If you are taking on your first employee or paying yourself a salary through your limited company, you need to set up PAYE. PAYE stands for Pay As You Earn, and it is the system HMRC uses to collect income tax and National Insurance from salaries and wages.

This guide walks through every step of how to set up PAYE for a new business. It covers registration, software, running payroll, and the ongoing obligations you cannot afford to miss.

As ICAEW qualified accountants, we handle payroll setup for clients across the UK from Manchester's Northern Quarter to Bristol's Harbourside. The steps below are what we follow every time.

Do You Need to Register as an Employer?

You must register for PAYE if you pay any of the following to someone who works for you:

  • An employee earning above £123 a week (the Lower Earnings Limit for NIC purposes)
  • An employee receiving expenses or benefits
  • A director of a limited company taking a salary
  • A pensioner receiving occupational pensions from you

If you are a sole trader or partnership with no employees and you only take drawings from the business, you do not need PAYE. Drawings are not salary. You report your profits through self assessment instead.

But if you are a limited company director paying yourself a salary, you must register. Even if the salary is only £12,570 a year. Even if you are the only director and the only employee.

Step 1: Register with HMRC as an Employer

Registration is done through your HMRC online account. You need your Government Gateway user ID and password. If you do not have one, create it at gov.uk. Allow 30 minutes for the process.

Go to the "Register as an employer" page on gov.uk. You will need:

  • Your company name and registered number (for limited companies)
  • Your business address and contact details
  • The date you will pay your first employee
  • The number of employees you expect to pay in the next 12 months

HMRC will issue you a PAYE reference number. This is a 3-digit tax office number followed by a forward slash and a 10-character reference. You will use this on every payroll submission and every communication with HMRC about payroll.

Registration typically takes 5 to 10 working days. Do it at least two weeks before your first pay date. You cannot run payroll without a PAYE reference.

Step 2: Choose Payroll Software

You must submit payroll reports to HMRC in real time. This is called Real Time Information or RTI. Every time you pay an employee, you send a Full Payment Submission (FPS) to HMRC before or on payday. You cannot do this on paper.

You need HMRC-recognised payroll software. The main options are:

  • FreeAgent: included free with many business bank accounts. Good for limited company directors and small teams. Does RTI, auto-enrolment, and pension submissions.
  • Xero: integrated payroll module. Works well if you already use Xero for bookkeeping. Costs £5 plus £5 per employee per month.
  • BrightPay: standalone payroll software. Popular with accountants and businesses with 5+ employees. One-off licence or annual subscription.
  • HMRC Basic PAYE Tools: free for businesses with 9 or fewer employees. Functional but clunky. No auto-enrolment integration. No cloud access. Use only as a last resort.
  • Sage 50 Payroll: traditional desktop software. Common in trade and manufacturing businesses. Requires manual backup and updates.

For most small businesses and contractor Ltd companies, FreeAgent or Xero is the right choice. They handle RTI, pension submissions, and P60s automatically.

Step 3: Gather Employee Information

Before you can add an employee to your payroll, you need:

  • Full legal name
  • Date of birth
  • National Insurance number
  • Address
  • Start date
  • Contracted hours and pay rate
  • Tax code (most new employees use 1257L)

Ask the employee for their P45 from their previous employer. If they do not have one, use HMRC's "starter checklist" to determine the correct tax code. The checklist has three statements A, B, and C. Choose the one that applies to the employee's circumstances since 6 April.

For a director taking a salary from their own limited company, there is no P45. Use statement A on the starter checklist. The tax code will be 1257L unless the director has other income.

Step 4: Set Up Your Payroll in the Software

Log into your payroll software. Enter your PAYE reference, Accounts Office reference (if you have one), and company details. Then add each employee with their personal details, tax code, and pay frequency.

Most small businesses pay monthly. Directors often pay themselves monthly or quarterly. Contractors on inside IR35 contracts are typically paid weekly or monthly through an umbrella company, but if you run your own Ltd and take a salary, monthly is standard.

Set the pay frequency to match when you will actually pay. Do not set it to "monthly" if you plan to pay yourself quarterly. The software will expect a submission every month and flag a warning if you miss one.

Step 5: Run Your First Payroll

Enter the gross pay for each employee. The software calculates:

  • Income tax (based on tax code and cumulative pay)
  • Employee National Insurance (Class 1, 8% on earnings between £12,570 and £50,270, then 2% above that)
  • Employer National Insurance (13.8% on earnings above £9,100 a year)
  • Net pay (gross pay minus deductions)

Check the figures before submitting. A common mistake is forgetting to apply the Employment Allowance. If you are eligible (most businesses with employer NI bills under £100,000 qualify), you can claim up to £10,500 off your employer NI each year. Tick the box in your software to apply it.

Submit the FPS to HMRC. The software sends it electronically. You will get a confirmation message. Keep a record of every submission.

Step 6: Pay Your Employees

You must pay employees their net pay on or before the contractual pay date. Payment can be by BACS, Faster Payment, or cash. BACS is standard. If you pay by cash, keep a signed receipt from the employee.

HMRC does not need to see the bank transfer. They only need the FPS data. But you must pay the employee what the FPS says. If you do not, you are breaking employment law as well as tax law.

Step 7: Pay HMRC

You pay HMRC the income tax and National Insurance you deducted from employees, plus your employer NI, by the 22nd of the following month (or the 19th if paying by cheque, which almost no one does anymore).

For example, if you run payroll for April on 30 April, the payment deadline is 22 May.

If your average monthly PAYE bill is under £1,500, HMRC may let you pay quarterly. Most small businesses pay monthly. Check your HMRC online account for your payment schedule.

Use your Accounts Office reference (starts with 123PA followed by a 7-digit number) when making the payment. Do not use your PAYE reference. Using the wrong reference means HMRC allocates the payment to the wrong account and you get late payment penalties.

Ongoing Obligations After Setup

Setting up PAYE is not a one-off task. You have recurring responsibilities:

  • RTI submissions: send an FPS every time you pay an employee, even if the amount is zero. If you pay no one in a month, send an Employer Payment Summary (EPS) to report no pay.
  • P60s: give each employee a P60 by 31 May after the tax year ends. Your software generates these.
  • P11Ds: if you provide benefits in kind (company car, private health insurance, gym membership), report them on form P11D by 6 July. Pay Class 1A NIC on the value by 22 July.
  • Pension auto-enrolment: you must enrol eligible employees into a workplace pension scheme and make contributions. The minimum is 3% employer, 5% employee (total 8% of qualifying earnings).
  • Year-end payroll: submit final FPS and EPS by 19 April after the tax year ends. Confirm final submissions in your software.

Common Mistakes New Employers Make

We see the same errors repeatedly. Here are the ones to avoid:

  • Not registering before paying the first salary. You cannot backdate registration. If you pay someone before you have a PAYE reference, you have broken the law. Register early.
  • Using the wrong tax code. A director's tax code is often 1257L, but if they have other income or benefits, it may be different. Check HMRC's tax code notice.
  • Forgetting the Employment Allowance. If you have multiple directors each taking £12,570, your employer NI may be zero anyway. But if you have employees above the secondary threshold, claim the allowance.
  • Mixing director's loan account with salary. Salary goes through payroll. Drawings from the director's loan account do not. Do not report loan account drawings as salary. They are not subject to PAYE.
  • Missing the 22nd payment deadline. HMRC charges interest and penalties for late PAYE payments. Set up a Direct Debit to avoid this.

Do You Need an Accountant for Payroll?

Many small business owners run payroll themselves using FreeAgent or Xero. If you have one or two employees and a straightforward pay structure, you can manage it. The software does the calculations and submissions.

But if you have multiple employees, variable hours, benefits in kind, or pension auto-enrolment, an accountant saves you time and prevents costly errors. Our payroll services cover everything from setup to year-end submissions. We also handle P11Ds and pension compliance so you do not have to.

If you are a limited company director paying yourself the minimum salary and taking dividends, payroll is simple. But you still need to register, submit RTI, and file year-end returns. Missing any step triggers penalties.

What About Sole Traders and Partnerships?

If you are a sole trader or partnership with no employees, you do not need PAYE. Your drawings are not salary. You pay tax through self assessment using form SA103 (self-employment pages) or SA800 (partnership return).

But if you hire even one employee, you must register as an employer and set up PAYE. The same steps above apply. You use your personal name and UTR (Unique Taxpayer Reference) instead of a company number, but everything else is the same.

If you are unsure whether you need to register, check with an accountant. The cost of getting it wrong (penalties, interest, HMRC compliance checks) far outweighs the cost of professional advice.

Setting Up PAYE for a Director's Salary

Most limited company directors pay themselves a small salary and take the rest as dividends. The most tax-efficient salary for 2025/26 is £12,570 a year. This matches the personal allowance and the primary NI threshold. You pay no income tax and no employee NI on this amount.

But employer NI applies above the secondary threshold of £9,100. On a £12,570 salary, the employer NI is roughly £478 a year. If you claim the Employment Allowance, that £478 is covered. Many multi-director companies claim the allowance and pay no employer NI at all.

To set up payroll for yourself as a director, follow the same steps above. Add yourself as an employee with your correct details. Use tax code 1257L. Pay yourself monthly or quarterly. Submit the FPS each time.

Do not try to avoid payroll by paying yourself only dividends. Dividends are not salary. They do not count as qualifying earnings for pension contributions, mortgage applications, or state pension entitlement. You need at least some salary to build your NI record.

For more detail on director pay strategies, read our guide on director pay and dividends.

Final Checklist

Before your first payday, tick off these items:

  • Registered as an employer with HMRC (got your PAYE reference)
  • Chosen and set up payroll software
  • Gathered employee details including NI numbers
  • Set correct tax codes using starter checklist or P45
  • Run a test payroll to check calculations
  • Submitted FPS to HMRC
  • Paid employees net pay on time
  • Set up payment to HMRC by 22nd of next month
  • Claimed Employment Allowance if eligible
  • Set up pension auto-enrolment if required

If any of these steps are unclear, speak to an accountant. Our team can walk you through the process in under an hour. We set up PAYE for new businesses every week. It is straightforward when you know what to do.