How to pay employees in a small business

‘How do I pay employees in a small business?’ It might seem like a simple question, but the answer isn’t exactly straightforward. First, you need to understand how payroll works.

Employee payroll is a comprehensive process that goes beyond merely paying employees for time worked. It spans several key HR functions, from calculating gross wages or salaries to deducting taxes and additional withholdings (such as National Insurance Contributions, pension contributions, and health insurance) and processing of net pay to employees.

Payroll also requires that you keep accurate, timely records of all payroll activities in accordance with HMRC’s guidelines on compliance. Plus, there are labour laws and data protection legislation to consider, as well as reporting and auditing requirements to be mindful of.

If it all sounds like a bit of a minefield, don’t stress – we’ve prepped this guide to payroll for small businesses to help you understand the process.

Table of Contents

Understanding Legal Requirements

Small business owners need to be able to navigate a complex landscape of tax rules and labour laws. This is to ensure that your people are treated fairly and paid the right amount, but it’s also to protect you in case of any legal issues around non-compliance – which helps you to avoid hefty penalties.

There's a lot to consider, from National Insurance Contributions (NICs) to Income Tax and Pension Contributions. HMRC has produced a handy guide to PAYE and payroll, which should help you determine your payroll status and how to report your employees’ payroll and deductions directly.

IR35 is a piece of legislation designed to combat the issue of ‘disguised employees’: contractors who are expected to work in the same official capacity as employees on payroll. It’s your responsibility to categorise employees correctly. Failure to correctly classify off-payroll workers can culminate in legal issues and hefty fines. Classifying employees correctly can be an arduous, confusing task, and many small businesses prefer to use HR software to help them assign classification to employees automatically.

Set up a payroll system

 There are a few options to consider when setting up your payroll: manual payroll processing, whereby you manage payroll yourself using manual systems and spreadsheets, investing in payroll software, or outsourcing your payroll system entirely to a third-party provider.

Manual payroll is cost-effective but incredibly time-consuming and error-prone, and it doesn’t facilitate scalability as your business grows. Outsourcing payroll can save you time and resources, helping you focus on your business priorities instead.

What you choose will depend on your business needs. Here are some of the pros and cons:

Managing Payroll Taxes

As an employer operating PAYE (Pay As You Earn) as part of your payroll, you need to complete certain tasks during each tax month. Tax months run from the 6th of one month to the 5th of the next. Here are the regular payroll tasks you should be conscious of:

  • Recording Employee Pay: Use your payroll software to record employees’ pay, including their salary, wages, and other compensation.
  • Calculating Deductions: Calculate deductions from employees’ pay, such as income tax and National Insurance contributions.
  • Employer’s National Insurance Contribution: Calculate the employer’s National Insurance contribution that you’ll need to pay on their earnings above £242 a week.
  • Payslips: Produce payslips for each employee (if your software doesn’t provide this feature, consider changing to a different software).
  • Reporting to HMRC: Submit a Full Payment Submission (FPS) to HMRC, reporting employees’ pay and deductions.
  • Special Cases: Even if an employee doesn’t meet the conditions for PAYE, you still need to record and report their pay.
  • Claiming Reductions: If you’ve not paid any employees in a tax month, send an Employer Payment Summary (EPS) to HMRC. You can also use the EPS to claim reductions (e.g., statutory pay).
  • Payment Deadlines: You can view what you owe from your FPS online from the 10th of the month. To claim reductions, send the EPS by the 19th. Pay HMRC by the 22nd (or the 19th if paying by post). Late payments may result in penalties.
  • Late Reporting: HMRC will send a late filing notice if you fail to send an FPS or submit it late. Late, missing, or incorrect payroll reports can impact employees’ income-related benefits.
  • New Employers: If you’re a new employer and don’t report to or pay HMRC within 120 days, they may close your PAYE scheme.

Payroll Best Practices

There are some best practices to enable your payroll to run smoothly and mitigate any risk of errors or non-compliance. Here are some best practices to keep things efficient and safe:

  • Continuously update employee data: Ensure that employee data, including name, address, tax codes, and banking details, are accurate and timely to avoid any payment errors or risks of non-compliance.
  • Keep watertight records of everything: Maintain digital records of all payroll transactions, tax filings and communication regarding payroll from employees to ensure your data is ready for auditing and to stay on the right side of compliance laws.
  • Safeguard employee data: Consider security features to protect sensitive employee information and ensure compliance with data protection regulations, such as the General Data Protection Regulation (GDPR). A centralised digital software will help you do this.
  • Establish a regular and clear payroll schedule: Set clear deadlines for processing payroll, issuing payments, and submitting tax filings to keep your people happy and to avoid any delays.
  • Use a time tracking system: Use a time tracking system to capture employee hours accurately worked, overtime, and absences, including holidays.

Common Payroll Mistakes to Avoid

No matter how closely you follow the rules or how robust your payroll system is, payroll errors happen. This can lead to undesirable consequences, such as legal disputes, overpayments and reputational damage to your brand. These are some of the most common payroll mistakes to be aware of:

  • Late tax payments and filings: This should be central to your payroll strategy, as missed deadlines for tax and fillings can risk expensive fines and penalties from HMRC.
  • Inaccurate payroll records: Any errors in payroll calculations, employee classification or tax withholdings can very easily result in employee underpayments, overpayments or compliance issues. Audits can be burdensome and costly, especially if your payroll data is inaccurate.
  • Misclassifying employees: Misclassifying employees as contractors can result in huge legal risks and tax obligations.

Tools and Resources

When it comes to managing payroll efficiently, having the right tools and resources at hand can make all the difference. There are payroll software solutions designed for businesses just like yours. ADP is the leading provider of Payroll and HR solutions globally, trusted by PayPal, Amazon, and Cisco. With its small business payroll solutions, ADP offers an affordable, elegant solution for payroll.  Priced per employee, per month, you only pay for what you need.

ADP small business services are totally adapted to your needs, whether you want to control payroll tasks or outsource them entirely. ADP helps navigate regulatory changes, compliance, audits, and data security. Security Magazine ranks ADP #1 among business service peers, providing reliable, secure payroll solutions for small businesses.

By leveraging these payroll solutions from ADP, small business owners can streamline their payroll processes, ensure compliance with legal and regulatory requirements, and empower their workforce with accurate and timely compensation, ultimately driving business success and growth.

Managing payroll is a fine balancing act. It’s essential to get it right, and a well-oiled payroll system will save you time and resources in the long run, especially as you scale your company. By understanding the essential legal requirements, following best-practice advice, and using the best software available, small business owners can quickly streamline their payroll systems to work efficiently and compliantly.

That minimises the risk of errors, non-compliance, and penalties – and enables small business owners to focus on what matters most: growing your business. ADP does the hard work for you, managing mundane payroll tasks with automated solutions, ensuring total compliance with HMRC and empowering your workforce to get on with what they do best. Book a demo today.