How Does PAYE Tax Work? A Complete Guide to Pay As You Earn in the UK

Pay As You Earn (PAYE) is the system HMRC uses to collect Income Tax and National Insurance Contributions (NICs) directly from employees' wages before they receive their pay. Around 32 million people in the UK are paid through PAYE, making it the backbone of the UK tax collection system. Despite its near-universal reach, few employees understand precisely how it works — which means errors can go unnoticed for years.

The fundamentals of PAYE

Under PAYE, your employer acts as an unpaid tax collector for HMRC. Each time you are paid — whether weekly, fortnightly, or monthly — your employer calculates the tax and NICs you owe on that payment and deducts it from your gross pay before transferring it to HMRC. You receive the net (after-tax) amount in your bank account.

The system is cumulative: your employer uses a running total of your income and tax paid since the start of the tax year (6 April) to determine how much to deduct from each payment. This means that if you are overpaid tax early in the year, subsequent payslips automatically correct it — you do not need to claim a refund mid-year.

How tax codes work

The tax code on your payslip tells your employer how much of your income is tax-free before calculating the tax on the rest. The most common code is 1257L, which reflects the standard Personal Allowance of £12,570 for 2025-26. The number in the code (1257) is the Personal Allowance divided by 10, and the letter indicates how the code should be applied.

Common tax code letters:

• L — Standard Personal Allowance. The most common suffix.
• M — Marriage Allowance received (10% of partner's Personal Allowance transferred to you).
• N — Marriage Allowance given (10% of your Personal Allowance transferred to your partner).
• T — Various adjustments in the code; HMRC wants to review it at year end.
• 0T — No Personal Allowance. Used when HMRC has no information or the allowance is fully used up.
• BR — All income taxed at basic rate (20%). Often used for second jobs.
• D0 — All income taxed at higher rate (40%). For second jobs where first job already uses all basic rate band.
• D1 — All income taxed at additional rate (45%).
• K — Negative allowance. More tax deducted than the standard amount. Used when untaxed income (e.g. State Pension, company car benefit) exceeds the Personal Allowance.
• S prefix — Scottish taxpayer. SR, SD0, SD1, SD2, SD3 reflect Scotland's additional bands.
• C prefix — Welsh taxpayer (same rates as England currently).
• W1/M1 — Emergency code. Non-cumulative, applied week by week or month by month without looking at the year to date.

Real Time Information (RTI)

Since 2013, employers have been required to submit payroll data to HMRC on or before every payday under Real Time Information (RTI). This allows HMRC to see your pay and tax deductions in near real time, cross-reference it against other information (benefits, pensions, student loans), and update your tax code if needed. RTI replaced the old end-of-year P35 submission and transformed HMRC's ability to identify under- and overpayments during the year rather than waiting until after 5 April.

What happens at the end of the tax year

After 5 April, HMRC reconciles the cumulative tax paid against the tax owed for the full year. There are three possible outcomes:

• Correct tax paid: No action needed.
• Overpaid tax: HMRC sends a P800 (tax calculation) showing the overpayment and arranges a refund, either to your bank account or by cheque.
• Underpaid tax: HMRC sends a Simple Assessment or adjusts your tax code for the following year to collect the underpayment gradually.

Common PAYE errors to watch for

• Wrong tax code: If your employer uses the wrong code, you may pay too much or too little tax. Check your payslip every time you change jobs or receive a new P45/P46.
• Emergency tax on a new job: If you start a job without providing a P45, your employer may use an emergency code (W1/M1) which treats each pay period in isolation and often overtaxes. Provide your P45 as soon as possible.
• Two jobs, both using Personal Allowance: If two employers both apply a 1257L code, you will underpay tax because your allowance is being counted twice. Contact HMRC to reallocate.
• Benefit-in-kind not reflected: If you have company car, private medical insurance, or other benefits, HMRC should adjust your tax code to collect the additional tax. If it does not, you may accumulate an underpayment.

How to check and update your tax code

You can view and manage your tax code via the HMRC Personal Tax Account at gov.uk/personal-tax-account. Log in with your Government Gateway credentials to see your current code, understand why it has been set, and report any inaccuracies. HMRC will update your employer automatically once a change is made.

You will also receive a PAYE coding notice (P2) by post or digitally if your tax code changes. Read these carefully — they explain exactly what adjustments have been made to your code.

Frequently asked questions

Does my employer know my total income or just what they pay me?

Your employer only knows what they pay you. HMRC co-ordinates information across multiple sources, but your individual employer sees only their payroll data. If you have multiple income sources, HMRC uses the tax code system to ensure the right total tax is collected — your employer does not see information from other employers or income sources.

What is a P60 and do I need to keep it?

A P60 is the end-of-year summary your employer must provide by 31 May. It shows your total pay and tax deducted for the full tax year. Keep it for at least six years — you may need it for mortgage applications, tax refund claims, or Self Assessment returns. Employers must provide P60s electronically or on paper; many now send them via payroll portals.