Understanding Employer's Income Tax and National Insurance

Employers have a range of important tax responsibilities. These can be difficult to understand, particularly if you are just taking on your first employee.

You must remember, though, that these are legal obligations. It is therefore vital that you know exactly what you are expected to do.

Do I have to set up PAYE?

As an employer you may well have to set up a PAYE, or Pay As You Earn, system. This is the means by which tax and other deductions are collected from employees’ wages.

You are legally obliged to operate PAYE for every employee whose earnings exceed the Lower Earnings Limit. For the 2010-11 tax year this is set at £97 a week, £421 a month, or £5,044 a year.

You will then have to make deductions from wages, and pay those deductions to HM Revenue and Customs. The amount you must deduct is calculated by looking at the tax code. Payments must be made to HMRC by 19th of every month. You will get an extra three days to pay if you choose to do so electronically.

Small firms can sometimes pay their bill quarterly, rather than monthly; you can do this if your average monthly bill will be less than £1,500.

What else do I have to provide?

You must give your employees an individual payslip either on or before the day that you pay them. This must show a range of figures, including their pay before and after deductions, and a breakdown of the deductions that were made.

You are also required to provide a P60 to every employee working for your business at 5 April every year. This form is essentially an outline of their pay during the year, along with the deductions that were made.

Finally, you will have to provide HMRC with an Employer Annual Return. You must complete and submit this return by 19 May every year. Most businesses must now complete this process online; otherwise, you need forms P35 and P14s from HMRC.

What about National Insurance?

In addition to the National Insurance Contributions (NICs) you deduct from employees’ wages through PAYE, you will also be required to make employers’ National Insurance Contributions on their behalf.

You have three main responsibilities when it comes to National Insurance. The first is to deduct Class 1 National Insurance Contributions from your employees’ wages, and pay these, along with your employers’ Class 1 NICs, to HMRC. The second responsibility is to pay employer Class 1A NICs at the end of each tax year. The final responsibility is to pay employer Class 1B NICs at the end of the tax year if these are required.

What are the NI Classes?

There are six separate Classes of NIC. As an employer you will probably only need to worry about four of these.

Class 1 NICs are paid by both employees and employers, through the PAYE system. They are paid by employees aged over 16 years old, and on earnings that exceed a certain threshold. Information on NIC thresholds is available elsewhere on this site.

Class 1A NICs are paid by employers on taxable benefits, and are levied as a percentage of the cash value of those benefits.

Finally, Class 1B NICs are paid by employers who have entered into a Settlement Agreement with HMRC.

Your tax responsibilities are important. If you are in any doubt, you should seek independent advice.