Setting Up Your Payroll: The right way to pay yourself and your staffs
The Payroll Mistake That Could Cost You Everything
Meet Seun. He has been running his logistics company in Lagos for two years. Business is growing, he has five staff, a small fleet of bikes, and a steady stream of clients. Every month, he pays himself and his team from the business account whenever he feels like it. No payslips. No PAYE remittance to the Lagos Internal Revenue Service. No pension contributions. Just transfers here and there, sometimes cash, sometimes bank.
Then one Tuesday morning, a team from the state tax authority shows up at his office. They want to see his payroll records for the past two years. What follows is a nightmare — back taxes, penalties, and interest that nearly wipe out everything he has built. He spends the next six months firefighting instead of growing his business.
Seun's story is not unusual. It plays out across Nigeria every day, in small offices, warehouses, and shops. The good news? It is entirely avoidable. This lesson shows you how to set up payroll the right way from the very start — so you can pay yourself, pay your staff, stay compliant, and sleep well at night.
Why Payroll Matters (Beyond Just Paying People)
A lot of Nigerian entrepreneurs think payroll is simply about moving money from the business account into people's pockets. It is much more than that. Payroll is a legal framework — and getting it wrong has real consequences.
Payroll is a legal obligation under both the Nigerian Labour Act and the Nigeria Tax Act 2025 (effective January 2026). Ignoring it is not a grey area, it is non-compliance.
Proper payroll protects you from tax audits, labour disputes, and regulatory penalties that can cripple your business.
It helps you understand your true cost of doing business. When you know exactly what each employee costs you, salary, pension, taxes, you can price your products and services correctly.
Banks and investors look at payroll records when assessing your business. A clean, consistent payroll history signals that you run a serious, well-managed operation.
Practical reality in 2026: State tax authorities like LIRS, OIRS, and others are now using integrated data systems that connect bank transactions, TIN records, and company filings. This means inconsistent salary payments, irregular transfers, or missing PAYE filings are easier to flag than ever before.
If you need help structuring a compliant payroll system from scratch or reviewing your current setup, you can reach out here: https://www.ao7solutions.com/contact
Step 1: Understand the Components of a Nigerian Salary
Before you can run payroll, you need to understand how a Nigerian salary is structured. Most formal employment packages in Nigeria are broken down into components, and this structure matters, not just for clarity, but for tax purposes.
Basic Salary: The fixed base pay. Typically 40–60% of the total package. This is the foundation everything else is calculated on.
Housing Allowance: Typically 20–30% of basic salary. Helps employees cover accommodation costs.
Transport Allowance: Typically 10–20% of basic salary. Covers commuting costs.
Meal/Utility Allowance: Varies by company and role.
Gross Salary = Basic Salary + All Allowances. This is the total amount before any deductions.
Here is why the structure matters: PAYE (Pay As You Earn) tax is calculated on the gross salary. However, certain allowances, when structured correctly, can legally reduce the taxable income of your employees. This is not tax evasion; it is smart, lawful tax planning. A good accountant or payroll professional can help you structure your salary packages to be both competitive and tax-efficient.
Additional note for 2026: Proper salary structuring also affects your pension contributions, NHF compliance, and even employee retention. Many employees now compare offers based on net take-home pay, not just gross salary.
Step 2: Calculate PAYE (Pay As You Earn) Tax
PAYE is the income tax deducted from your employees' salaries every month and remitted to the relevant state tax authority, the Lagos Internal Revenue Service (LIRS) if you operate in Lagos, the Abuja Internal Revenue Service (AIRS) in the FCT, or the Rivers State Internal Revenue Service (RIRS) in Port Harcourt, for example. As the employer, you are responsible for calculating, deducting, and remitting this tax on behalf of your staff.
The New PAYE Tax Bands Under the Nigeria Tax Act 2025
The Nigeria Tax Act 2025, which takes effect from January 2026, introduced revised PAYE bands. Here is how they work on an annual basis:
First ₦800,000 per year (about ₦66,667/month): 0%, completely tax-free
₦800,001 – ₦3,000,000 per year: 15%
₦3,000,001 – ₦12,000,000 per year: 18%
₦12,000,001 – ₦25,000,000 per year: 21%
₦25,000,001 – ₦50,000,000 per year: 23%
Above ₦50,000,000 per year: 25%
Worked Example: Ngozi's Monthly PAYE
Ngozi earns ₦150,000 per month gross, that is ₦1,800,000 per year. Here is how her PAYE is calculated:
First ₦800,000: taxed at 0% = ₦0
Remaining ₦1,000,000 (₦1,800,000 − ₦800,000): taxed at 15% = ₦150,000
Total annual PAYE = ₦150,000 → Monthly PAYE = ₦12,500
Ngozi's monthly take-home (before pension deductions): ₦150,000 − ₦12,500 = ₦137,500
Before calculating PAYE, you are also allowed to deduct certain items from gross income: the employee's pension contribution (8% of gross), NHIS contributions, NHF contributions, and rent relief (20% of annual rent paid, capped at ₦500,000). These deductions reduce the taxable income, which in turn reduces the PAYE liability.
Important: PAYE must be remitted to the relevant state tax authority by the 10th of the following month. Miss this deadline and you will attract penalties and interest.
Step 3: Pension Contributions: It Is Not Optional
This is the one that catches many small business owners off guard. Under the Pension Reform Act 2014, which is still fully in force, every employer with three or more employees is legally required to enroll their staff in a contributory pension scheme. There are no exemptions for small businesses.
Contribution Rates
Employee contributes: 8% of monthly gross salary (deducted from their pay)
Employer contributes: 10% of monthly gross salary (this is an additional cost to you, on top of the salary)
Total pension contribution per employee: 18% of gross salary per month
Worked Example: Ngozi's Pension
Ngozi earns ₦150,000/month gross. Here is how pension works for her:
Employee pension (8%): ₦12,000, deducted from Ngozi's salary
Employer pension (10%): ₦15,000, paid by you, the employer, on top of her salary
Total going into Ngozi's Retirement Savings Account (RSA) every month: ₦27,000
The penalty for non-compliance is steep: 2% of your total monthly payroll for every month you default, plus full recovery of all unpaid contributions. Do not let this accumulate.
To enroll, register with a licensed Pension Fund Administrator (PFA). Well-known PFAs in Nigeria include ARM Pension, Stanbic IBTC Pension, and Leadway Pensure. One important rule: your employees choose their own PFA, you cannot make that choice for them. Your job is to ensure contributions are remitted to whichever PFA each employee selects.
Practical tip: Always reconcile pension remittances monthly and keep evidence. In audits, PFAs and regulators often request proof of consistent remittance.
Step 4: How to Pay Yourself as a Business Owner
This is the section most Nigerian entrepreneurs get completely wrong, and it is understandable, because nobody teaches you this when you start a business. The rules depend on how your business is structured.
If You Run a Business Name (Sole Proprietorship)
You do not have a 'salary' in the legal sense. What you take from the business is called drawings. In the eyes of the law, you and your business are the same entity, so your entire business profit is treated as your personal income and taxed as Personal Income Tax (PIT). You still need to file annual tax returns and pay PIT on your net profit.
If You Run a Private Limited Company (Ltd)
This is where it gets interesting. As a director of your own limited company, you are legally an employee of that company. You should pay yourself a formal director's salary, deduct PAYE on it, and remit it to the state tax authority, just like you would for any other staff member.
Why bother paying yourself a formal salary? Three reasons:
It creates a clear paper trail that protects you during audits.
Your salary is a deductible business expense, it reduces your company's taxable profit, which means less Company Income Tax (CIT).
It separates your personal finances from the business, a critical discipline for any serious entrepreneur.
How much should you pay yourself? Enough to cover your personal living expenses comfortably, but not so much that it drains the business of working capital. A common and tax-efficient approach is to pay yourself a modest monthly salary and then take dividends from the company's profits at year-end. Dividends are taxed at a flat 10% Withholding Tax (WHT), which is still lower than the top PIT rate of 25% under the Nigeria Tax Act 2025.
Practical tip: Do not pay yourself in cash from the till. Set a fixed salary date, say, the 25th of every month, and transfer your salary from the business account to your personal account, just like you would for any other employee. This simple habit will save you enormous headaches during audits.
Step 5: Issue Payslips and Keep Records
Every employee must receive a payslip every month. This is not just good practice, it is a requirement under the Nigerian Labour Act. A proper payslip should clearly show:
Gross salary (basic + all allowances)
All deductions: PAYE tax, employee pension (8%), NHIS, NHF
Net pay: the actual amount credited to the employee's account
Keep all payroll records for a minimum of seven years. Tax authorities can request records going back several years, and you need to be ready. You do not need expensive software to get started. A well-structured Excel or Google Sheets template works perfectly for small teams. As you grow, you can graduate to dedicated payroll software like Sage Payroll, BrightPay, or PaySpace, some of which offer free tiers for small businesses.
Important addition: In 2026, many regulators now accept digital records, but they must be well-organised and easily retrievable. Poor documentation is treated the same as no documentation.
If you want help setting up a simple but compliant payroll tracking system tailored to your business size, you can reach out here: https://www.ao7solutions.com/contact
Step 6: Annual Tax Filing for Employees
Your payroll obligations do not end with monthly remittances. At the end of each year, you are required to file an Annual PAYE Return with the relevant state tax authority. This document summarises the total salaries paid and the total PAYE remitted for every employee during the year.
You must also issue each employee a Tax Deduction Card (TDC), sometimes called a tax certificate, showing their total earnings and total tax paid for the year. Your employees need this document to file their own personal annual tax returns.
The deadline for filing the Annual PAYE Return is January 31 of the following year. Mark it in your calendar now.
Practical reality: Failure to file annual returns is one of the fastest ways businesses get flagged for audit, even if monthly payments were made correctly.
Common Payroll Mistakes Nigerian Entrepreneurs Make
Before we close, here is a quick checklist of the most common payroll errors to avoid:
- Paying staff in cash with no records or payslips
- Not remitting PAYE to the state tax authority, or remitting late
- Skipping pension contributions entirely, or deducting from employees but not remitting to the PFA
- Mixing personal and business finances: using the business account as a personal wallet
- Not issuing payslips to employees
- Paying yourself irregularly with no structure or documentation
- Assuming that because your business is small, payroll obligations do not apply to you, they absolutely do
Setting up payroll properly is one of the most powerful things you can do for your business. It protects you legally, builds genuine trust with your team, and positions your business as a serious, credible operation, the kind that banks lend to, investors back, and clients respect. The good news is that with the right tools and a bit of discipline, it is not complicated at all. You do not need a big HR department or an expensive consultant to get started. A clear salary structure, a simple spreadsheet, a registered PFA, and a reminder to remit PAYE by the 10th of every month, that is your foundation.
If you would rather have professionals handle your payroll setup, compliance structure, and monthly filings so you can focus on growing your business, you can reach out here: https://www.ao7solutions.com/contact
Start today. Your future self and your staff will thank you.