How do you calculate tax in the UK for payroll (2026)?

UK payroll tax is one of the most regulated areas of HR, with HMRC compliance yield reaching £45.7 billion in 2024/25 (HMRC Annual Report 2024/25)

Employers must apply Income Tax and NICs correctly through PAYE, as even minor errors in RTI reporting can trigger automated penalties that scale with your headcount.

This article explains how UK tax is calculated in payroll, including thresholds, NICs, and key steps for accurate and compliant processing. 

What are payroll taxes in the UK?

Payroll taxes in the UK are mandatory deductions and employer contributions applied to employee earnings, including Income Tax and NICs, and reported through the PAYE system.

These taxes are deducted directly from salaries and submitted to HMRC by the employer.

 👉To note: Payroll taxes can also include other deductions such as student loan repayments and pension contributions, depending on the employee’s situation.

What types of payroll taxes must employers calculate?

Employers must calculate more than just Income Tax and NICs. Payroll processing must also account for the Apprenticeship Levy (for larger pay bills), Student Loan repayments, and mandatory pension auto-enrolment contributions, all of which impact your total cost of employment.

What is Income Tax and how is it applied?

Income Tax is calculated by applying progressive tax rates to earnings above the personal allowance, based on the employee’s tax code.

For England, Wales and Northern Ireland (2026/27):

Current rates and thresholds are available on the GOV.UK page for employer tax rates.

What are National Insurance contributions (NICs)?

National Insurance contributions are calculated by applying fixed percentage rates to earnings above specific thresholds. 

Employee NICs (Class 1):

• 8% on earnings between £12,570 and £50,270 per year.

• 2% on all earnings above £50,270.

Employer NICs (Class 1):

• 15% on all employee earnings above the £5,000 per year secondary threshold.

• Most eligible employers can offset up to £10,500 per year of Employer NICs through the Employment Allowance (GOV.UK).

 👉To note: NIC thresholds are applied per pay period, not just annually.

How do you calculate payroll tax in the UK step by step?

Payroll tax in the UK is calculated by applying Income Tax bands and NIC thresholds to an employee’s gross pay, based on their tax code and earnings. It follows these steps:

Step 1: Determine gross pay

Gross pay is the employee’s total earnings before deductions, including salary, bonuses, and overtime.

Step 2: Apply the personal allowance

The personal allowance (£12,570 annually) is deducted from total earnings before applying Income Tax, adjusted according to the employee’s tax code.

Step 3: Calculate Income Tax

Income Tax is calculated progressively:

• Basic rate (20%): On earnings between £12,571 and £50,270.

• Higher rate (40%): On earnings between £50,271 and £125,140.

• Additional rate (45%): On all earnings above £125,140.

Step 4: Calculate National Insurance

NICs are calculated using the relevant thresholds and contribution rates.

Step 5: Calculate employer contributions

Calculate employer NICs (typically 15%) on eligible earnings.

Step 6: Report payroll taxes to HMRC

 Payroll taxes must be reported to HMRC using Real Time Information (RTI) submissions on or before each payday.

 👉To note: Accurate reporting is essential to avoid HMRC penalties.

How is payroll tax calculated in practice? (example)

Payroll tax in practice is calculated by applying tax allowances and contribution rates to an employee’s earnings for each pay period. This example shows the different components:

 💡Good to know: This example is simplified for illustration. Actual calculations vary depending on tax codes, benefits, and deductions.

What should HR teams consider when calculating payroll taxes?

HR teams must ensure payroll tax calculations are accurate, compliant, and based on up-to-date legislation.

Key considerations include:

• Applying the correct tax code.

• Using current rates and thresholds (2026/27).

• Managing different NIC categories.

• Ensuring accurate RTI reporting.

• Keeping payroll records for HMRC compliance.

What is the most efficient way to calculate payroll taxes?

The most efficient way to calculate payroll taxes is to use payroll software that automates calculations, applies current rates, and ensures compliance.

Using payroll software helps:

• Apply correct tax rates automatically.

• Reduce manual errors.

• Ensure RTI compliance.

• Save time for HR and payroll teams. 

With frozen thresholds through to 2028 and the employer NIC rate at 15% above a lowered £5,000 threshold, the cost of getting payroll tax wrong has risen sharply. Build a monthly review into your payroll process: cross-check tax codes, NIC categories and RTI submissions against the latest HMRC rates and thresholds before each payday.

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