Mandatory Payrolling: What Small Businesses Need to Know (and How to Avoid a Double Tax Hit)

As a small business owner with a lean team, you're likely focused on keeping things simple and efficient. But upcoming tax changes could significantly impact your payroll and your employees' take-home pay. Here's what you need to know about mandatory payrolling, and how to avoid a potential "double tax" situation.

What is Mandatory Payrolling?

Currently, if you provide taxable benefits to your employees (like company cars or private medical insurance), you often report these on a P11D form after the tax year ends. However, from 6 April 2026, this is changing. Payrolling will become mandatory for most taxable benefits. This means you'll need to add the value of these benefits to your employees' monthly pay, and deduct the associated tax in real-time.  

Why is This Happening?

HMRC says this simplifies the tax system. However, for small businesses, it may create extra administrative work and a potential financial headache for your employees.  

How Does It Affect My Small Business?

• Increased Administrative Burden:

  • You'll need to calculate the cash equivalent of each benefit, divide it by 12 (if paying monthly), and add it to your employee's gross pay each month.

  • If benefit values change (e.g., insurance premiums increase), you'll need to recalculate and adjust the payrolled amount.  

  • You will have to include the Class 1A National Insurance contributions within your payroll also.

• Potential for Errors:

  • With more data to process, there's a greater risk of errors, which could lead to incorrect tax deductions and unhappy employees.  

  • You will have to ensure that all the correct information is passed to your payroll provider, or software.

• Preparation is Key:

  • If you're not prepared by April 2026, your employees could face unexpected tax bills.

The "Double Tax" Problem (and How to Warn Your Employees)

Here's the crucial issue:

• In the 2025/26 tax year, if you're not payrolling, your employees will receive a P11D after the year ends. HMRC will then adjust their tax codes in the following year (2026/27) to collect the tax due on those benefits.  

• In 2026/27, you'll also be mandatorily payrolling benefits, meaning tax is deducted monthly.  

• This results in your employees paying tax on the previous year's benefits through their tax code, and tax on the current year's benefits through payrolling. Effectively, a "double tax" hit in that one year.

• This will reduce your employee's take home pay.

Example:

Imagine an employee with a £6,000 taxable benefit in 2025/26. They'll likely see a tax code adjustment in 2026/27 to collect the tax due. In the same year, they'll also be taxed monthly on their 2026/27 benefits. They will be paying tax on two years worth of benefits in one tax year.

What Can You Do?

• Warn Your Employees:

  • Explain the potential "double tax" situation so they can prepare.

  • Consider advising them to review their benefits and potentially opt out for the 2025/26 or 2026/27 tax year if they're concerned about the financial impact.

• Prepare Your Business:

  • Consider voluntarily registering for payrolling before April 2026 to get familiar with the process.

  • Start planning and working towards the new requirements now.

  • Ensure your payroll software, or provider, is ready for the changes.

  • Keep accurate records of all benefits provided.

• Seek Professional Advice:

  • Consult with your accountant or payroll provider to ensure you're compliant and prepared.

Key Takeaways for Small Businesses:

• Mandatory payrolling is coming, and it will affect you.

• The "double tax" issue could impact your employees' finances.  

• Preparation and communication are crucial.

By taking proactive steps, you can minimise the impact of these changes and ensure a smoother transition for your business and your employees.