Payment on account: a guide for the self-employed
Self-assessments and payment on account can cause a lot of angst if you’re self-employed.
The annual rush to get your tax return submitted on time coupled with unexpected tax bills is far from fun.
Payment on account is a commonly misunderstood part of the self-assessment process. It was developed by HMRC to help self-employed people spread out their tax bill. (This is HMRC trying to be helpful, although it may not feel like it the first time it happens to you!).
Payments on account are tax payments made twice yearly by self-employed individuals so that you don’t have to find it all in one go for the 31st January.
Does payment on account apply to me?
If you owe more than £1,000 in tax and less than 80% of your income tax is collected at source (e.g., through PAYE), then HMRC will require you to make payments on account.
For example, if your tax bill for the 2018 to 2019 tax year was £2,000, then you will pay two instalments of £1,000.
When do I need to pay?
You make two payments each year:
• By 31st January: during the tax year in question
• By 31st July: after the tax year end
By paying in two instalments, you spread the cost of your tax bill – a bit like paying monthly if you are an employee.
How does HMRC know how much I need to pay?
Payments on account are calculated based on your previous year’s tax bill.
If you owed £2,000 for the 2018 – 2019 tax year, you will need to make two payments on account of £1,000 for the 2019 – 2020 tax year.
If you know you are going to pay too much in tax (for example, you are winding your business down), you can apply to HMRC to have the payments reduced. Though be warned -if you reduce the payments too much, then you could be charged interest and penalties by HMRC.
If it turns out that you should have paid more tax in the year, then you will need to make a balancing payment on 31st January and future payments on account will be adjusted.
For example, if it turns out that your tax bill for the year is £2,500 and you have already paid £2,000, a balancing payment of £500 will be due on 31st January.
And your future payments on account will then be increased to £1,250.
Making payments on account for the first time
This can be a nasty surprise if you haven’t prepared for it as you will be expected to pay all the tax for the previous tax year, and the first payment on account all in one go.
Using the figures in the above example, that would mean a bill of £3,000 (£2,000 for 2018/2019 and £1,000 payment on account for 2019/2020).
It’s one reason to do your tax return as soon as possible so you have time to save for the bill if you hadn’t expected it.
If you complete your tax return early, you won’t pay tax any earlier but you will know how much you have to pay so you can budget. And, if you are due a refund you will receive this earlier.
If you can’t afford your bill, the sooner you contact HMRC the better. If you owe less than £10,000, you might be able to set up a Time to Pay Arrangement online. This lets you pay your self-assessment tax bill in instalments.
Keep an eye on your profit through the year and try to put money aside to pay your tax bill. A good rule of thumb is saving 20% of profit then you should have more than enough to pay your bill. If it turns out you owe less, you will have a nice little bonus to spend.
Need help completing your tax return or understanding payments on account? Get in touch. We’re here to help.