If you employ any staff, or plan to do so, you’ll need a payroll. Many accounting firms can provide this vital function for you, but it’s still important to have a good grasp of how payroll works.
Whether you run your payroll internally or outsource it, here’s a simple breakdown of the key things you need to know. This article covers:
- What is payroll?
- How do you set up payroll?
- How much should you pay your employees?
- Pensions & benefits and other payroll deductions
- Tax reporting (PAYE) via payroll
- How to run your payroll
You can also talk to your accountant about your best options for payroll.
What is payroll?
Technically, your payroll is just the list of all your employees and how much they earn. However, it has come to mean the actual process of managing your employees’ pay.
This means the payroll process includes:
- Calculating each employee’s wages and issuing them
- Managing bonuses and benefits
- Calculating pay for time not worked (e.g. sickness, holidays, maternity leave)
- Paying employees’ tax and National Insurance (NI)
- Maintaining all financial records for these things
Even for a small organization, this can amount to a lot of work. Accuracy and dependability are also paramount, which is why many businesses outsource their payroll function to a specialist provider such as their accountant.
If you employ any staff (not including partners in a partnership or LLP) then you’ll need to run a payroll. This is also the case if you run a limited company and are its only employee (i.e. the director).
How do I set up my first payroll and register for PAYE?
To set up your payroll, first register as an employer with HMRC (for UK). HMRC will then send you your PAYE Reference and your PAYE Accounts Office Reference (don’t confuse them!). You will need both these numbers in order to file your payroll data to HMRC.
Now decide whether you want to run payroll in-house or outsource it. If you choose to do it yourself, you’ll need to use approved software. HMRC provides its own software (there is a free version for organizations with fewer than 10 employees) but many other packages are available.
If you don’t want to do it yourself, you can search for an accountant who provides a payroll service.
How much should I pay my employees?
You must pay each employee at least the National Living Wage if they are aged 25 or over. If they are younger, you must pay them at least the National Minimum Wage (which varies depending on their age and whether they are an apprentice). Aside from that, wage levels are up to you. You may want to offer higher salaries to posts you consider especially vital, so as to attract the best people. However, remember that an attractive benefits package and/or pension scheme can be just as effective as a recruitment tool.
Your own pay as director is slightly different, as it is not subject to any minimum wage requirements. Many directors opt to save on income tax by paying themselves only their personal allowance for each tax year, and taking the rest of their income in dividends from company profits. This can reduce your overall tax bill, but there are potential pitfalls so talk to your accountant about this.
Pensions, benefits, expenses and other deductions
You are required to offer all eligible employees a workplace pension, and you may also offer them additional benefits such as flexible holidays, childcare vouchers, gym memberships, cheaper insurance, workplace ISAs etc. Sometimes these benefits will be taxable, so must either be processed through the payroll or reported directly to HMRC using the form P11D.
Some benefits can be provided through salary sacrifice, which means the employee agrees to receive a lower salary in exchange for them (this makes the benefits cheaper as no income tax is paid on that money). These deductions will also have to be calculated through the payroll.
If any employee claims work-related expenses, you will have to monitor these through the payroll and reimburse the employee as part of their pay packet.
Finally, you must deduct tax and NI contributions from each employee’s pay before you pay them, via Pay As You Earn (PAYE).
PAYE reporting through payroll
When you calculate each employee’s pay for the month, your payroll software (if you’re doing it yourself) will work out how much income tax and NI must be deducted from the gross figure. This will leave you with the net amount you must pay the employee, and the rest you will send to HMRC.
Payroll software also allows real-time reporting. HMRC must have all of your month’s payroll information (though not the PAYE payment) no later than you pay your employees. In other words, it is best to ensure this is done before you actually pay anyone.
Finally, you must make your payment to HMRC. This needs to be completed by the 22nd of the following month, but it’s best to do it sooner in case unexpected events (such as IT problems) cause a last-minute delay. When paying HMRC you will need your PAYE Accounts Office Reference number.
How long do you have to keep payroll records?
In the UK, you’re legally obliged to keep records for three years minimum, but many employees keep records for up to six years. As an employer, you’ll need to keep some basic employee information, such as salary, salary deductions, employee leave, tax codes and other key information.
How should I run my payroll?
Though it is possible to perform payroll yourself with low-cost software, or hire someone to do it in-house, this can have disadvantages. Payroll can be onerous for a non-specialist to handle, leading to wasted time and potential mistakes. Similarly, if payroll is the sole responsibility of someone on your staff, you will have to work out what to do when they are off sick or on annual leave.
If you have a very small number of staff (say, five or fewer) and feel confident managing it yourself, this may be more cost effective. For a larger organization, however, an outsourced payroll function may be preferable. The cost of payroll is relatively low for the level of security it provides, and it can free you up to grow at the pace you want. Be sure to choose a reputable accountant (beware of ultra-low cost online services as these may fall foul of the PAYE regulations). Payroll may well be included in the wide range of services that your accountant can provide.