How Does PAYE Work?
Your complete guide to the UK’s Pay As You Earn system. Understand tax codes, National Insurance, and how your take-home pay is calculated.
The PAYE Process Explained
PAYE (Pay As You Earn) is the system HM Revenue and Customs (HMRC) uses to collect Income Tax and National Insurance directly from your salary or pension. Here is how it works step-by-step.
How Your Employer Calculates Pay
Five essential phases of the PAYE payroll cycle
HMRC Issues a Tax Code
Based on your estimated annual income and tax-free Personal Allowance, HMRC sends your employer a tax code (e.g., 1257L). This tells your employer how much tax-free pay you are entitled to each pay period.
Gross Pay Calculation
Your employer calculates your gross pay for the period, including your base salary, overtime, bonuses, or any taxable benefits in kind (like a company car or health insurance).
Deductions Are Applied
Using your tax code, your employer’s payroll software automatically calculates and deducts the correct amount of Income Tax and Class 1 National Insurance contributions from your gross pay.
Remittance to HMRC
Your employer pays your net (take-home) salary into your bank account. They are then legally required to send the deducted Tax and National Insurance, along with their own employer NI contributions, to HMRC.
Payslip Generation
You receive a detailed payslip showing your gross pay, tax code, exact deductions for tax and NI, pension contributions, and your final net pay. This is a legal requirement for all employees.
Anatomy of a Payslip
Key components of your PAYE deduction summary
Common UK Tax Codes Explained
Understanding the letters and numbers on your PAYE coding notice from HMRC.
| Tax Code | Meaning | Who It Applies To |
|---|---|---|
| 1257L | Standard tax code. The numbers represent a £12,570 tax-free Personal Allowance. ‘L’ means you are entitled to the standard allowance. | Most employees with one job and no complex tax affairs. |
| BR | Basic Rate. All income from this source is taxed at 20% with no tax-free allowance applied. | Second jobs, pension income, or when your main job uses your full allowance. |
| D0 | Higher Rate. All income from this source is taxed at 40%. | Higher earners with multiple income streams or significant benefits in kind. |
| D1 | Additional Rate. All income from this source is taxed at 45%. | Additional rate taxpayers earning over £125,140 annually. |
| 0T | Zero tax-free allowance. All income is taxed, starting at the basic rate, then higher, then additional. | Employees who have used up their allowance, or when HMRC lacks sufficient information. |
| W1 / M1 / X | Emergency or non-cumulative tax codes. Tax is calculated only on the current pay period, ignoring previous earnings. | New employees, those returning to work, or when HMRC is processing updated details. |
PAYE & Payroll FAQ
Answers to the most frequently asked questions about the UK Pay As You Earn system.
PAYE stands for ‘Pay As You Earn’. It is the system used by HM Revenue and Customs (HMRC) in the UK to collect Income Tax and National Insurance contributions directly from an employee’s salary or pension before they receive their pay.
Your tax code is calculated by HMRC based on your tax-free Personal Allowance (currently £12,570 for most people, represented by the code 1257L) minus any adjustments for benefits in kind, unpaid tax from previous years, or professional subscriptions.
Yes. Your employer is responsible for calculating and deducting both Income Tax and Class 1 National Insurance contributions from your gross pay through the PAYE system, and paying them directly to HMRC on your behalf.
If you are on an emergency tax code (such as 1257L W1, M1, or X), it means you are only receiving your tax-free allowance for that specific pay period. You should check your coding notice from HMRC or contact them to ensure they have your correct employment and income details to issue a standard cumulative code.