PAYE (Pay As You Earn) is HMRC's system for collecting Income Tax and National Insurance directly from employees' wages before they receive them. It's the primary way most UK workers pay tax - automatically, efficiently, and (mostly) invisibly. This comprehensive guide explains exactly how PAYE works, what gets deducted, and how to ensure you're paying the right amount.
What Is PAYE?
Pay As You Earn (PAYE) is HMRC's system for collecting:
- Income Tax - Based on your earnings and tax code
- National Insurance contributions - Funding State Pension and other benefits
- Student loan repayments - If applicable
- Pension contributions - If you're in a workplace pension
How it works: Your employer calculates what you owe, deducts it from your gross pay, and sends it directly to HMRC. You receive your "net pay" (take-home pay) after all deductions.
The key benefit: You never have to file a tax return or write a check to HMRC. Tax is collected gradually throughout the year, making it easier to manage than a single large bill.
Use our Take Home Pay Calculator to see exactly what gets deducted through PAYE from your salary.
How PAYE Calculates Your Tax
PAYE operates on a cumulative basis throughout the tax year (6 April to 5 April). This means:
- Each payday, your employer calculates how much tax you should have paid year-to-date
- They subtract what you've already paid
- The difference is what you pay this period
Example - Monthly pay of £3,000:
Month 1 (April): - Year-to-date earnings: £3,000 - Tax-free allowance used: £1,048 (£12,570 / 12) - Taxable: £3,000 - £1,048 = £1,952 - Tax due year-to-date: £1,952 × 20% = £390 - Tax already paid: £0 - Tax this month: £390
Month 2 (May): - Year-to-date earnings: £6,000 - Tax-free allowance used: £2,095 (£1,048 × 2) - Taxable: £6,000 - £2,095 = £3,905 - Tax due year-to-date: £3,905 × 20% = £781 - Tax already paid: £390 - Tax this month: £391
This cumulative approach means if you overpay in one month (perhaps due to a bonus), you automatically pay less in subsequent months to balance it out.
Non-cumulative codes (W1/M1): Some tax codes have W1 (Week 1) or M1 (Month 1) suffixes, meaning tax is calculated only on current period earnings without considering year-to-date. This usually results in overpayment and is typically emergency tax. Read our Emergency Tax Guide if you have W1/M1 codes.
What Your Payslip Shows
Every payslip must show:
Gross Pay: - Basic salary - Overtime - Bonuses - Commission - Total gross earnings
Deductions: - Income Tax (based on tax code) - National Insurance - Pension contributions - Student loan repayments - Total deductions
Net Pay: - Gross pay - Total deductions = Your take-home pay
Year-to-date totals:
- Total gross pay this tax year
- Total tax paid this tax year
- Total NI paid this tax year
Your tax code: Usually shown at the top (e.g., 1257L)
Read our Tax Code Guide to understand what your code means and check if it's correct.
PAYE Tax Codes
Your tax code tells your employer how much tax-free pay you're entitled to. The most common code is 1257L for 2025/26, meaning:
- 1257 = £12,570 Personal Allowance (divided by 10 for calculation purposes)
- L = Entitled to standard Personal Allowance
Other common codes:
| Code | Meaning | Effect |
|---|---|---|
| BR | Basic Rate (20% on everything) | Used for second jobs - no allowance |
| D0 | Higher Rate (40% on everything) | Used for additional income |
| NT | No Tax | Rare - usually non-UK residents |
| K codes | Negative allowance | You owe tax from previous years or untaxed income |
| 0T | No allowance, full calculation | Often used if HMRC needs more information |
Your tax code changes when:
- New tax year starts (usually stays same if circumstances unchanged)
- You get benefits in kind (company car, private medical)
- You claim Marriage Allowance
- HMRC collects underpaid tax from previous years
- Your income or job situation changes
Use our Tax Code Calculator to check if your code is correct for your circumstances.
PAYE and National Insurance
PAYE collects National Insurance alongside Income Tax, but they're calculated differently:
Income Tax:
- Calculated cumulatively across the tax year
- Based on annual income and allowances
National Insurance:
- Calculated separately each pay period
- Only on that period's earnings
- No carry-forward or cumulative calculation
Why this matters: If you have variable income, you might pay more NI than if your income were spread evenly, even though total Income Tax is the same.
Example:
Scenario A - Steady £4,000/month:
- Monthly NI: £307 × 12 = £3,684/year
Scenario B - £2,000 × 6 months, then £6,000 × 6 months: - First 6 months: £127 × 6 = £762 - Last 6 months: £627 × 6 = £3,762 - Total: £4,524/year
Same total income (£48,000), but £840 more NI due to the period-based calculation.
This is particularly relevant for self-employed people considering dividend vs salary strategies, or employees with large bonuses. Read our complete National Insurance Guide for detailed rates and planning strategies.
PAYE and Student Loans
If you have a student loan, your employer deducts repayments through PAYE alongside tax and NI. The repayment threshold and rate depend on your plan:
Plan 2 (England/Wales, post-2012):
- Threshold: £27,295/year (£2,274/month)
- Rate: 9% on income above threshold
Plan 1 (England/Wales, pre-2012, Scotland/NI):
- Threshold: £24,990/year (£2,082/month)
- Rate: 9% on income above threshold
Postgraduate Loan:
- Threshold: £21,000/year (£1,750/month)
- Rate: 6% on income above threshold
Example - £35,000 salary, Plan 2: - Monthly earnings: £2,917 - Threshold: £2,275 - Over threshold: £642 - Monthly repayment: £642 × 9% = £58
Your employer knows your plan type from your P45 or from HMRC directly. It appears on your payslip as "Student Loan" or "SL".
Important: Student loan repayments are separate from tax - you pay them IN ADDITION to Income Tax and NI. Use our Student Loan Calculator to see exact repayments.
PAYE for Different Employment Types
Permanent Employees
Standard PAYE applies:
- Tax code provided by HMRC or P45
- Cumulative tax calculation
- Tax and NI deducted monthly or weekly
- P60 provided at year-end
Part-Time and Multiple Jobs
Each job operates PAYE independently:
- Your main job usually gets your Personal Allowance (1257L code)
- Second/third jobs typically use BR (20% flat rate)
- NI calculated separately for each job with separate thresholds
Read our Multiple Jobs Guide for detailed examples.
Directors
Company directors can choose:
- Standard method: PAYE calculated each pay period like employees
- Annual method: NI calculated across full tax year (allows some optimization)
Most directors use annual method to smooth NI across the year and potentially reduce total NI through careful salary/dividend timing.
Agency Workers
Agency workers may be paid under:
- PAYE: Agency operates normal PAYE
- Umbrella company: Umbrella deducts PAYE then pays you
- Outside IR35: You invoice the agency, handle your own tax
Check your IR35 status carefully - incorrect treatment can lead to large tax bills.
Common PAYE Problems and How to Fix Them
Emergency Tax
Problem: You're on 1257L W1/M1 or BR and paying too much tax.
Causes:
- Started new job without giving P45
- Returned to work after time off
- Started second job
Solution:
- Give P45 to employer immediately (if you have one)
- Update HMRC online at gov.uk/personal-tax-account
- Call HMRC 0300 200 3300 if urgent
You'll get refunds through later pay or at year-end. Read our Emergency Tax Guide for the complete refund process.
Wrong Tax Code
Problem: Your tax code doesn't match your circumstances.
Common causes:
- Didn't update HMRC when circumstances changed
- HMRC has incorrect information about benefits/allowances
- Multiple jobs not configured correctly
Solution:
- Check your Personal Tax Account online
- Update employment/benefit information
- HMRC issues new code within 3-5 days
- Employer applies new code in next payroll
Use our Tax Code Calculator to identify what your code should be.
Underpayment from Previous Years
Problem: Your tax code has reduced to collect underpaid tax.
Example: Code changes from 1257L to 957L
This means HMRC is collecting £3,000 of unpaid tax (1257 - 957 = 300 × 10 = £3,000) over the year through your PAYE.
Options:
- Let it be collected through PAYE (easiest)
- Pay a lump sum and get your normal code restored
- Arrange a longer payment plan if struggling
Prevention: Check your P800 tax calculation each year and query any underpayments immediately.
Year-End P800 Calculations
At the end of each tax year, HMRC sends a P800 tax calculation if:
- You're owed a refund (overpaid tax)
- You owe more tax (underpaid)
Refunds: Usually paid automatically within 5 weeks Underpayments: Collected through next year's tax code (if under £3,000)
Important: Your tax code for the new tax year (starting 6 April) should reflect current circumstances. If things changed during the year, update HMRC before 6 April.
Tax vs Self Assessment
PAYE only:
- All your income comes through employment
- Tax is automatically correct
- No need to file tax return
Self Assessment required if:
- Self-employed income over £1,000
- Rental income over £1,000
- Investment income over £10,000
- High earner (over £100,000)
If you're self-employed, read our Self Assessment Guide for complete filing requirements and deadlines.
Optimizing PAYE - Salary Sacrifice
Salary sacrifice lets you reduce taxable income by giving up salary in exchange for benefits. The most tax-efficient sacrifice is into your pension:
Example - £40,000 salary, £5,000 pension sacrifice:
Before sacrifice:
- Gross salary: £40,000
- Income Tax: £5,486
- NI: £2,194
- Take-home: £32,320
After sacrifice: - Gross salary: £35,000 (reduced) - Income Tax: £4,486 (-£1,000) - NI: £1,794 (-£400) - Pension: £5,000 - Take-home: £28,720 - But pension pot receives full £5,000 (not £3,600 net)
Savings: £1,400 in tax/NI while £5,000 goes into pension instead of £3,600 if you paid from net income.
Calculate your savings with our Salary Sacrifice Calculator.
## Related Resources
- Take Home Pay Calculator - Calculate exact PAYE deductions from your salary
- Tax Code Explained - Understand what your PAYE tax code means
- Emergency Tax Guide - Fix emergency tax and claim refunds
- National Insurance Guide - NI rates and how it's deducted through PAYE
- Income Tax Rates 2025/26 - Complete tax bands and allowances
- Salary Sacrifice Calculator - Optimize PAYE deductions through pension contributions
PAYE is designed to be simple and automatic, but errors happen. Always check your payslip, verify your tax code is correct, and query anything that looks wrong - HMRC will refund overpayments, but only if you tell them there's a problem.