What Is PAYE? A Plain English Guide to Pay As You Earn

What Is PAYE?

PAYE stands for Pay As You Earn. It is the system HMRC uses to collect Income Tax and National Insurance from employees straight out of their wages, before the money reaches their bank account. If you are employed, you are almost certainly inside PAYE, and the tax you owe is handled for you every payday rather than in one lump at the end of the year.

The idea is simple. Instead of workers saving up their tax and paying it later, the employer takes the right amount off each payslip and sends it to HMRC on their behalf. You get your pay after tax, and the sums have already been done. It has worked this way in the UK since 1944, and today it collects the largest single slice of the country's tax.

The important thing to understand is that PAYE is not a separate tax. It is a method of collecting two taxes you would owe anyway: Income Tax and National Insurance. When people ask what PAYE tax is, that is really the answer. It is ordinary Income Tax, gathered as you earn rather than after the fact.

What PAYE Actually Collects

Every time you are paid, your employer works out and deducts two things:

• Income Tax, based on how much you earn and your tax code.
• National Insurance, an employee contribution on earnings above a set threshold.

For the 2026/27 tax year, Income Tax on employment works in bands. The first £12,570 you earn is covered by your Personal Allowance and taxed at nothing. Earnings between £12,571 and £50,270 are taxed at the basic rate of 20 percent. Earnings from £50,271 to £125,140 are taxed at the higher rate of 40 percent, and anything above £125,140 is taxed at the additional rate of 45 percent. These thresholds are the same as recent years because they have been frozen, which quietly pulls more people into higher bands as wages rise.

On top of that sits employee National Insurance. In 2026/27 you pay 8 percent on earnings between roughly £242 and £967 a week, and 2 percent on anything above that. Your employer also pays their own National Insurance on your wages, currently 15 percent, but that is a cost to them and does not come off your payslip.

PAYE can also collect tax on other things through your code, such as the tax due on a company car or other benefits in kind, and it can even claw back a small underpayment from a previous year by adjusting what you take home.

How PAYE Works Step by Step

The mechanics are more involved than most employees ever see. Behind each payslip, this is roughly what happens:

1. HMRC issues the employee a tax code, which tells the employer how much tax free pay that person is entitled to.
2. Each payday, the employer calculates the Income Tax and National Insurance due on that pay, using the tax code and the National Insurance thresholds.
3. The employer deducts those amounts and pays the employee the net figure.
4. On or before payday, the employer sends HMRC a report of the pay and deductions. This is done through a Full Payment Submission under the Real Time Information system, which has been compulsory since 2013.
5. The employer then pays the tax and National Insurance it has collected over to HMRC, usually by the 22nd of the following month.

Real Time Information is the part that changed everything. Before 2013, employers reported once a year and HMRC was always looking backwards. Now the report goes in every single payday, so HMRC's records update as you earn. It is also why an incorrect submission can throw your tax code out within weeks rather than at year end.

Understanding Your Tax Code

Your tax code is the engine that drives your PAYE deductions, and it is worth learning to read. The standard code for someone with one job and the full Personal Allowance in 2026/27 is 1257L. The numbers, 1257, are your tax free allowance of £12,570 with the last digit removed. The letter carries extra meaning:

• L is the ordinary code for most employees on the standard Personal Allowance.
• M and N relate to the Marriage Allowance, where one partner has transferred part of their allowance to the other.
• BR means all the income from that job is taxed at the basic rate, common on a second job.
• D0 and D1 tax everything at the higher and additional rates, again usually a second income.
• K codes work in reverse, adding to your taxable pay rather than reducing it, used when you owe tax on benefits worth more than your allowance.
• NT means no tax is taken at all.

If your code looks wrong, it often is. A change of job, a company benefit, or a mix up between two employers can all produce a code that takes too much or too little. You can check your code in your Personal Tax Account on GOV.UK, and if it is wrong, only HMRC can change it, not your employer.

Emergency Tax Codes and Why You Get One

An emergency tax code is a temporary code used when your employer does not yet have enough information to work out the right one. You will usually see it if you start a new job without handing over a P45 from your last one, start your first job partway through the year, or move from self employment into employment.

Emergency codes for 2026/27 typically appear as 1257L W1, 1257L M1 or 1257L X. The W1 and M1 stand for week one and month one, and they mean the code is applied on a non cumulative basis. In plain terms, each pay period is taxed in isolation, without taking account of what you have earned so far this year. That often leads to too much tax being deducted, particularly if you had a gap in work.

The good news is that emergency tax usually sorts itself out. Once HMRC receives the right details, it issues a correct cumulative code and any overpayment is refunded through your pay, or reclaimed after the tax year ends. If you have been on an emergency code for months and nothing has changed, that is a sign to chase it rather than wait.

Your PAYE Reference Number

Every employer that runs PAYE is given an Employer PAYE reference, sometimes called an ERN or PAYE reference number. It identifies the employer's PAYE scheme with HMRC and looks something like 123/AB45678, a three digit tax office number, a slash, then a mix of letters and numbers.

As an employee you do not need to memorise it, but you will find it on your payslip, your P60 and your P45. It matters when you claim certain benefits, apply for tax credits or student finance, or need to prove where you have been working. Do not confuse it with your own National Insurance number, which stays with you for life regardless of employer. The PAYE reference belongs to the employer's scheme, not to you.

PAYE vs Self Assessment

PAYE is not the only way tax gets paid. The other main route is Self Assessment, where you work out and pay your own tax through a return. The dividing line is roughly this: if you are employed, PAYE handles it for you; if you are self employed, a company director with untaxed income, or you have income that PAYE cannot reach, you use Self Assessment instead.

Plenty of people use both. An employee with a side business pays PAYE on the job and files a Self Assessment return for the rest. A sole trader who moves to a limited company often shifts from paying everything through Self Assessment to drawing a PAYE salary plus dividends. And unlike PAYE, Self Assessment can require you to make payments on account, paying next year's tax in advance, which catches a lot of people out in their first year.

Key PAYE Forms

A handful of forms travel with you through the PAYE system, and knowing what each does saves confusion:

• P45 is issued when you leave a job. It records your pay and tax so far and lets your next employer set the right code. Hand it over promptly to avoid emergency tax.
• P60 is a summary of your total pay and tax for the year, given to you after 5 April. Keep it, because it is your proof of income for mortgages, loans and tax refunds.
• P11D reports taxable benefits in kind such as a company car or private medical cover, which are taxed through your code rather than deducted from cash pay.

Employer Responsibilities and Deadlines

For a business, PAYE is one of the more unforgiving parts of running a payroll, because it happens every pay run and HMRC is watching in real time. An employer has to register as an employer before the first payday, operate the right tax code for each person, deduct the correct Income Tax and National Insurance, report through RTI on or before each payday, and pay HMRC by the 22nd of the following month for electronic payments. Small employers can sometimes pay quarterly.

Directors have their own quirks here, because National Insurance for directors is worked out on an annual basis rather than pay period by pay period, which is one of many reasons directors' pay is worth setting up carefully. Get any of this wrong and the penalties, interest and corrections can pile up quickly. That is why so many small businesses hand payroll to an accountant rather than risk it in house.

Our View

PAYE is one of the best pieces of tax administration the UK has, precisely because most people never have to think about it. The tax is collected quietly, spread across the year, and for a straightforward employee it just works. The trouble starts at the edges: a wrong tax code, an emergency code that lingers, a benefit that is not being taxed, or a second job pushing you into a band you did not expect.

Our honest view is that employees should check their tax code at least once a year, because HMRC gets codes wrong far more often than people realise, and the money at stake, in either direction, is real. For employers, PAYE is not the place to cut corners. Real Time Information means mistakes surface fast, and the cost of putting them right almost always exceeds the cost of running payroll properly in the first place.

How IAK Can Help

We run payroll for employers across North London, and PAYE sits at the heart of it. Our payroll service handles the whole cycle: registering your scheme, operating the right codes, submitting RTI on time every payday, producing payslips and P60s, and telling you exactly what to pay HMRC and when. For directors, we set the salary and code up so your PAYE and National Insurance work together with your dividends rather than against them.

If you are an employee who thinks your tax code is wrong, or an employer setting up payroll for the first time, contact us for a free consultation. Our personal tax team can check whether you have overpaid, and our salary calculator gives you a quick estimate of your take home pay after Income Tax and National Insurance.

Sources

• PAYE and payroll for employers, GOV.UK, on how PAYE works, employer registration, RTI reporting and payment deadlines.
• Income Tax rates and Personal Allowances, GOV.UK, on the £12,570 Personal Allowance and the 20, 40 and 45 percent bands for 2026/27.
• National Insurance rates and categories, GOV.UK, on the 8 percent and 2 percent employee rates and the 15 percent employer rate.
• Tax codes, GOV.UK, on what the numbers and letters mean, the 1257L standard code and emergency codes.
• Find your employer PAYE reference, GOV.UK, on the P45, P60 and P11D and where the Employer PAYE reference appears.