Those new to self employment completing their Self Assessment tax return for the first time can be left somewhat baffled when their tax bill is much larger than they expected.
It happens because after they file their first Self-Assessment tax return, they find out they need to make a “payment on account”.
But, what are payments on account and what key things should you know about them?
1 HMRC uses the payments on account system to ensure that it collects at least some of the tax you owe in the current tax year.
2 Payments on account are based on earnings in the previous tax year. They can make it easier to pay your tax bill at the end of the current year.
3 When you complete your Self-Assessment tax return for the previous year, you’re nearly at the end of the current tax year. So, you’re not really paying tax in advance at all.
- Take the tax year 2022 / 2023, which started on 6th April 2022 and finished on 5 April 2023.
The tax for this year is due by 31 January 2024 - The next tax year, 2023 / 2024, will finish on 5 April 2024, just over two months after the tax for the previous year is paid
- If you qualify to make payments on account you would pay half of this tax bill on 31 January 2024 (10 months into the current tax year) and the other half on 31 July 2024 (four months after the end of the tax year).
So, you’re not paying anything in advance compared to the Pay As You Earn scheme, which taxes employees’ income earned each week or month. - Each payment on account is half of the estimated tax bill based upon the amount paid on tax for the previous tax year
4 If you’re self-employed, your payments on account will include your Class 4 National Insurance contributions (NICs).
5 If your tax bill for the year for which you’re completing the Self-Assessment is more than £1,000, you’ll have to make a payment on account towards the current tax year.
However, if more than 80% of your income is taxed at source (e.g. if you’re a subcontractor working under the Construction Industry Scheme), you won’t.
6 Payments on account must be made in two instalments: before midnight on 31 January in the current tax year and before midnight on 31 July.
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Because payments on account must be made in two instalments, effectively, it means that in your first year you’ll need to fork out 1.5 times your tax bill on 31 January, which is fine if you’ve been budgeting for it as you go. To avoid tax bills that you can’t afford to pay, make sure that you set aside enough of your earnings as you go. In second and subsequent years your payments on account are deducted from your tax bill leaving a balancing charge (additional tax to pay) or a refund if you’ve paid too much.
7 If you still owe tax after you’ve made your payments on account, you must make a “balancing payment” by midnight on 31 January in the next year.
8 Payments on account won’t include amounts you owe for capital gains tax or student loans (if you’re self-employed). You pay for these in your balancing payment.
9 If you’ve ceased trading or your profits are falling, you can request a reduction in your payments on account, using the Self-Assessment form, although it may not allow you to reduce payments on account to nil. Alternatively, you can use the HMRC form specifically for this purpose (i.e. the SA303 form) or sign into your tax account.
10 If your payment on account means you pay too much, because your actual tax bill turns out to be lower, HMRC will send you a refund. If you reduce your payments on account and underpay tax, you’ll be charged interest.
More information about payments on account can be found on the HMRC Gov.uk web site.