If you’re self-employed and considering hiring your first employee, getting to grips with payroll, tax implications and reporting processes can be daunting. It’s complicated, tricky to manage and can be expensive if you get it wrong. However, with a little help, it’s certainly possible. In this comprehensive guide to setting up and managing self employed payroll, we’ll walk you through every step and provide you with some invaluable advice as to what you need to do.
1. Register as an employer
When it’s time to expand your business and hire an employee, the first step is to register as an employer with HMRC. As an employer, you’ll be responsible for paying the staff member through the PAYE system. This is the system through which all businesses calculate the Income Tax and National Insurance Contributions (NICs) owed by your employees. Registering with HMRC informs the government that you’ll be taking on staff members and that your company is in charge of processing their wages and tax information.
As an employer, you must register before your employee’s first payday. Businesses are not permitted to register more than two months in advance of hiring their first employee and receiving your PAYE number can take up to five working days, so plan ahead. You can register through the UK government site, here.
2. Register your first employee
Once you’re registered as an employer, you’ll need to register the employee, too. This involves submitting the employee’s details to HMRC. If your new member of staff has a relatively recent P45, you’ll be able to find all the relevant details on that document. However, if a P45 isn’t available for whatever reason, you’ll need to request the information from the employee. You can find a full checklist of what you need, here.
The checklist contains various pieces of personal information. These include:
- Full name
- Address
- Employment start date
- National Insurance number
- Benefits and pension status
- Student Loans details
You’ll also need to assign the employee a payroll ID number. If you’re processing payroll yourself with self employed payroll software, you should be prompted to create a unique ID number every time someone is added to the system. If you’re using a payroll specialist, they’ll likely create the ID for you.
Remember, every payroll ID has to be unique. If they’re not, you’ll create duplicate records that will cause long-term difficulties and confusion. You’ll still need to assign a new, unique ID if you’re rehiring someone who has worked for you in the past or if the employee has another job.
3. Getting to grips with PAYE
While you’re responsible for paying your employee for the hours they’ve worked, you’re also responsible for applying PAYE to those payments. In fact, you have a legal obligation to do so.
There is only one instance in which you won’t have to apply PAYE - if your employee earns less than the National Insurance Lower Earnings Limit (LEL). This changes to account for inflation, so make sure you double-check that your employee doesn’t meet the most up-to-date threshold figure. In the financial year 2020-2021, it was set at £120 a week, £520 a month or £6,240 a year. If the employee doesn’t meet the threshold, you’ll still need to keep records of their wage payments.
Though the PAYE system may seem difficult to understand at first, with a little research and guidance, you’ll soon feel comfortable using it. As a basic introduction, PAYE is used to make the following deductions from the employee’s pay:
- Income tax
- NICs
- Student loan repayments
- Pension contributions
- Repayment of loans made to employees
Essentially, PAYE is a way of processing all of these deductions automatically, rather than the employee shouldering the burden.
4. Setting up the payroll system
You’ll also need to set up a dedicated self employed payroll system. In this regard, you have four main options:
- Manage payroll yourself using manual means, such as spreadsheets and written records
- Utilise specialist payroll software
- Hire an in-house payroll manager
- Work with a payroll specialist to whom you can outsource the responsibility
The option you choose will largely depend on your financial circumstances and priority. Can you afford to pay a specialist? Do you think it’s worth getting someone else to handle payroll so that you can focus on other parts of the business? Are you working with one employee for the foreseeable future or will you soon be bringing on more employees?
If you can, we believe outsourcing payroll is the best way to go. Especially if you believe you’ll be growing your workforce anytime soon. Not only is it a cost-effective option, but it also ensures you’re legally compliant and frees up time to work on those things that really matter to your business. However, dedicated payroll software is also a good choice.
We would be wary of managing payroll manually. This is largely due to the fact that payroll and PAYE deductions can be complicated and often require a little bit of expertise to get right. Incorrect processing can also result in significant financial penalties.
5. Using your payroll system on a monthly basis
With your self employed payroll system set up, you can start to get to grips with how it works. This will obviously take longer if you’re managing it yourself. Whether or not you’ve chosen to manage payroll yourself, the process will include the same steps every month. Below, we take a brief look at each of those steps.
Record employee pay
Each month, you’ll have to record and submit your employee’s pay. This is true whether or not they earn more than the Lower Earnings Limit. However, make sure you record all types of payments made, not just their standard wage. For instance, if they’ve received statutory sick pay, that needs to be submitted, too.
You can find a full list of the payments you need to record here. It includes, but is not limited to:
- Bonuses
- Commission
- Holiday pay
- Inducement payments
- Travel compensation
Factor in deductions
Next, you’ll need to make the necessary deductions. If you’re using payroll software or outsourcing payroll, this will all be done for you. If not, you’ll use the employee’s NI category letter and tax code to work out what deductions should be made. There are other deductions to consider, too. For instance:
- Student loan repayments
- Pension payments
- Payroll Giving payments
- Child Maintenance payments
For more information on each of these payments, take a look at the dedicated gov.uk deductions page.
Work out NICs
You’ll also need to work out what NICs your employee should pay. As long as the individual earns more than £184 a week, they’ll pay Class 1 NICs automatically through PAYE. NICs are calculated based on the staff member’s pre-tax, pre-deductions earnings. However, they’re only calculated for the amount that exceeds the NIC threshold. For example, if an employee pays an NI rate of 2% and earns £250 a week, their contributions will be worked out as 2% of £66 (£250 - £184 = £66).
An employee’s NI rate depends on their NI category letter. You can find a full table covering all the category letters on the government’s Rates and Thresholds page.
Create payslips
As well as maintaining your own payroll records, you’ll also need to provide employees with payroll documentation. This traditionally takes the form of a payslip. This is a legal requirement and there are strict regulations detailing what information must be included on the payslip. Compulsory information includes:
- Gross pay
- Total amount deducted
- Net pay
- How the payment was made
- Income tax deductions
- NICs
- Student loan deductions
- Any pension contributions
While many companies have gone paperless, you can choose how to deliver your employees’ wage slips. You may find that some employees prefer having paper records and might want to provide them with the option of having their document printed out.
HMRC reports
The final step in your monthly process is submitting a payroll report to HMRC. This is known as a Full Payment Submission (FPS) report. The FPS must be sent monthly, even if you’re paying HMRC on a quarterly basis. Failure to do so can result in financial penalties for each of the employees whose records are delayed.
Most FPS submissions are handled automatically via payroll software or your payroll specialist. Once you’ve provided them with your PAYE reference, they’ll take it from there, ensuring your submissions are always on time and accurate.
6. Using online resources
Having paid your employee and submitted the FPS report, you can now use the government’s online portal to check the status of your self employed payroll operations. To do so, you’ll need to log in to your HMRC Online account. From there, you can perform several different functions.
- View statements and what you owe HMRC from previous months
- Claim reductions on certain statutory payments
- Make payments to the government and HMRC
Usually, all the information you’ll need will be available in the online portal on the 6th of every month. If you’re working with payroll software, you’ll likely be able to perform several different report functions, allowing you to see what you owe and what needs paying. Likewise, a payroll specialist will often provide you with detailed reports and give you plenty of warning should you have missed an outstanding payment.
7. Make payments
In order to make payments to HMRC, you’ll need your PAYE Accounts Office Reference Number. You will have received this when you initially registered with HMRC - it’s a unique 13-digit code that was printed on the registration letter. While the vast majority of your payments are made every month, there are some annual payments you need to keep in mind.
At the end of each tax year, employers must submit one last FPS. This needs to be done before your employees’ final payday of the tax year. In the following cases, you may need to send an Employer Payment Summary (EPS):
- You failed to notify HMRC that your last FPS was the final submission of the year
- You did not pay any employees during the last payment period of the year
- You submitted your last FPS early and didn’t pay anyone during the last month(s) of the tax year.
You can find out more information about EPS and when it’s necessary to complete an EPS on the HMRC Reporting EPS page.
8. Other considerations
Throughout this article, there have been several mentions of the other deductions (outside of NICs) you’ll have to make for your employees. While each of these deductions is worthy of an in-depth guide, we don’t have the space for that. Instead, we thought it might be useful to take a quick look at each of the most common deductions and provide a brief explanation of what they are, how they work and what you’ve got to look out for.
Student loans
If your employee is repaying a student loan, those repayments will be made through the PAYE system and need to be deducted from the individual’s pay. How this works depends on when they received their loan and which plan they’re on. Whether they’re an English, Scottish or Northern Irish citizen may also make a difference. In 2021/2022, the four main plans were as follows:
- Plan 1 - 9% of income above £19,895 threshold
- Plan 2 - 9% of income above £27,295 threshold
- Plan 4 - a newly introduced plan for both recent and old Scottish loans - 9% of income above £25,000 threshold
- Postgraduate Masters or Doctorate - 6% of income above £21,000 threshold for English students and 9% of income above £18,330 threshold for Scottish and Northern Irish students
Pensions
Pension rules have undergone quite drastic changes in recent years. Currently, anyone older than 22 (but younger than the state pension age) who earns more than £10,000 a year must be enrolled in a pension scheme. This is known as automatic enrollment. When you become an employer, you’ll need to make sure you’re complying with pensions legislation. The Pensions Regulator is responsible for ensuring you’re compliant and boasts an excellent resource library if you need help setting up a scheme.
If you are employing someone who meets the above conditions, you’ll need to take the following steps:
- Select a pension scheme - there are several available. You may want to take advice from a professional pensions specialist to ensure you maximise benefits from you and your employees
- Contact your staff - you’ll need to write to each of your employees and detail how auto enrollment affects them. The Pensions Regulator provides templates
- Declaration of compliance - you must also submit a declaration of compliance to the Pensions Regulator. This contains information as to how you’ve met your legal obligations.
Maintenance
There may be instances in which you’ll also need to make deductions for child maintenance payments. If this is the case, you’ll be contacted by the Child Maintenance Service which may request information about the employee in question. They may also request that you set up a deduction from earnings order (DEO) or that you liaise with other relevant organisations that collect maintenance payments. Finally, you may also be given an attachment of earnings order (AEO) by a court, which will inform you of the need to make deductions from an employee’s pay.
When it comes to child maintenance deductions, you must:
- Provide information to Child Maintenance Services when it’s requested
- Send payments as promptly as possible
- Report any problems or difficulties taking payments
If you would like more detailed information on how Child Maintenance deductions work, we would recommend HMRC’s dedicated maintenance page.
Expenses
Like all pay and tax matters, employee expenses can get complicated. You’ll need to record them in your payroll system and you can reimburse employees for the expense through their payslip, too. However, make sure you’re only recording business expenses. Those expenses that don’t qualify as business expenses are personal and will be taxable.
9. Employee benefits
Many businesses offer their employees a range of benefits. This can help companies attract and retain talent without having to offer significant increases in base salaries. As a new employer, you may not be in the position to offer benefits just yet. However, it doesn’t hurt to learn a little about how they’re processed through payroll - particularly if you think you may offer them in the future.
There are so many different types of benefits that it’s difficult to generalise as to how they’re treated by and reported to HMRC. That being said, you’ll probably have to fill in a P11D form covering the benefits at the end of each tax year. It’s worth noting that this can often affect the employee’s tax code for the year to come.
For a full list of benefits and how they’re treated, take a look at the government’s Expenses page.
What next?
As you can see, managing a self employed payroll is a complex and time-consuming task. That’s why many growing businesses opt to outsource their payroll operations. That being said, with a little professional advice and a lot of research, there’s no reason why you can’t handle everything yourself. If you would like to find out more about payroll services or want to better understand the benefits of outsourcing, don’t hesitate to get in touch with Finesse Resources today.