — taken off before tax is calculated (relief-at-source schemes work differently: the provider claims basic-rate relief instead)
- Salary sacrifice — reduces gross pay itself, so it saves National Insurance as well as tax
- Payrolled benefits in kind — added to taxable pay, not deducted
Step 2: Apply the Tax Code
The tax code tells you how much tax-free pay the employee gets. The standard code 1257L gives the full Personal Allowance of £12,570 a year — about £1,048 a month. Codes starting with S use the Scottish bands; codes starting with C use the Welsh rates (currently the same as England's).
- Tapered away above £100,000 — £1 of allowance lost for every £2 of income
- Fully withdrawn at £125,140, creating an effective 60% band in between
- No age rebates — unlike some countries, the UK gives everyone the same Personal Allowance regardless of age
Step 3: Apply the Tax Bands
The UK uses a progressive system — each rate applies only to the slice of taxable income in that band. For 2026/2027 in England, Wales and Northern Ireland:
| Taxable Income (after Personal Allowance) | Tax Rate |
|---|---|
| £12,571 — £50,270 | 20% |
| £50,271 — £125,140 | 40% |
| £125,141 and above | 45% |
Scottish taxpayers pay six rates from 19% to 48% on non-savings income.
Example: £60,000 Salary, Tax Code 1257L
Taxable income = £60,000 − £12,570 Personal 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: Work It Out Per Pay Period
Payroll doesn't wait until the end of the year. On a normal (cumulative) tax code, each month you compare the employee's total taxable pay so far this tax year with their total tax-free allowance so far, work out the tax due to date, and deduct the difference from what's already been taken. For someone paid the same every month, that simply comes to one twelfth of the annual figure:
Monthly PAYE = £11,432 ÷ 12 = £952.67
Codes marked W1, M1 or X are non-cumulative (emergency) codes: each period is taxed on its own, without looking back at earlier pay.
Step 5: Add National Insurance
Employee Class 1 National Insurance is 8% on earnings between £12,570 and £50,270 a year, and 2% above. Unlike income tax, NI is worked out separately for each pay period and isn't cumulative. Employers pay 15% on earnings above £5,000 a year on top.
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
You report each payday on a Full Payment Submission on or before the day you pay employees. PAYE and National Insurance for a tax month (6th to 5th) must reach HMRC by the 22nd of the following month if you pay electronically (19th by post). Small employers with an average monthly bill under £1,500 can pay quarterly.
Common Mistakes to Avoid
- Applying the rate to total income — each rate applies only to the income within that band.
- Forgetting the allowance taper — above £100,000 the effective marginal rate hits 60%, not 40%.
- Ignoring the tax code — a K code, BR or emergency code changes the result completely.
- Ignoring pension deductions — net pay arrangement contributions reduce taxable pay and therefore PAYE.
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