Payroll is one of the most time sensitive areas of running a business. Whether you are hiring your first employee, paying yourself as a limited company director or taking on a team, getting your payroll setup right from the outset is essential. Errors can lead to incorrect tax deductions, unhappy employees and penalties from HMRC. This guide explains everything UK small business owners need to know about setting up payroll.
When Do You Need to Register for PAYE?
PAYE (Pay As You Earn) is HMRC's system for collecting Income Tax and National Insurance from employees' pay. You need to register as an employer with HMRC and set up PAYE if you are paying any employee, including yourself as a director, at or above the Lower Earnings Limit, which is currently £123 per week for the 2025 to 2026 tax year.
You should register with HMRC before your first payday. HMRC recommends registering at least two weeks in advance of your first payroll run. Once registered, HMRC will issue you with a PAYE reference number which you will need to make submissions and payments.
What Is the Most Tax Efficient Salary for a Limited Company Director?
For directors of limited companies who are also shareholders, the most tax efficient approach is typically to draw a combination of a low salary and dividends rather than a high salary alone. This is because dividends are not subject to National Insurance, unlike a salary.
For the 2025 to 2026 tax year, many accountants recommend a director salary set at either the National Insurance Lower Earnings Limit (£123 per week or £6,396 per year) or at the Primary Threshold (£12,570 per year). The lower amount preserves National Insurance contribution credits without triggering an actual NICs liability. The higher amount falls within the personal allowance so no Income Tax arises, though a small employer NICs charge may apply depending on whether the Employment Allowance is available to the company.
At Affinity Associates Isaacs & Co, we work with our limited company clients to identify the most tax efficient salary and dividend strategy based on their individual circumstances each tax year.
How to Set Up Payroll for Your Small Business
- Register as an employer with HMRC. Do this before your first payday. You can register online through the Government Gateway.
- Choose payroll software. You will need payroll software to calculate pay, deductions and employer costs and to submit Real Time Information (RTI) reports to HMRC. HMRC provides a list of approved payroll software providers.
- Collect employee information. You will need details for each employee including their National Insurance number, date of birth, address and their starter declaration to determine the correct tax code.
- Set up your payroll records. Enter employee details into your payroll software and set up pay schedules (weekly, monthly, etc.).
- Run payroll and submit RTI. Each time you pay employees, you must calculate their net pay after deductions and submit a Full Payment Submission (FPS) to HMRC on or before the date of payment.
- Pay HMRC. The Income Tax and National Insurance you have deducted from employees, along with employer NICs, must be paid to HMRC by the 19th of the month following the payroll period (or 22nd if paying electronically).
- Consider workplace pension auto enrolment. If you employ staff, you may have auto enrolment obligations. New employers are given a staging date or duties start date from which auto enrolment responsibilities begin.
Do You Need Payroll Software?
Yes. Since HMRC introduced Real Time Information reporting, all employers must submit payroll information to HMRC electronically on or before every payday. This makes payroll software a practical necessity rather than an optional extra. HMRC does offer a free Basic PAYE Tools product for employers with fewer than ten employees, though most businesses find a dedicated payroll software or outsourced payroll service more efficient.
Should You Outsource Your Payroll?
Many small business owners choose to outsource payroll to their accountant or a specialist payroll bureau. The benefits of outsourcing include freeing up your time, reducing the risk of errors and ensuring your RTI submissions and HMRC payments are always made on time. For directors who simply need to process their own monthly salary and submit the relevant returns, outsourcing is particularly cost effective.
At Affinity Associates Isaacs & Co, we offer managed payroll services for businesses of all sizes. We handle everything from RTI submissions and payslips to auto enrolment management and year end P60 production.