Hiring Your First Employee: Tax, PAYE, and Legal Obligations

The Accounted Business Team·19 January 2026·8 min read

Hiring your first employee is a milestone. It means your business has grown beyond what you can handle alone, and that is a good sign. But it also means stepping into a world of employer obligations that can feel overwhelming if you have never dealt with them before.

The good news is that thousands of small businesses go through this process every year, and once the initial setup is done, running payroll becomes routine. This guide covers everything you need to do, from registering as an employer through to your ongoing reporting duties.

Step 1: Register as an Employer with HMRC

Before you pay anyone a penny, you need to register as an employer with HMRC. You can do this online at gov.uk, and you should register as soon as you know you are going to hire someone — ideally at least two weeks before their start date.

When you register, HMRC will send you:

An employer PAYE reference number
An Accounts Office reference number
Login details for PAYE Online

You need these references to file your payroll reports. Without them, you cannot operate PAYE legally.

Who Counts as an Employee?

This sounds obvious, but it trips people up. You need to register as an employer if you are paying anyone who:

Works set hours that you control
Uses your equipment
Cannot send a substitute to do their work
Is integrated into your business

If someone is genuinely self-employed — they set their own hours, use their own tools, work for multiple clients — they are not your employee and you do not need to run PAYE for them. But be careful. HMRC scrutinises these arrangements closely, and getting the classification wrong can result in backdated tax, NI, and penalties.

If you are unsure, use HMRC's Check Employment Status for Tax (CEST) tool or get professional advice.

Step 2: Set Up PAYE

PAYE — Pay As You Earn — is the system through which you deduct Income Tax and National Insurance from your employee's wages and pay them to HMRC on their behalf.

What You Need to Deduct

Each time you pay your employee, you must calculate and deduct:

Income Tax: based on their tax code, which HMRC will provide. For most new employees on a standard tax code (1257L for 2025/26), this means no tax on the first £12,570 of annual earnings and 20% on earnings above that.
Employee National Insurance: 8% on earnings between £242 and £967 per week (for 2025/26), and 2% on earnings above £967 per week.

On top of what you deduct from your employee, you also owe:

Employer National Insurance: 13.8% on earnings above £175 per week. This comes out of your pocket, not your employee's pay packet.

Payroll Software

You need payroll software to calculate the correct deductions and file reports with HMRC. HMRC provides a list of recognised software on gov.uk. Many cloud accounting packages include payroll functionality, or you can use a standalone payroll service.

For very small businesses with just one or two employees, HMRC's own Basic PAYE Tools software is free. It is not the most user-friendly option, but it does the job.

Step 3: Employment Contracts

You are legally required to give your employee a written statement of employment particulars on or before their first day of work. This has been a legal requirement since April 2020 — it is not optional.

The statement must include:

Your name and the employee's name
Job title or description of work
Start date
Pay rate and pay intervals (weekly, monthly)
Hours of work
Holiday entitlement (minimum 28 days for full-time, including bank holidays)
Notice periods
Pension arrangements
Place of work
Any probationary period and conditions

You can provide this as a single document or split it across a principal statement (given on day one) and a wider written statement (given within two months). Most employers combine them into a single employment contract for simplicity.

Getting Contracts Right

Template employment contracts are widely available online, and organisations like ACAS provide free guidance. However, if your situation is complex — for example, you need restrictive covenants, intellectual property clauses, or specific confidentiality terms — consider getting a solicitor to draft or review your contract. The cost is modest compared to the potential cost of a dispute later.

Step 4: Employer National Insurance Contributions

Employer NI is the hidden cost that catches many new employers off guard. It is the tax you pay on top of your employee's gross salary, and it comes out of your business funds.

For 2025/26, the employer NI rate is 13.8% on earnings above the secondary threshold of £175 per week (£9,100 per year). There is no upper limit — unlike employee NI, which drops to 2% above the upper earnings limit, employer NI stays at 13.8% on all earnings above the threshold.

Example

If you pay an employee £30,000 per year:

Earnings above secondary threshold: £30,000 minus £9,100 = £20,900
Employer NI: 13.8% of £20,900 = £2,884 per year

That £2,884 is an additional cost to your business on top of the salary. Factor this into your budget before you decide what salary to offer.

Step 5: Employment Allowance

Here is the good news. The Employment Allowance lets eligible employers reduce their employer NI bill by up to £10,500 per year for 2025/26.

This means that if your total employer NI liability is less than £10,500, you may pay nothing at all. For many small businesses hiring their first employee, the Employment Allowance effectively eliminates employer NI for the first year or more.

Who Qualifies?

Most small employers qualify for the Employment Allowance. You are eligible if:

Your employer NI bill in the previous tax year was below £100,000
You are not a single-director company with no other employees (you cannot use it to offset NI on just your own director's salary)
You are not a public body or doing more than half your work in the public sector

You claim the Employment Allowance through your payroll software — it is not a separate application. Make sure you tick the right box when you set up your payroll.

Step 6: Auto-Enrolment Pension

The moment you hire your first employee, you have auto-enrolment duties. Every UK employer, regardless of size, must provide a workplace pension scheme.

Who You Must Enrol

You must automatically enrol any employee who:

Is aged between 22 and State Pension age
Earns more than £10,000 per year
Works or ordinarily works in the UK

Contribution Rates

The minimum contributions for 2025/26 are:

Employer: 3% of qualifying earnings
Employee: 5% of qualifying earnings (deducted through payroll)
Total: 8% of qualifying earnings

Qualifying earnings are the portion of salary between £6,240 and £50,270 per year. You calculate contributions on this band, not on total pay.

Choosing a Pension Provider

You need to choose a pension scheme before your employee's start date. NEST (National Employment Savings Trust) is the government-backed scheme that accepts all employers. It is free to set up and straightforward to use. Other popular options for small businesses include The People's Pension and Smart Pension.

The Pensions Regulator

You must register with The Pensions Regulator (TPR) and complete a declaration of compliance within five months of your duties start date. Failure to do so can result in fines starting at £400.

Step 7: Real Time Information (RTI) Reporting

Every time you run payroll — whether that is weekly, fortnightly, or monthly — you must report the details to HMRC using Real Time Information. This is done electronically through your payroll software.

What You Report

There are two main RTI submissions:

Full Payment Submission (FPS): sent on or before each payday. This reports each employee's gross pay, tax deducted, NI contributions, student loan deductions, and any statutory payments.

Employer Payment Summary (EPS): sent by the 19th of each month if you need to report things like Employment Allowance claims, statutory payment reclaims, or periods of inactivity. If you have nothing extra to report, you do not need to send one.

Payment to HMRC

You must pay the tax and NI you have deducted (plus your employer NI contribution) to HMRC by:

The 22nd of the following month if you pay electronically
The 19th of the following month if you pay by cheque (though electronic payment is strongly recommended)

If your total monthly PAYE liability is under £1,500, you may be able to pay quarterly instead of monthly. HMRC will tell you if you are eligible for quarterly payments.

Step 8: Other Obligations to Remember

Employer's Liability Insurance

You are legally required to have employer's liability insurance as soon as you hire your first employee. The minimum cover is £5 million, and most policies offer £10 million. Failure to have a valid policy can result in a fine of £2,500 per day.

Right to Work Checks

Before your employee starts, you must verify their right to work in the UK. This means checking original documents (passport, visa, or share code from the Home Office online service) and keeping copies for the duration of employment plus two years.

Health and Safety

You have a legal duty to ensure the health and safety of your employees. For businesses with fewer than five employees, you do not need a written health and safety policy, but you still need to carry out risk assessments and take reasonable steps to protect your staff.

Payslips

You must provide your employee with a payslip on or before each payday. The payslip must show gross pay, deductions (tax, NI, pension, student loan), and net pay. Most payroll software generates these automatically.

The Cost of Your First Employee

Before you hire, make sure you have budgeted for the true cost, not just the salary:

Gross salary: what you have agreed to pay
Employer NI: 13.8% above the threshold (offset by Employment Allowance)
Employer pension contribution: minimum 3% of qualifying earnings
Employer's liability insurance: typically £100 to £500 per year for low-risk roles
Payroll administration: your time or a payroll service fee
Equipment, training, workspace: varies by role

A useful rule of thumb: budget for 110% to 130% of the gross salary to cover the true cost of employment.

Let Accounted Take the Stress Out of Employer Obligations

Managing payroll, tracking employer costs, and staying on top of HMRC deadlines gets much easier with the right tools. Accounted helps you keep your business finances organised, and Penny, your AI bookkeeper, automatically categorises expenses — including employer costs — so nothing falls through the cracks. Start your free trial and see how simple it can be.

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