Your First Employee

You’ve done it! Your business is growing and it’s time to bring on some help. Hiring your first employee is an exciting step. It can also feel daunting, and it’s normal to have questions about the financial implications. This blog will guide you through the essential things you need to know.

do i need an employee?

The first thing to get clear on is what employment status the person working for you should have for tax purposes: employed or self-employed (freelance). Unfortunately it’s not as simple as choosing which you or they would prefer. We explain the issues in more detail in our ‘Freelance or Employee?’ blog. Here we will assume the employment status is ‘employed’.

can i afford an employee?

This is often the biggest question for people. To answer it we need to think about two things: what are the costs, and can the business afford them?

What is it going to cost?

We will delve into more detail later in the blog, but put simply:

Total Cost = Gross Salary* + Employer National Insurance Contributions + Employer Pension Contributions

*Gross salary: the salary before any tax deductions are made. Think of it as the salary you have offered or advertised. 

Additional costs to consider include:

• Payroll software fees

• Pension scheme fees

• Accountants fees (if you do not set up and run the payroll and pension schemes yourself) 

Can the business afford the costs?

The best way to gain confidence that your business can afford the costs of an employee is to set up a financial plan showing all the expected income and expenses of the business, alongside a cash flow forecast. 

how do i pay an employee?

Once you know that you can afford an employee, what are the next steps to get ready to pay them?

Register a payroll scheme

A payroll scheme (also known as a Pay As You Earn or PAYE scheme) needs to be in place in order to pay someone as an employee. A business only needs one scheme (regardless of number of employees) and the scheme is set up with HMRC.

Chose payroll software

HMRC requires PAYE information to be reported online, using one of the HMRC recognised payroll software solutions. The payroll software is used to:

• Record employee and employment details

• Calculate pay, deductions, and how much to pay HMRC 

• Report information to HMRC

Some solutions will also let you produce payslips, record pension deductions, and report to pension providers. 

what taxes will i owe?

As a business owner you don’t need to be a tax specialist, but knowledge of employment taxes is a powerful part of your toolkit once you become an employer. There is one tax payment (PAYE) to make, and it is mostly made up of two parts:

PAYE = Income Tax + National Insurance Contributions

These taxes are calculated on both the employee’s salary and any taxable expenses and benefits they have received outside of payroll. 

You may also be required to deduct student loan repayments and pay these to HMRC as part of your PAYE payment.

Income Tax

This is deducted from your employee's gross salary. It will be calculated by your payroll software based on their tax code. 

National Insurance Contributions

Employee Contributions are deducted from your employee’s gross salary in a similar way to Income Tax. The amount is calculated by your payroll software based on their National Insurance category letter.

Employer Contributions, though slightly more complex, are still calculated by your payroll software based on a National Insurance category letter. Businesses with an Employers National Insurance liability of less than £10,000 in the previous tax year, can reduce their annual National Insurance liability for the current year by up to £5,000. For a business taking on their first employee, this means there is almost always no Employer Contributions to pay. 

Timing

PAYE bills are due on the 22nd of the next tax month (assuming you pay monthly). The tax month runs from the 6th of one month to 5th of the following. So, if you pay on 31st January, PAYE is due on 22nd February. 

do i have to provide a pension scheme?

If you pay your employee more than £10,000 per year, in most cases you will need to automatically enrol them in a workplace pension scheme. You can choose the scheme, and the employee can choose to opt out. While they are enrolled in the scheme, there are minimum contributions for each of you to make:

• Employee contributions: 5% of gross salary

• Employer contributions: 3% of gross salary