HMRC has designed payment on account to help the self-employed stay on top of their payments. Additionally, in comparison to an employed individual who are taxed monthly at source through PAYE, a self-employed individual will only pay their tax bill in the January after the end of the previous tax year, so not to benefit too much the self-employed individual from paying tax in arrears, HMRC require an additional payment on account payment.
Therefore, payments on account are tax payments made twice a year by self-employed Self-Assessment taxpayers to spread the cost of the upcoming year’s tax, the deadlines are 31 January and 31 July. The calculation is based on previous year’s tax bill. In other words, HMRC is making a prediction about the individuals future income based on their past income. They’re due in two instalments –
The payment on account can catch out many newly self-employed people out and while in theory tax payment on account helps the self-employed spread out their bill, it can lead to more financial hardship for those who’re already having difficulty paying.
Please note, any individual who has property income or certain other income, apart from capital gains, may also need to pay payment on account where less than 80% of your income has tax deducted at source.
Example
David become self-employed in 2020/21 tax year and his tax bill was £5,000. David needed to pay HMRC the following –
- £5,000 for his 2020/21 income – due by January 31st, 2022
- 2,500 for his first payment on account for 2021/22 tax year– due by January 31st, 2022
- 2,500 for his second payment on account for 2021/22 tax year – due by July 31st, 2022
So, David, has actually paid HMRC £10,000 in 2022, a tax bill higher than he may have expected and had planned for his cashflow.
However, please note the following, if we continue the above example, if in 2021/22 tax year, David’s tax bill was again £5,000 then David will need to pay HMRC the following –
- £0 for his 2021/22 income – due by January 31st, 2023, as he has already paid HMRC £10,000 in 2022, 2 instalments of payment on account
- £2,500 for his first payment on account for 2022/23 tax year– due by January 31st, 2023
- 2,500 for his second payment on account for 2022/23 tax year – due by July 31st, 2023
So, David, will gain in his second year of self-assessment, that will only need to pay £2,500 in January payment, gaining in his cashflow.
Can you reduce payments on account?
All self-employed people’s income can fluctuate from year to year. If an individual foresees that their income for the next tax year will be lower than the previous tax year, they can apply to have HMRC reduce payment on account for their business via their tax return.
However, you need to be careful when making this decision, as if your income is the same or higher in the next tax year, you’ll still have to pay the same amount, meaning you’ve only delayed the burden. Also, if you reduced your payment on account and you underpaid your payment on account, you’ll have to pay interest on the outstanding amount. This can significantly increase your tax bill.
If you don’t pay your payment on account payments, you will be liable for HMRC penalties, please see my blog on this topic https://www.fkgb.co.uk/self-assessment-hmrc-deadlines-and-penalties/.
Exemption from payment on account
In following 2 scenarios you will not be required to make the payment on account payment
- If your tax return tax bill is lower than £1,000
- If you have already paid more than 80% of your total personal tax calculation, for example if you are in employment (PAYE) then your employer will be deducting tax through your salary and tax code. For example, if you are both employed and self-employed and your total tax calculation for the year is £15,000 and you have already paid £13,000 of this through your employment, you won’t be drawn into payments on account as you will have already paid more than 80% of your tax owed through your employment.
