Setting up payroll correctly in any business once you have employees, particularly if you are a small business owner, is a key priority.
If your payroll isn’t set up and run in the correct way, your employees won’t get paid – or paid on time – your suppliers might not be paid when they should be, and your staff morale will be low.
To avoid the issues highlighted above, an efficient payroll system needs to be set up either by yourself (in-house) using HMRC-recognised cloud payroll software or by outsourcing to a payroll company or provider, such as an accountant or a payroll bureau.
Read this article on setting up payroll to learn about the following topics:
Why run payroll in-house?
Just hired your first members of staff? Time to sort your payroll.
Some small business owners might choose the option of setting up payroll in-house for cost reasons and flexibility.
Other reasons for running payroll in-house are:
- More control of your finances
- You can catch payroll errors quickly
- Enhanced security and protection from data breaches and integration with other business systems.
James Dunworth, co-founder and chairman of ECigaretteDirect, says: “We handle payroll in-house, as it enables us to achieve cost savings, control and flexibility.
“With an in-house account team, running payroll itself does not take much time – the majority of the work is in the preparation that goes into getting payroll ready, such as calculating hours, absences and bonus for a mixture of salaried and hourly paid staff.
“As the actual processing of payroll is the quickest part of the process, it makes little sense to outsource this.
“With a team of over 90 people, there are inevitably late submissions, changes and errors, and Sage payroll allows us to make last-minute adjustments and corrections to payroll, which could provide awkward with an external provider.”
Why outsource your payroll?
If you don’t have enough time to run your payroll, you could outsource it to an accountant or a payroll bureau.
This is exactly what Marcus Franck, co-founder of heat pump specialists Smart Renewable Heat, did.
He says: “As the leader of a startup or an SME [small or medium-sized enterprise], you only have a certain amount of bandwidth.
“At this critical stage of business growth, entrepreneurs and their teams need to focus on customer acquisition and retention.
“Payroll can be incredibly time-consuming, and even more so if it’s not your specialist area of expertise.
“By outsourcing to an accredited professional, you won’t just remove an admin headache, you are more likely to stay compliant.
“By taking this off your desk, you can focus on the business-critical actions that affect long-term success.
“You should also seek to partner with a provider that can make any collaboration and record-keeping as easy as possible using smart cloud software.”
Vicky Newham, managing director at Solutions Accountancy Limited, says many small businesses make mistakes when they are managing their payroll, and in the end, they’re forced to find another solution – outsourcing it.
She says: “The common mistakes are the input errors; they have a general lack of knowledge about expenses; they constantly miss monthly deadlines and they lack knowledge of industry trends such as auto-enrolment and automation.”
How to choose the right payroll provider
First of all, you’ll need to consider how much help you need with your payroll matters and whether you’re going to use an accountant or a bureau.
However, you’re responsible for collecting and keeping records of your employees’ details. Your payroll provider will need these to run payroll for you.
Some payroll providers can offer you more support if you need it, for example keeping employee records, providing payslips and making payments to HMRC.
If you opt to manage your processes using payroll software, check with your vendor to ensure you can easily send real-time data submissions to HMRC, offer online payslips and P60s to your employees, and have access to support when you need it.
Setting up payroll for your business
If you decide to run or set up payroll yourself, you’ll need payroll software to report to HMRC. It will help you to:
- Record your employees’ details
- Work out your employees’ pay and deductions
- Report payroll information to HMRC
- Work out how much you need to pay HMRC
- Calculate statutory pay, such as sick pay or maternity pay.
Other things you have to do, if you are setting up payroll in-house, are as follows:
1. Register as an employer with HMRC
You need to do this when you start employing staff or using sub-contractors. If you’re only employing yourself as the only director of a limited company, you still must register with HMRC.
It usually takes up to five days to get your employer PAYE reference number. You can’t register more than two months before you start paying people.
If your business starts employing people on or after 6 April – the start of the new tax year – you’ll get your employer PAYE reference number by 17 May.
2. Get a login for PAYE Online
Most new employers get a login when they register as an employer online.
If you don’t have one because you registered in a different way, you’ll need to enrol for PAYE Online separately.
3. Tell HMRC about your employees
You must tell HMRC when you take on a new employee.
You’ll also need to:
- Check whether the new employee needs to be paid through PAYE
- Get employee information to work out their tax code – if you don’t have their P45, use HMRC’s starter checklist
- Find out if their student loan is outstanding.
After getting this information, you can use these details to set up your new employee in your payroll software.
Finally, you can register your employee with HMRC using a Full Payment Submission (FPS).
4. Collect and keep records
You must keep records of what you pay your employees and the deductions you make, as well as the following:
- Employee leave and sickness absences
- Tax code notices
- Taxable expenses or benefits.
Your need to keep these records for three years from the end of the tax year they relate to. From time to time, HMRC may check your records for accuracy and to make sure you’re paying the right amount of tax.
You can keep these records on paper, digitally or as part of a software program. If you don’t keep full records, HMRC may issue you with a penalty of up to £3,000.
5. Record pay, make deductions, report to HMRC
As part of your payroll, you need to complete a number of tasks during each tax month – which run from the 6th of one month to the 5th of the next.
You must tell HMRC if you’ve not paid any employees in a tax month.
Every time you pay your employees, you need to use your payroll software to:
- Record their pay
- Calculate deductions from their pay (such as tax and National Insurance)
- Calculate the employer’s National Insurance contribution that you’ll need to pay on their earnings.
- Produce payslips for each employee
- Report their pay and deductions to HMRC in a Full Payment Submission (FPS).
6. Pay HMRC the tax and National Insurance you owe
Every month, you have to pay HMRC the tax and National Insurance you owe as reported on your FPS in the previous tax month minus the reductions on any Employer Payment Summary (EPS) you sent before the 19th in the current tax month.
Your payroll software will work out how much tax and National Insurance you owe, including an employer’s National Insurance contribution on each employee’s earnings.
7. Complete annual reports and tasks to prepare for the next tax year
As part of the payroll year end process, you need to report to HMRC on the previous tax year (which ends on 5 April), give your employees a P60, and prepare for the new tax year, which starts on 6 April.
In your annual report, you must include your employees’ pay, any payroll benefits and deductions in an FPS.
In order to prepare for the next tax year, you will need to update employee payroll records from 6 April, update payroll software, give your employees a P60 and report employee expenses and benefits.
Records and other payments to be aware of
Other types of pay that you need to record and steps you need to be aware of with your payroll include the following:
1. Statutory pay
You may have to pay your employee:
- Statutory Sick Pay (SSP)
- Statutory pay for parents (maternity, paternity, adoption or shared parental pay).
You must record these in your software – they’re taxed like normal pay. You can reclaim statutory pay for parents.
2. Expenses and benefits
Expenses or benefits such as uniforms or company cars are reported separately at the end of the tax year.
Check the rules to find out what counts as expenses and benefits, and what you should record in your software as normal pay.
3. Tips and other payments
Treat tips to your staff as normal pay if they’re paid into your till – this includes tips added from your customers’ cards or payments by cheque.
Other payments you may give your employee that you should record as normal pay include:
- Holiday pay (unless you pay it in advance or use a holiday pay scheme)
- Payments for time your employee has spent travelling
- Passenger payments, except the first 5p per mile
- Medical suspension payments, given to an employee you’ve suspended for health reasons
- Maternity suspension payments, given to an employee you’ve suspended for her, or her baby’s, health
- Guarantee payments, paid to an employee for a day they do not work (and not paid holiday)
- Office holders’ payments (honoraria), given to employees for providing a service, for example being your company’s sports club secretary.
Your payroll software will calculate how much tax and National Insurance to deduct from your employees’ pay.
These deductions are worked out using each employee’s tax code and National Insurance category letter.
You may also need to deduct student loan repayments, pension contributions, Payroll Giving donations and child maintenance payments.
5. Student loan repayments
Use your payroll software to record if your employee needs to make student loan repayments – both in your software and on payslips.
You’ll need to calculate and deduct how much they need to repay based on which plan they’re on. They’ll repay:
- 9% of their income above £1,682 a month for Plan 1
- 9% of their income above £2,274 a month for Plan 2
- 9% of their income above £2,114 a month for Plan 4
- 9% of their income above £2,083 a month for Plan 5
- 6% of their income above £1,750 a month for postgraduate loans.
Make pension deductions after you take off National Insurance. You normally make pension deductions before you take off tax – check with your workplace pension provider.
You’ll also need to pay any employer contributions into your employee’s pension.
All employers have to provide and pay into a workplace pension scheme for their employees – this is called automatic enrolment.
You must give your employees and workers a payslip on or before their payday.
Payslips must show:
- Pay before any deductions (gross wages)
- Deductions such as tax and National Insurance
- Pay after deductions (net wages)
- The number of hours worked, if the pay varies depending on time worked.
Payslips can also include information such as your employee’s National Insurance number and tax code, their rate of pay, and the total amount of pay and deductions so far in the tax year.
8. Producing payslips
You may be able to produce payslips using your payroll software, if it has this feature. You can use different software if it does not.
You can either print payslips to give to your employees, or you can send them electronically.
Alternatively, your employees may be able to access their payslips via an online portal, if your payroll software offers that functionality.
This means you’ll save time and effort on having to send payslips to your people, and they can securely access their documents when they need to.
Damon Tunnicliffe, payroll manager at chartered accountants and business advisers Duncan & Toplis, says there is a lot of legislation small businesses have to follow in relation to data protection and the General Data Protection Regulation (GDPR).
He says: “There is a lot of pressure on small businesses to be more responsible about their payroll whether they are doing it in-house or outsourcing to someone else.
“They need to be knowledgeable about the latest legislation surrounding the minimum wage, maternity pay, paternity pay, sick pay, holiday pay, student loans, pension contributions, National Insurance, auto-enrolment and so on.”
He advises small business owners to keep up to date with legislation, changing tax codes and use up-to-date payroll software.
Four payroll points to get right
In order for your payroll to run smoothly, it’s important that you’re aware of the rules and regulations laid down by HMRC, otherwise you risk being fined – not to mention having unhappy employees if they’re not being paid correctly.
1. Minimum wages
The National Living Wage applies to those who are 23 and over.
Meanwhile, the National Minimum Wage applies to people who are between school-leaving age and under the age of 23.
The National Living Wage and National Minimum Wage rates (which are legally binding) for the 2022/23 tax year are:
- 23 and over: £9.50
- 21-22: £9.18
- 18-20: £6.83
- Under 18 (but above school-leaving age): £4.81
- Apprentices (under 19): £4.81
- Apprentices (19 and over, but in their first year): £4.81
- Apprentices (19 and over, but completed their first year): National Living Wage or National Minimum Wage for their age.
2. Employee status
The next thing to consider is the status of your employee – are they an employee or an independent contractor?
It’s crucial to understand the differences or it could cost you dearly.
Independent contractors can be self-employed workers who aren’t paid through PAYE, and they don’t have the employment rights and responsibilities of employees.
3. Keeping records
Getting your administrative house in order is key. Keep accurate records – both in your payroll and software. HMRC can check your records at anytime.
And be aware that tax codes change – keep a close eye on this and act on any notifications you receive.
4. Payment deadlines
Finally, don’t miss payment deadlines.
HMRC will send you a late filing notice if you’ve paid any employees and do not send an FPS or send one late. It can also charge you a penalty, unless you have a valid reason for reporting late.
Late, missing or incorrect payroll reports can affect your employees’ Universal Credit payments.
HMRC will close your PAYE scheme if you’re a new employer and you do not send a report to or pay HMRC in 120 days.
Final thoughts on setting up payroll
When setting up payroll for your business, there are a number of processes to go through, no matter whether you are doing it in-house or outsourcing to an accountant or a bureau, and it can be overwhelming.
To make life easier, choosing the right payroll software will go a long way. Remember, it needs to fulfil HMRC’s requirements, as well as your business requirements.
If you’re struggling, don’t hesitate to contact HMRC or a trusted adviser such as an accountant to discuss any queries related to your payroll.
Editor’s note: This article was first published in June 2019 and has been updated for relevance.
Recommended Next Read
Autumn Statement 2023: What it means for your business