How does PAYE calculate my monthly tax deductions?

PAYE (Pay As You Earn) works on a cumulative basis throughout the tax year. HMRC gives your employer a tax code — typically 1257L — which tells them how much of your income is tax-free. Your employer divides your annual Personal Allowance (£12,570 for 1257L) by the number of pay periods remaining and deducts tax only on earnings above that threshold. For example, if you are paid monthly, your tax-free amount is approximately £1,048 per month. Anything you earn above that is taxed at the appropriate rate: 20% up to £37,700 of taxable income, 40% between £37,701 and £125,140, and 45% above £125,140. Because PAYE is cumulative, if you earn less in one month, the system automatically adjusts the next month to account for the underpayment, ensuring you pay the correct total by year end. This is why your net pay can fluctuate month to month even when your salary hasn’t changed.

Why is my first payslip different from what the PAYE calculator shows?

There are several common reasons. First, if you started mid-month, your employer may have pro-rated your salary, so you received only a partial month’s pay. Second, if your previous employer didn’t provide a P45 in time, your new employer may have put you on an emergency tax code (usually 1257L M1 or W1), which calculates tax on a non-cumulative basis — meaning each pay period is treated independently with no carried-forward allowances. Third, your employer may deduct contributions that hadn’t been set up yet when you modelled the calculation, such as workplace pension auto-enrolment, student loan repayments, or cycle-to-work salary sacrifice. Always compare like-for-like: check that the calculator inputs match exactly what appears on your payslip, including pension percentages and any pre-tax deductions.

What happens if HMRC collects too much tax through PAYE?

Because PAYE is cumulative, HMRC should automatically adjust your tax during the year if you have overpaid. However, there are situations where overpayments are not corrected automatically — for example, if you left a job mid-year and did not start a new one, or if you were placed on the wrong tax code for several months. In these cases, HMRC will usually send you a P800 tax calculation after the tax year ends (typically between June and November), which will tell you whether you are owed a refund. You can also check your Personal Tax Account on GOV.UK at any time to see your year-to-date position. If you are owed money, HMRC can refund it directly to your bank account or by cheque, or they may adjust your tax code for the following year to repay it gradually. To avoid overpayment, check your tax code whenever you change jobs and keep your Personal Tax Account up to date.

How PAYE Works: A Complete Guide to Pay As You Earn in the UK (2026/27)

Published 24 Feb 2026

New employeesFirst job startersCareer changersAnyone reading their payslip

Key Insight

PAYE is designed to spread your tax evenly across the year, but if you start a job mid-year or have an incorrect tax code, you could overpay by hundreds of pounds before HMRC corrects it. Always check your first payslip's tax code against your P45 or HMRC online account.

PAYE (Pay As You Earn) is the system HMRC uses to collect Income Tax and National Insurance directly from your wages before you receive them. Around 31 million UK workers are taxed through PAYE, yet most have little idea how the numbers on their payslip are actually calculated. This guide walks you through every step of the process — from how your employer uses your tax code to work out your deductions, to what happens when things go wrong.

What You'll Learn

The step-by-step process your employer follows each payday
How tax codes translate into monthly allowances
The difference between cumulative and Week 1/Month 1 basis
How to read and verify your payslip
What emergency tax is and how to fix it

1. What Is PAYE?

PAYE stands for Pay As You Earn. It is the mechanism by which employers deduct Income Tax and National Insurance from your wages on behalf of HMRC. Instead of receiving your full salary and paying tax in one lump sum at the end of the year, deductions are spread across each pay period (weekly, fortnightly, four-weekly, or monthly) so you pay a proportionate amount of tax with each payday.

The system was introduced in 1944 and is designed so that by the end of the tax year (5 April), you have paid almost exactly the right amount of tax — no refund needed, no underpayment to chase.

2. The Key Players in PAYE

HMRC — Sets your tax code, collects payments from your employer, and reconciles at year-end
Your employer — Runs payroll, applies your tax code, calculates and deducts tax/NI, sends the money to HMRC
You — Provide your P45 (or complete a Starter Checklist if you don't have one), check your payslips, and query any errors

3. How Your Tax Code Drives the Calculation

Your tax code tells your employer how much tax-free income you're entitled to. The standard code for 2026/27 is 1257L:

1257 = multiply by 10 to get your annual tax-free allowance (£12,570)
L = standard letter suffix (adjusts automatically if thresholds change)

On a monthly payroll, your employer divides £12,570 by 12 = £1,047.50 tax-free per month. Only earnings above this amount are taxed. For a full breakdown of every code letter and its meaning, see our Tax Code Guide.

4. Step-by-Step: How Your Monthly Pay Is Calculated

Here is exactly what happens each month for someone earning £36,000 per year (£3,000/month gross) with tax code 1257L:

Step 1: Work Out Taxable Pay

Monthly gross pay: £3,000
Monthly tax-free allowance: £1,047.50
Taxable pay this month: £1,952.50

Step 2: Calculate Income Tax

All £1,952.50 falls within the Basic Rate band (20%):
Tax this month: £1,952.50 × 20% = £390.50

Note: If you live in Scotland, your tax code will begin with “S” and different income tax bands and rates apply. See our Scottish vs English Tax comparison for a full breakdown.

Step 3: Calculate National Insurance

The NI Primary Threshold for 2026/27 is £12,570/year (£1,048/month). Employee NI is 8% on earnings between the Primary Threshold and the Upper Earnings Limit (£4,189/month):
NI this month: (£3,000 − £1,048) × 8% = £156.16

Your employer also pays NI on your salary (currently 15% on earnings above the Secondary Threshold). These employer contributions don't reduce your take-home pay, but they do affect the total cost of employing you. See our guide to employer National Insurance changes for details on the latest rates.

Step 4: Apply Other Deductions

If applicable: pension contributions, student loan repayments, salary sacrifice deductions, attachment of earnings orders, etc.

Step 5: Calculate Net Pay

Payslip Line	Amount
Gross pay	£3,000.00
Income Tax	−£390.50
Employee NI	−£156.16
Net pay (take-home)	£2,453.34

5. Cumulative vs Week 1/Month 1 Basis

There are two ways PAYE can calculate your tax:

Cumulative basis (normal) — your employer tracks your total pay and total tax from 6 April onwards. Each month, they recalculate whether you've paid the right total amount for the year so far. This means if you were overpaid in one month (e.g. emergency tax), you get an automatic refund in subsequent months.
Week 1/Month 1 basis (non-cumulative, shown as “X” or “W1/M1” on your tax code) — each pay period is treated in isolation with no reference to previous months. This is used as a temporary measure when HMRC doesn't have enough information to set a cumulative code (e.g. new starters without a P45).

6. Emergency Tax: What It Is & How to Fix It

Emergency tax is applied when your employer doesn't have a valid tax code for you — typically when you start a new job without a P45. The emergency codes for 2026/27 are:

Code	What It Means
1257L W1/M1	Standard allowance but non-cumulative — you still get £12,570 tax-free, just calculated per period
BR	All pay taxed at 20% (no allowance) — used for second jobs or when no Starter Checklist is completed
0T	No allowance, taxed at all rates — used when HMRC has no information at all

How to fix it: Give your new employer your P45. If you don't have one, complete a Starter Checklist. HMRC usually sends the correct code within 2–4 weeks and your employer will refund any overpaid tax under the cumulative method. For a full breakdown of what each code letter and suffix means, see our guide to understanding your tax code.

7. What Your Employer Reports to HMRC

Under Real Time Information (RTI), your employer submits a Full Payment Submission (FPS) to HMRC every time they run payroll. This includes your gross pay, tax deducted, NI contributions, student loan deductions, and pension contributions. HMRC uses this data in real time to check your tax position, which is why your Personal Tax Account often shows your current employment details within days.

8. Year-End: P60 and Reconciliation

After 5 April each year, your employer gives you a P60 — a summary of your total pay and total deductions for the year. HMRC also runs an automatic reconciliation: comparing what you've paid against what you should have paid. If there's a discrepancy, you'll receive either:

A P800 tax calculation showing you overpaid — you can claim your refund online
A PA302 coding notice showing you underpaid — the amount is usually collected by adjusting next year's tax code

9. Common PAYE Problems & Solutions

Problem	Solution
Tax code seems too low	Check your Personal Tax Account; call HMRC 0300 200 3300
Paying tax on two jobs with no allowance on either	Contact HMRC to split your allowance across employers
Still on emergency tax after 4+ weeks	Ensure your employer submitted RTI; contact HMRC with your employer PAYE reference
P60 doesn't match your payslips	Query with your employer's payroll department first

10. PAYE vs Self Assessment: What's the Difference?

PAYE handles tax automatically through your employer. Self Assessment is for self-employed workers, higher earners with complex tax affairs, or anyone with income not covered by PAYE (rental income, dividends, capital gains). Some people use both — you can be on PAYE for employment income and also file a Self Assessment return for additional income. See our Self-Employed Guide for details.

Case Study: Liam, a Warehouse Supervisor in Sheffield on £31,000

Liam is a 26-year-old warehouse supervisor in Sheffield earning £31,000 per year. He recently started his first full-time role after several years of agency work. When he received his first payslip, the tax deduction was much higher than he expected — £486 instead of the roughly £310 he calculated using our PAYE tool.

The issue was his tax code. Because Liam's previous agency employer had not issued a P45 before his start date, his new employer placed him on an emergency tax code of 1257L M1. The “M1” suffix meant PAYE was calculating his tax on a month-one (non-cumulative) basis — treating each month independently rather than spreading his Personal Allowance cumulatively across the year.

Liam logged in to his Personal Tax Account on GOV.UK and submitted his P46 details, confirming this was his only job and he had no other income. Within three weeks, HMRC issued his employer with the correct cumulative code of 1257L. On his next payslip, the PAYE system automatically recalculated his year-to-date position, and Liam received a £352 in-year refund covering the overpaid tax from his first two months.

Liam also noticed a workplace pension deduction of £93 (3% auto-enrolment via net pay arrangement). Initially he thought this was reducing his take-home pay unfairly, but after modelling it in our calculator with the pension field set to 3% salary sacrifice, he saw that the employer contributed 5% on top, giving him a total of 8% going into his pension at a real cost to him of only 3%. He decided to keep the pension running and focus on getting his tax code resolved as the quicker win.

Understanding how PAYE works puts you in control of checking your payslip is correct. Use our salary calculator to verify that your monthly deductions match what you expect.

Disclaimer: This guide is for informational purposes only and does not constitute financial or legal advice. Always check the latest guidance on GOV.UK or consult a qualified adviser.