How Does Payroll Work for a Small Business?

Who this guide is for

This guide is for UK small businesses that employ staff, pay directors, or are considering taking on their first employee.

It is especially useful for limited company directors who want to understand when payroll is needed and what HMRC expects.

What is PAYE?

PAYE stands for Pay As You Earn. It is HMRC's system for collecting Income Tax and National Insurance from employment income.

If your business pays employees, it may need to operate PAYE as part of payroll.

PAYE can apply to directors as well as employees, depending on how the company pays them.

What does payroll involve?

Running payroll can include:

• calculating gross pay
• deducting Income Tax
• deducting employee National Insurance
• calculating employer National Insurance where due
• handling pensions where applicable
• issuing payslips
• reporting to HMRC
• paying HMRC
• keeping payroll records
• producing year-end forms such as P60s

The exact duties depend on the business and employees.

What is RTI?

RTI stands for Real Time Information. It is the system used to report payroll information to HMRC.

Employers usually send payroll information through payroll software each time employees are paid.

The main report is the Full Payment Submission, or FPS.

What is a Full Payment Submission?

An FPS tells HMRC about pay, tax, National Insurance and other payroll details for employees paid in that pay period.

It is normally sent on or before payday. Sending it late can create HMRC notices or penalties.

Payroll software is used to submit the FPS.

What is an Employer Payment Summary?

An Employer Payment Summary, or EPS, is another payroll report used in certain situations.

It may be used to report statutory payment recovery, employment allowance claims, no payments in a period or other adjustments.

Not every payroll needs an EPS every month, but employers should know when one is required.

Payroll for directors

Limited company directors can be paid through payroll. Director payroll has specific National Insurance rules because director NICs are usually calculated on an annual basis.

A company paying a director salary should make sure payroll is set up correctly and reported through PAYE where required.

Dividends are not payroll. They are a separate way shareholders may receive company profits.

Common mistakes

A common mistake is paying staff or directors without reporting payroll correctly to HMRC.

Another mistake is confusing dividends with salary. Dividends do not replace payroll where salary is being paid.

Some employers also miss FPS deadlines or forget final payroll reports at the end of the tax year.

Payroll errors can affect employees' tax codes, benefits, loan deductions and HMRC records.

What to do next

Before running payroll:

1. Check whether the business needs to register as an employer.
2. Choose payroll software or an accountant.
3. Collect employee details and starter information.
4. Set a regular payday.
5. Submit FPS reports on or before payday.
6. Keep payroll records and payslips.
7. Review pensions and year-end duties.