How to Calculate Income Tax for Employees

Calculating the correct amount of Income Tax to deduct from employee pay is a core responsibility when running payroll. This article walks you through the step-by-step process of working out Income Tax deductions for each pay period, including what information you need and how...

Introduction

Understanding Your Obligation

When you pay employees, you must deduct Income Tax through the PAYE (Pay As You Earn) system and pay this to HMRC. The amount you deduct depends on several factors specific to each employee and pay period.

Most employers now operate payroll digitally, but a small number who have an agreed exemption from online filing can still run a manual payroll using paper tables provided by HMRC.

What Information You Need

Before you can calculate Income Tax for an employee, you must gather the following information:

For the current pay period:

Employee tax code
Payment date
Period of pay (weekly, 2 weekly, 4 weekly, or monthly)
Amount paid before any deductions (gross pay)

From the previous pay period (if applicable):

Total gross pay to date
Total tax due to date
Amount of tax not deducted due to the regulatory limit (if any)

The employee tax code is particularly important as it tells you how much an employee can earn before paying tax. You'll receive this from HMRC when a new employee starts, or your existing employees will have codes already assigned.

How to Calculate Income Tax

Using HMRC's Online Calculator

The simplest and most accurate method for most employers is to use HMRC's online Pay As You Earn tax calculator. This tool calculates how much Income Tax an employee needs to pay in a pay period in the current tax year (2025/26).

The calculator works by taking the information listed above and automatically working out the correct deduction based on current tax rates and thresholds. This reduces the risk of manual errors and ensures you're applying the most up-to-date rules.

Using Manual Payroll Tables

If you're one of the small number of employers who has an agreed exemption from online filing and operates a manual payroll, you can use paper tables instead.

HMRC publishes two sets of tables for manual payroll:

Tables A: Pay adjustment tables – These help you adjust pay figures when calculating tax manually.

Taxable pay tables – These show you how much tax to deduct based on the employee's tax code and gross pay.

Manual tables require you to look up figures and perform calculations by hand or spreadsheet. This method takes more time and carries a higher risk of error, which is why HMRC encourages digital payroll processing wherever possible.

Step-by-Step Calculation Process

Whichever method you use, the basic process follows these steps:

1. Identify the employee's tax code – This determines their tax-free allowance for the year.

2. Determine the pay period – Weekly, fortnightly, four-weekly, or monthly pay periods use different calculations.

3. Calculate gross pay – This is the total amount before any deductions.

4. Work out taxable pay – Subtract the portion of the tax-free allowance that applies to this pay period from gross pay.

5. Apply tax rates – Calculate tax due on the taxable pay using current Income Tax bands.

6. Account for previous periods – Add this period's calculation to the running total for the year, then subtract tax already deducted to find what to deduct now.

7. Check for regulatory limits – In rare cases, there may be limits on how much tax you can deduct in one period.

The online calculator handles all these steps automatically when you input the required information.

Important Considerations

Tax Codes Change

Employee tax codes can change during the year. HMRC will notify you of changes, and you must apply the new code from the date specified. This affects how much tax-free pay the employee receives.

Cumulative vs Week 1/Month 1

Most tax codes operate on a cumulative basis, meaning each pay period's calculation takes into account all previous pay periods in the tax year. This ensures the correct total tax is collected over the year, even if pay varies.

Some tax codes operate on a Week 1 or Month 1 basis (shown by W1, M1, or X suffix). These calculate tax only on current period pay without reference to earlier periods. You'll see this indicated on the tax code notice from HMRC.

Record Keeping

You must keep records of all calculations for each employee and pay period. If you use the online calculator, print or save the results. If you use manual tables, keep your working papers. HMRC may ask to see these records.

When You Need Support

If you're unsure about an employee's tax code, receive a notice from HMRC you don't understand, or encounter unusual situations (such as regulatory limit notifications), contact HMRC's employer helpline or consult your accountant before processing payroll.

Getting Income Tax calculations wrong can lead to underpayments (which you may have to make good) or overpayments (which you'll need to refund to employees). It can also trigger queries from HMRC that take time to resolve.

Sources

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.