How Does PAYE Work in the UK? A Complete 2025 Guide

What Is PAYE?

PAYE stands for Pay As You Earn. It is the system operated by HM Revenue and Customs (HMRC) that requires employers to deduct income tax and National Insurance contributions from employees' wages before paying their net salary. Rather than employees receiving their full gross pay and then calculating and paying their own tax in arrears, PAYE ensures the correct amount of tax is collected at the point of payment — hence the name.

The PAYE system covers nearly 40 million employees and pensioners in the UK and collects the majority of all income tax revenue. If you are employed under a contract of employment (rather than working as a self-employed contractor), you will almost certainly be paid under PAYE.

How Your Employer Calculates Your Tax

The calculation happens each pay period (weekly, fortnightly, or monthly) and follows these steps:

1. Gross pay is established — your regular salary or wages plus any bonuses, commissions, or taxable benefits.
2. The tax-free allowance for the period is calculated — using your tax code, your employer determines what fraction of your annual Personal Allowance applies to this pay period. For a monthly pay period, this is 1/12 of the annual allowance.
3. Taxable pay is calculated — gross pay minus the tax-free amount for the period.
4. Tax is applied to each band — income tax rates are applied to the taxable pay using the cumulative method (see below).
5. NI is calculated separately — using the NI thresholds and rates for the period.
6. Net pay is paid to you — gross pay minus income tax minus employee NI (minus any other deductions such as pension contributions).

Cumulative vs Week 1/Month 1 Basis

PAYE normally operates on a cumulative basis. This means your employer looks at your total earnings and total tax paid from the start of the tax year to date, and adjusts each period's deduction so that your cumulative tax position is exactly correct. This self-correcting mechanism means that if you were overtaxed in January (perhaps because of a one-off low-income month in a variable pay job), you would be undertaxed in February to compensate.

In certain circumstances — such as when you start a new job mid-year without a P45 — your employer may use a Week 1 or Month 1 basis. This non-cumulative approach taxes each period as if it were the first in the tax year, without considering previous periods. It prevents underpayment in uncertain situations but can lead to overpayment, which is corrected at year end.

Tax Codes Explained

Your tax code is the instruction HMRC sends to your employer telling them how much tax-free income you are entitled to and what adjustments to make. It is shown on your payslip, on any correspondence from HMRC about your tax code (called a P2 or Notice of Coding), and in your personal tax account at gov.uk.

How to Read Your Tax Code

Most tax codes consist of a number followed by a letter. The number represents your tax-free allowance: multiply it by 10 to get the annual allowance. The letter indicates the type of allowance or adjustment.

Suffix Letters

The letter at the end of standard codes indicates the type of allowance:

• L — Standard Personal Allowance. The most common letter.
• M — Marriage Allowance received (transfers from partner).
• N — Marriage Allowance transferred to partner.
• T — Your allowance includes other adjustments that HMRC has calculated — requires annual review.
• S — Scottish taxpayer rate applies.
• C — Welsh taxpayer rate applies.
• W1 or M1 — Week 1 or Month 1 basis (non-cumulative).

How Tax Codes Adjust for Benefits in Kind

If you receive taxable benefits from your employer — such as a company car, private medical insurance, or interest-free loan above £10,000 — HMRC reduces your tax code number to collect the extra tax due on those benefits through your pay. For example, if you receive a company car with a taxable value of £3,000 per year and your standard code is 1257L, your adjusted code might be 957L (£12,570 − £3,000 = £9,570, so the code number is 957).

How National Insurance Is Deducted

National Insurance (NI) is calculated separately from income tax and has its own thresholds and rates. For employees in 2025/26:

Your employer also pays Employer NI on your earnings above £5,000 per year at 15% for 2025/26. This does not come out of your pay — it is an additional cost for the employer on top of your gross salary.

NI is not cumulative in the same way as income tax. It is calculated on each pay period's earnings independently (except in some annual or multiple-year earnings schemes). This means that NI is not refunded or recalculated at year end in the same way that income tax over or underpayments are.

Your Payslip Explained

Your employer is legally required to provide you with a payslip on or before each pay date. The payslip must show your gross pay, each deduction itemised, and your net pay. Here is what a typical monthly payslip looks like for someone earning £35,000 per year with tax code 1257L:

Key Terms on Your Payslip

• Gross pay: Your total pay before any deductions — your salary, wages, bonus, or commission.
• Tax code: The code your employer uses to calculate income tax deductions. Check this is correct each month.
• Tax period: The pay period number in the tax year. Tax period 1 is April, period 2 is May, and so on for monthly pay.
• NI category: Usually Category A for most employees. Different categories apply to, for example, employees over State Pension age (Category C), or employees in certain industries.
• Net pay: Your take-home pay after all deductions — what actually lands in your bank account.
• Pension deduction: Your contribution to a workplace pension under auto-enrolment or a voluntary scheme. This may be shown as a pre-tax deduction (salary sacrifice) or a post-tax deduction depending on the scheme type.
• Employer's NI: This is usually shown for information only and does not reduce your take-home pay — it is an additional cost to the employer.

What to Do If You Have the Wrong Tax Code

Tax code errors are more common than many people realise. HMRC processes information automatically and codes are generated based on the most recent information available, which can sometimes be out of date or incorrect. Common situations that lead to wrong codes include:

• Changing jobs, especially if the P45 does not reach your new employer in time
• Starting a second job or taking on freelance work
• Receiving company benefits that have not been reported correctly to HMRC
• Marriage or civil partnership affecting the Marriage Allowance
• Being given an emergency code after starting work without a P45
• HMRC incorrectly including untaxed income estimates in your code

How to Check and Correct Your Tax Code

1. Check your current tax code on your payslip, P60, or any HMRC coding notice you have received.
2. Log in to your personal tax account at gov.uk/personal-tax-account to see your current code and the reasons for it.
3. If something looks wrong, contact HMRC on 0300 200 3300 (Monday to Friday, 8am–6pm) or use the online tax code checking service.
4. Once HMRC has the correct information, they will issue a new coding notice to you and your employer. Any over or underpaid tax due to a wrong code will be collected or refunded, usually through an adjusted code for the following year.

P60 and P45 Explained

What Is a P60?

A P60 is your end-of-year tax summary. Your employer must provide it to you by 31 May following the end of the tax year (i.e., by 31 May 2025 for the 2024/25 tax year). It shows:

• Your total gross pay for the tax year from this employer
• Total income tax deducted under PAYE
• Total National Insurance contributions (employee and employer separately)
• Your NI number and tax code as of 5 April

A P60 is an important document. Keep it safely — it is often required for mortgage applications, benefits claims, Self Assessment returns, and tax refund claims. HMRC accepts a P60 as proof of income and tax paid. Your employer is not obliged to issue a duplicate if you lose it (though many will produce a substitute from payroll records).

What Is a P45?

A P45 is the leaving document you receive from your employer when you stop working for them. It shows:

• Your employer's PAYE reference number
• Your tax code at the date of leaving
• Total gross pay and tax paid from the start of the tax year to your leaving date
• Whether you were on Week 1/Month 1 basis

The P45 comes in three parts. Part 1A is kept by HMRC; Parts 2 and 3 are given to you. You give Parts 2 and 3 to your new employer, who uses them to set up your tax correctly. If you are claiming Jobseeker's Allowance or Universal Credit, you give them the P45 instead. Always keep Part 1A for your own records.

Underpayment and Overpayment of Tax

Even with PAYE in place, it is possible to pay too much or too little tax in a given year, particularly if your circumstances changed mid-year. HMRC reviews PAYE records after the tax year ends and issues P800 notices where the tax collected does not match the amount due.

If You Have Overpaid Tax

HMRC will send you a P800 tax calculation showing the overpayment. You can:

• Claim the refund online through your personal tax account (usually paid within 5 working days)
• Wait for HMRC to send a cheque automatically (can take up to 6 weeks)
• If HMRC does not contact you but you believe you have overpaid, use the "Claim a tax refund" service at gov.uk or call HMRC

If You Have Underpaid Tax

HMRC will issue either a Simple Assessment bill (which you pay directly) or adjust your PAYE tax code for the following year to collect the underpayment. For underpayments of £3,000 or less, HMRC will normally collect the amount by reducing your tax code for the next year, spreading the collection across 12 monthly payments. For larger underpayments, you may receive a bill to pay directly.

Frequently Asked Questions