How does PAYE operate?

PensionsQuery

I'm trying to make a spreadsheet to forecast cashflow, with varying income month to month. 

I understand how to calculate the tax bands on an annual basis but not how it's calculated month to month.

For example, let's say Month 1 Gross Pay is £3000. How does PAYE calculate the tax? Is it as simple as saying £3k * 12 = £36k estimated annual income and so Month 1 is calculated as 1/12th of the annual liability of £36k?


Assuming so, let's now imagine Month 2 Gross Pay is £5000 - what's the next step? Does the system now think the estimated annual pay is any of the below, or something else?

£60k (5 * 12)
£58k (3 + (11 * 5)
£48k ((3 + 5) / 2 * 12)

If this is indeed how it operates, do I then calculate the estimated liability on that estimated salary, divide that by 12, multiply by 2 then subtract what's already been paid?


Or does it not forecast the estimated annual income at all, and instead operates on YTD basis e.g Month 1 is assessed using 1/12 of the bands, Month 2 takes YTD Gross Pay assesses against 2/12 of the bands etc?

Any guidance on what the calculation steps are would be appreciated!

DullGreyGuy

There is more than one way in which it can be calculated

Nomunnofun1

PensionsQuery said:

I'm trying to make a spreadsheet to forecast cashflow, with varying income month to month. 

I understand how to calculate the tax bands on an annual basis but not how it's calculated month to month.

For example, let's say Month 1 Gross Pay is £3000. How does PAYE calculate the tax? Is it as simple as saying £3k * 12 = £36k estimated annual income and so Month 1 is calculated as 1/12th of the annual liability of £36k?


Assuming so, let's now imagine Month 2 Gross Pay is £5000 - what's the next step? Does the system now think the estimated annual pay is any of the below, or something else?

£60k (5 * 12)
£58k (3 + (11 * 5)
£48k ((3 + 5) / 2 * 12)

If this is indeed how it operates, do I then calculate the estimated liability on that estimated salary, divide that by 12, multiply by 2 then subtract what's already been paid?


Or does it not forecast the estimated annual income at all, and instead operates on YTD basis e.g Month 1 is assessed using 1/12 of the bands, Month 2 takes YTD Gross Pay assesses against 2/12 of the bands etc?

Any guidance on what the calculation steps are would be appreciated!

Your first assumption isn’t too far off the mark. 

£48k is the answer. 

Bookworm105

in overly simplified terms it works on the basis of actual cumulative pay to date at this pay period (ie tax year to date) less actual tax code "allowance" to date. Apply tax to that to get tax due YTD, then deduct actual total tax paid to previous pay period from that to give tax due in this period (hence the ability to get a refund in a given month if tax paid previously now more than tax due to date)

your tax code is applied on a cumulative basis to work out the taxable amount this pay period. Obviously your code may not equate to the underlying personal allowance of 12,570 if you have entitlements to extras or deductions for benefits 

as above your 48k is close

PensionsQuery

Perfect, thanks so much folks

I think I've cracked it now...