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As an employer, you’re responsible for making sure the right amount of tax is deducted from your employees’ pay through the PAYE system. But mistakes can happen. Wrong tax codes, outdated employee information, or failure to act on HMRC notices. When these errors occur, it can result in underpaid tax. That means your employee could be left with an unexpected bill at the end of the tax year, and it could trace back to your payroll process.
Let’s walk through what underpaid tax means, how employers are involved, and how you can prevent this issue from affecting your team.
What Is Underpaid Tax?
Underpaid tax happens when the PAYE system fails to deduct the correct amount of income tax over the course of the tax year. At year-end, HMRC performs a reconciliation check, and if it finds that too little tax was collected, the shortfall becomes payable. Many common oversights can lead to under-deductions and may cause financial stress for your employees, not to mention potential compliance issues for your business.
A common employer mistake is failing to act on new coding notices or not ensuring employee data is current. Payroll errors like these can result in underpaid tax, putting your employees at risk of unexpected liabilities and reducing trust in your payroll accuracy. Let us dive into more such common mistakes made by employers so that you can avoid them in your business.
What are some Common Causes of Employer Tax Mistakes?
Here are some of the top causes related to underpaid paid too little tax (employer’s fault):
1. Incorrect PAYE Coding Notices
One of the most frequent causes of underpaid tax is the mismanagement of PAYE coding notices. Mistakes often happen when you:
- Use outdated PAYE tax codes
- Fail to apply new codes issued by HMRC
- Overlook employee documentation, such as P45s or starter checklists
These oversights can result in incorrect tax deductions, leaving employees liable for tax arrears and triggering corrective action from HMRC.
Tip: Always cross-reference HMRC coding notices with employee records, and act promptly on any updates.
2. Errors in Employee Starter or Leaver Information
Incorrect or incomplete information at the time of joining or leaving employment can lead to major tax issues. For instance:
- If a new employee has a second job but doesn’t submit accurate forms, you might unknowingly apply personal allowances twice.
- Similarly, failing to properly submit leaver details or provide a final pay slip can result in incorrect year-end reporting.
These errors often lead to tax underpayments that only surface after HMRC reviews an individual’s tax return, long after your business processed the payroll.
Tip: Ensure your onboarding and offboarding processes capture and report all necessary data to HMRC in a timely and complete manner.
3. Misreporting Overtime, Bonuses, or Benefits
Bonuses, overtime pay, and benefits like company cars must be handled with care in payroll. If taxable income is incorrectly calculated or left out, employees may face large tax bills they weren’t expecting.
Examples include:
- Incorrectly classifying a bonus as tax-free
- Forgetting to report benefits-in-kind
- Miscalculating the taxable value of a company car or private medical insurance
Tip: Keep payroll software updated with the latest tax rules and maintain clear documentation of all benefits and extra earnings.
4. Failing to Update Employee Details Promptly
Delayed updates to employee records, such as a change in address, national insurance number, role, or benefit entitlements, can result in the wrong tax code being applied. This often leads to incorrect tax deductions and long-term discrepancies.
Whether an employee moves abroad, switches to a different position internally, or starts receiving a new allowance, these changes must be reflected in your payroll and reported to HMRC immediately.
Tip: Maintain a proactive process for updating employee information and regularly audit payroll data to ensure accuracy.
What are the Consequences of Employer Tax Errors?
When you get things wrong with tax, it means more than just the problem of underpayment of tax. It leads to two major consequences:
1. Impact on Employees’ Tax Liabilities
When a tax error occurs, such as applying the wrong tax code or missing a change in employee status, your employees may face unexpected tax bills. HMRC may adjust their tax code in the following year to recover the unpaid amount, reducing their take-home pay and causing financial strain.
This can damage trust in your company’s payroll accuracy and affect employee morale. While employees are encouraged to review their tax codes, it’s ultimately your responsibility to ensure payroll deductions are correct from the outset.
Accurate tax handling not only protects your staff from financial stress but also reduces the risk of disputes and complaints within your workforce.
2. Risk of Penalties and HMRC Investigations
HMRC takes employer errors seriously, especially when they result in unpaid tax. If your business is found to have failed in applying reasonable care when operating PAYE, you could face penalties or trigger a full tax investigation.
This includes:
- Fines for carelessness or negligence
- Repayment of underpaid tax
- Increased scrutiny of your payroll operations
If errors are found to be deliberate or repeated, the penalties can be severe. However, if you can demonstrate that you’ve taken proactive steps, such as using correct tax codes, updating employee records promptly, and keeping thorough documentation, you may be able to reduce or avoid penalties.
Addressing issues internally before HMRC intervenes is the best approach. It shows your business is committed to compliance and reduces the risk of reputational and financial damage.
Want tips on how to avoid HMRC penalties? Check out this guide on Avoid HMRC Penalties: What To Know About UK Payroll Tax
What are Some Best Practices to Avoid Underpaid Tax?
Here are some handy tips you can follow to avoid underpaid tax for your employees:
- PAYE System Checks: Audit PAYE systems to spot any mistakes from coding notices.
- Employee Record Reviews: Work with employees to look at personal records like starter checklists.
- Update Benefit Changes: Send updates for any changes in employee benefits or untaxed income.
- Proof of Postage: Give proof of postage when sending letters or documents to HMRC. This shows you are acting in good faith and helps track what you send.
- Tax Code Updates: Regularly update tax codes so that you follow HMRC instructions.
- Payroll Automation: Automate your existing payroll systems so there are fewer manual mistakes.
- Payroll Staff Training: Training staff helps them get better at handling payroll. These sessions teach them about compliance checks, update steps, and tax credit issues. The team learns what they must do.
- Regular Payroll Audits: Doing regular audits can help find problems. For example, missing income declarations or making mistakes with HMRC rules. If payroll teams make mistakes, taxes get disrupted. So, good management of staff helps systems work well.
How Direct Payroll Services Can Help Avoid Underpaid Tax?
At Direct Payroll Services, we help you stay compliant and avoid issues like underpaid taxes by handling payroll with accuracy and care. Our systems are fully HMRC-compliant, which means we apply the correct tax codes, process changes promptly, and make sure all deductions are calculated properly. By managing every part of the payroll process, from tax and National Insurance to pensions and coding notices, we reduce the risk of costly mistakes.
With us taking care of the details, you can focus on running your business while knowing your payroll is in safe hands. Contact us now for an instant quote.
Avoid Big Penalties, Get Taxes Right
Small mistakes can have big impacts. Something as basic as underpaid tax can bring penalties and checks from HMRC. The rules are simple. Employ good payroll management and regularly train your employees. Keep checking HMRC messages and fix any errors quickly. Such basic sanity checks will help keep every tax report right. If you need help handling this, get in touch with us right away.
Frequently Asked Questions
1. What causes the wrong amount of tax to be deducted from an employee’s pay?
Underpayments of PAYE often happen due to mistakes in tax calculation, use of the wrong PAYE code, or errors in reporting employment income or pension income. If your payroll system doesn’t reflect the right tax code, it can result in the wrong amount of tax being deducted.
2. Can underpaid tax be due to errors by a pension provider or pension payer?
Yes. A pension provider error or a pension payer using outdated tax codes can lead to underpaid tax. This is especially common when lump sums or taxable state benefits are involved, and the correct amount of tax isn’t withheld at source.
3. How does HMRC calculate the tax due when underpayments are discovered?
HMRC uses a simple assessment process for the calculation of the underpayment. They assess whether enough tax was paid based on all sources of income, including savings interest, pension income, and employment income across earlier tax years.
4. What is a Simple Assessment Letter, and what should employers know about it?
A Simple Assessment Letter is issued by HMRC to inform individuals of tax due when they haven’t paid the full amount through PAYE. If an employer failed to submit the correct tax details, this could lead to such letters being issued. It’s crucial to check for any employer-side error before the employee is held accountable.
5. Is underpaid tax always the employer’s fault?
Not always. While employer mistakes in applying the right tax code or failing to report changes in income can cause underpayments, other genuine reasons include changes in source of income, new pension income, or shifts to a higher rate tax band.
6. What can businesses do to ensure accurate PAYE tax deductions?
There are a number of ways to reduce the risk of underpayments: verify all starter and leaver forms, check coding notices regularly, and ensure payroll systems are updated. If discrepancies arise, provide a full explanation to HMRC quickly to correct the issue and avoid penalties.
