Self Assessment can be a challenge when you're doing it for the first time. You rush to get your tax return to HMRC before the 31st January, only to then be presented with a tax bill that's higher than you were expecting thanks to additional payments on account! But what are they?
Payments on account are a widely misunderstood element of the Self Assessment process. Although the concept is to help self-employed people spread out their tax bill, it often results in unexpected financial hardship for those experiencing this process for the first time.
We're going to outline the key points here to give you some context on these seemingly mysterious payments, but it's always best to seek specialist advice from an accountant if you need guidance.
A payment on account is a tax payment made twice a year by those who complete a Self Assessment tax return in order to spread the cost of the of the upcoming year’s tax. It is calculated by looking at your previous year’s tax bill and assumes you’ll be earning the same amount with the same profit and so will pay the same amount of tax next year.
Payments on account can be thought of as a way of paying your tax bill off in advance, but they often come as a surprise when your first tax bill arrives. They are made in two instalments; the first is due on the 31st January (same day as your ‘balancing payment’, the name for the previous year's tax bill) and the second is due on the 31st July.
These payments will include Class 4 National Insurance contributions, if applicable but not student loan payments or Capital Gains Tax.
There are some circumstances in which payments on account will not be due, such as:
Let's have a quick look at an example of payments on account and how it works.
Imagine a freelancer has prepared their Self Assessment tax return for the 20/21 tax year. They've worked as a sole trader for the full tax year and have no other sources of income. After all, calculations considered they have a liability of £10,000.
Their payments to HMRC will be broken out as shown below:
As you can see, when your liability is over £1,000 this will trigger these payments on account towards the upcoming tax year.
Self-employed people's income can vary year to year. If you have reason to believe that your income will be lower for the next tax year, you can apply to have your payments on account reduced.
You can reduce these payments on account by logging into your HMRC account. Alternatively, you can reduce these when you're preparing your Self Assessment tax return for the year.
Note: you should carefully plan and consider your income if you are reducing payments on account. If your income is of the same level or higher you will still be required to make these payments on account.
It is also important to note that if you reduce these payments on account when your liability was the same or higher, HMRC will charge you interest for reducing the payments on accounts when it was not required.
All you are really doing is delaying the pain, rather than eliminating it altogether. It is also important to note that underpayments will be subject to interest. If you reduce your payments on account and it subsequently turns out that you have underpaid, you will have to pay interest on the outstanding amount - which can significantly increase your tax bill.
If you're still unsure about payments on account, contact HMRC directly or speak to an accountant for guidance.
We always recommend speaking with an accountant, they can help make sure you're paying the right amount of tax and that you're setting yourself up for success.
If you already work with an accountant you can securely share your transaction and bookkeeping data with them through the Coconut Accountant Portal.
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As part of HMRC’s Making Tax Digital, sole traders will soon be required to complete 4 tax submissions per year instead of 1.
Take a look at the latest sole trader tax rates for the 2021/22 as well as our advice on how to prepare for the new tax year.