What is PAYE Tax and how it is calculated?

PAYE is an abbreviation for Pay As You Earn. The HMRC uses it as a method to tax employed individuals or individuals who have other sources of income such as pension or annuity. PAYE tax is collected by your employer and forwarded to the appropriate tax authority on a weekly or monthly basis. The PAYE Tax you owe is based on your assigned tax code.

Paying tax through PAYE means any income tax you owe is deducted directly from your wages or other sources of income before you receive your paycheck.

PAYE and your tax code

Your PAYE tax code is extremely important since it informs your source of income. Moreover, how much tax to deduct from your earnings based on your income. In the course of each tax year or if your circumstances change, your employer will receive notification from the HMRC regarding your tax code.

The PAYE tax year

The tax year for PAYE employees is from April 6th to April 5th of next year’s calendar. In order to reclaim any overpayments of income tax, you have four tax years in which to do so. It is therefore important to understand when the tax year begins and ends in order to avoid missing the deadline.

PAYE forms

The most common forms given to employed individuals are:

P60 – at the end of each tax year, this form will show your total earnings and tax paid

P45 – if you quit your work

P11d – for individuals who get a business benefit, such as a healthcare plan

Almost all of the forms required by PAYE are provided to you by your employer.

How is PAYE tax calculated?

The amount of PAYE you should pay is calculated based on your earnings, as well as any personal allowances to which you are entitled.  Furthermore, keep in mind that the tax collected through PAYE is an estimate. Therefore it is not necessarily the total amount you have to pay.

Everyone is provided with a personal allowance. It is the amount of money you can earn in a given financial year before you are subject to income tax on that income. For the year 2020/2021, the personal allowance is £12,500.

However, if your income exceeds £100,000 or if you owe the HMRC unpaid tax. As a result your personal allowance can decrease. On the other hand, if you have overpaid your taxes. You may be eligible for a higher personal allowance as a result.

If you earn anything over and above your personal allowance. You are liable to pay tax at the applicable tax rate. Which will vary depending on your income. A 20 percent basic tax rate will be levied, if you earn between £12,501 and £50,000. A 40 percent percent tax rate will be levied if you earn between between £50,001 and £150,000. For anyone who earns £150,001 or above your tax rate will be 45%.


Lets consider you make £52,000 per year. In this case your tax payment will be as follows:

On the first £12,500, there is no tax.

20 percent of the next £37,500 (a total of £7,500).

40% of the remaining £2,000 (a total of £800).

Employers and pension providers rely on tax codes from HMRC to determine how much tax they should take from your wages or pension benefits. If they don’t have the accurate tax code. Your employer will need to use an emergency tax code until they can gather the required information to produce an accurate tax code.

PAYE on your pension

People who receive pension income are subject to PAYE taxation. You will receive the net amount after the tax deduction.

Your pension provider (often a pension scheme or annuity firm) collects the tax you owe and forwards it to the HMRC. Your pension provider will also take any tax you owe on your state pension.

How much PAYE tax do you need to pay when you’re self-employed

Self-employed individuals typically complete one self-assessment tax return form per year and make two ‘payment on account’ deposits to HMRC in January and July of each year. But in some cases you can pay your tax through PAYE. This means your tax is paid automatically, and you don’t have to worry about missing a payment deadline.

You can pay your self-assessment bill through PAYE if:

  • In a case where you owe less than £3,000 on your tax bill.
  • You already pay tax through PAYE – for example, if you’re an employee or you get a company pension as well as earning income from self-employment.
  • You submitted your paper tax return by 31 October or your online tax return online by 30 December.

What are the Tax-free pays?

Some payments from your employer are tax-free, despite the fact that you must pay income tax on the majority of your wages (including overtime, bonuses, commissions, gratuities, and holiday pay). If you receive a tax return. The following will not be included in your taxable income and need not be declared.

They are as follows:

  • reimbursed expenses for which your employer has entered into a formal agreement (a ‘dispensation’) with HMRC 
  • Refunded expenses when your employer enters into a voluntary arrangement with HMRC to pay your tax on your behalf.
  • If you drive your own car to work, you can claim a mileage allowance up to the HMRC-approved rates (45p per mile for the first 10,000 business miles, and 25p per mile thereafter).
  • If you routinely work from home by agreement with your employer, you may be eligible for payments of up to £4 per week or £18 per month to cover additional household expenses. Your employer may pay more if you can supply evidence that it is justified.
  • numerous allowances provided to members of the HM forces, for example: operational allowance for members serving in combat zones, such as Afghanistan; 
  • Mess allowance, transport to and from leave expenditures, and council tax relief payments are some of the benefits available.

What to do if I’ve paid too much tax ?

As a general rule, if the P800 form reveals that you’ve paid too much tax. The HMRC will refund the excess by sending you a cheque in the mail. You should get this payment by September after the end of the tax year. Contact HMRC directly to request a refund if you feel you have overpaid in tax. But you have not yet received a refund, or submit an online claim to get a refund.

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