Setting Up Payroll for the First Time

Setting up payroll for the first time involves more than just working out how much to pay your employees. You need to choose HMRC-recognised software, understand your reporting obligations, and complete specific tasks each time you run payroll. This guide walks you through the...

Introduction

Before you start

Before choosing payroll software, you should get your business ready to employ staff. This means registering as an employer with HMRC and obtaining your employer PAYE reference number.

Once you're registered, you need to decide whether to run payroll yourself or use an accountant or payroll service. If you choose to run it yourself, you'll need payroll software to report to HMRC – this is a legal requirement unless you're exempt from online payroll reporting.

Choosing the right payroll software

Your payroll software must be recognised by HMRC. You can choose from free options (if you have fewer than 10 employees) or paid-for software depending on your needs.

Essential features to consider

All payroll software must report PAYE information online to HMRC. However, not all software includes the same features. Before choosing, check whether the software can:

Produce payslips
Record pension deductions
Make pension payments
Pay different people over different periods (for example, both weekly and monthly)
Send an Employer Payment Summary (EPS) report or Earlier Year Update (EYU) to HMRC

Different software packages vary in their capabilities, so consider which features matter most for your business.

Free payroll software options

If you have fewer than 10 employees, you can use free HMRC-recognised software. Options include:

1st FREE+ Payroll & HR (from 1st Money)
Primo Payroll (from Accentra Technologies)
Collegia FreePayroll
Employment Hero Free Payroll
Enrolpay Small Payroll
RTI Lite (from Hartigan Software Design)
Basic PAYE Tools (from HMRC)
IRIS Payroll Basics
1 A Simple Payroll
Stansoft Linux

Paid-for software

Many providers offer paid-for payroll software with more extensive features. These range from simple cloud-based solutions to comprehensive packages that handle complex payroll scenarios. HMRC maintains a full list of recognised suppliers on GOV.UK, including providers like BrightPay, FreeAgent, Clear Books and many others.

HMRC cannot recommend one product or service over another and is not responsible for any problems you have with software you've bought.

Understanding tax months

As an employer operating PAYE, you need to complete certain tasks during each tax month. Tax months run from the 6th of one month to the 5th of the next – not calendar months.

This timing is important because it determines when you need to report pay information and make payments to HMRC.

Tasks to complete on or before payday

Every time you pay your employees, you must use your payroll software to:

Record their pay – Include their salary or wages and any other pay such as bonuses, commission, holiday pay, or tips paid through your till.

Calculate deductions – Your software will work out how much income tax and National Insurance to deduct based on each employee's tax code and National Insurance category letter.

Calculate employer's National Insurance – You need to pay employer's National Insurance contributions on employee earnings above £242 a week.

Produce payslips – Each employee must receive a payslip. You can use different software if your payroll software doesn't have this feature.

Report to HMRC – Send a Full Payment Submission (FPS) to HMRC reporting each employee's pay and deductions. This must be done on or before payday.

You must complete these steps for all employees, even those who earn less than £96 a week.

What to include in your payroll records

Recording statutory pay

You may need to pay employees:

Statutory Sick Pay (SSP)
Statutory Maternity Pay
Statutory Paternity Pay
Statutory Adoption Pay
Statutory Parental Bereavement Pay
Statutory Shared Parental Pay
Neonatal Care Pay

Record these payments in your software – they're taxed like normal pay. You can reclaim statutory pay for parents.

Other payments to record

You should record as normal pay:

Bonuses and commission
Holiday pay (unless you pay it in advance or use a holiday pay scheme)
Payments for travel time
Passenger payments (except the first 5 pence per mile)
Medical suspension payments
Maternity suspension payments
Guarantee payments for days not worked
Office holders' payments (honoraria)
Payments convertible to cash (such as cheques, Savings Certificates or Premium Bonds)
Inducement payments ('golden hello' payments)
Cash prizes from competitions you run

Tips paid through your till or added to card payments are treated as normal pay. Different rules apply if tips are given directly to employees by customers or paid through a tronc.

Calculating deductions

Student and postgraduate loan repayments

If an employee needs to make student loan repayments, record this in your software and on their payslips. The amount you deduct depends on which plan they're on:

Plan 1: 9% of income above £26,900 a year
Plan 2: 9% of income above £29,385 a year
Plan 4: 9% of income above £33,795 a year
Plan 5: 9% of income above £25,000 a year
Postgraduate loans: 6% of income above £21,000 a year

Pension contributions

Make pension deductions after you take off National Insurance. You normally make pension deductions before you take off tax, but check with your workplace pension provider.

You'll also need to pay any employer contributions into your employee's pension. Remember that automatic enrolment means all employers must provide and pay into a workplace pension scheme for eligible employees.

Payroll Giving

Employees can donate to charity directly from their pay before tax is deducted through Payroll Giving. To offer this, register with a Payroll Giving agency who will explain how to make deductions.

Tasks for the following tax month

From the 6th of the next month, you need to:

Send an Employer Payment Summary (EPS) – If you need to claim any reductions on what you owe HMRC (for example, for statutory pay you've paid), send an EPS by the 19th of the month.

Check what you owe – You can view the balance in your HMRC online account within 2 days of sending your EPS (or by the 14th if you sent the EPS before the 11th). You can view what you owe from your FPS online from the 10th.

Pay HMRC – Pay what you owe by the 22nd of the month (or the 19th if paying by post). Late payment may result in penalties.

If you usually pay less than £1,500 per month, you may be able to pay quarterly instead of monthly. Contact the HMRC payment helpline to find out.

If you don't pay any employees in a tax month

You must send an Employer Payment Summary to HMRC if you haven't paid any employees in a tax month. This prevents HMRC from expecting payment or sending late filing notices.

Avoiding penalties

HMRC will send you a late filing notice if you've paid employees but don't send an FPS or send one late. They can also charge you a penalty unless you have a valid reason for reporting late.

Late, missing or incorrect payroll reports can also affect your employees' income-related benefits, such as Universal Credit.

If you're a new employer and don't send a report to or pay HMRC within 120 days, HMRC will close your PAYE scheme.

If you change payroll software

Some payroll software won't let you continue with the same employee Payroll IDs if you've already used them in other software. If your new software doesn't allow this, put 'Yes' in the 'Payroll ID changed indicator' for each employee in your Full Payment Submission.

Your PAYE bill may be calculated incorrectly and payroll records duplicated if you don't do this.

Sources

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