If you’re about to submit a Self Assessment or you’re still fairly new to it, then you might stumble across ‘payments on account’. These are basically advance payments that you make towards your self-employed tax bill, but not everyone needs to make them.
To help you plan ahead and manage your cash flow, we explain what payments on account are, who has to pay them, and how to budget for them.
What are payments on account?
When you work for yourself, the money you earn isn’t taxed at source like it is when you earn money from an employer. Instead, self-employed people are responsible for reporting and paying tax on their personal income through Self Assessment.
Paying your Self Assessment tax bill is normally an annual event, but to support self-employed people HMRC introduced payments on account to spread the cost of paying tax. That said, it can sometimes feel more like a financial hit than help if you weren’t expecting it.
It’s worth noting that payments on account include Class 4 National Insurance contributions, but not Capital Gains Tax or student loan repayments.
How much are payments on account?
Each payment on account is half of the previous year’s tax bill.
- If this year’s tax bill is £2,000, you’ll make two payments on account of £1,000 each towards next year’s bill.
- If this year’s bill is £3,000, you’ll make two payments on account of £1,500 towards next year’s bill.
- And so on!
When are payments on account due?
The thing about payments on account that catches lots of people out is the timing of them. This is usually the point at which people start to feel like they’re drowning in numbers, so we’ll explain it in stages.
The normal deadline for submitting your Self Assessment return and paying the bill is 31st January (following the tax year it relates to).
For example, the 2022/23 tax year ends in April 2023. The deadline to submit your return and pay the bill for the 2022/23 tax year is 31st January 2024.
The following tax year, which in this example is 2023/24, won’t have finished by that point, so you won’t have submitted a tax return for it.
Even so, HMRC assume that you’ll earn the same amount in 2023/24 as you did in 2022/23…
…And ask you to pay the equivalent of half of 2022/23’s bill as an advance payment towards 2023/24.
The deadline for that advance payment is 31st January 2024. Yep, the same deadline for paying your 2022/23 tax bill, so it might be a bit of a shock.
You can see why that can be quite stressful!
The problem with payments on account
Here’s the kicker: HMRC calculates your payments on account on the assumption that next year’s profit will be the same as this year’s, so if you actually earn less, you’ll pay more tax than you need to. OK, so you’ll get that back as a tax rebate, but it can cause problems for your cash flow.
This is where meticulous bookkeeping and accounting can swoop in the save the day. If you practice good bookkeeping habits, you should be able to spot you’re going to make less profit than predicted. You can then inform HMRC of this, and they’ll adjust your payments on account accordingly.
But do beware! If you make an error and end up paying too little tax as a result, HMRC will collect what’s owed and in some cases, additional interest on top. You can request a change to your payments on account either online or by post.
All starting to make more sense? Okay, now let’s take a look at who needs to make payments on account.
Do I need to make payments on account?
If you fall under either of the following categories, you will most likely need to make payments on account towards your tax bill:
- If you’re self-employed, completing Self Assessment tax returns, and you owe more than £1,000 in tax.
- If less than 80% of the tax you pay is collected at source (through employment, for example).
To clarify, this means that if you owe less than £1,000 to HMRC in Income Tax or if more than 80% of your tax bill has been collected at source, you won’t be liable to make payments on account.
What are the payments on account deadlines?
There are two payments on account deadlines that you need to be aware of.
- The first payment on account towards next year’s bill is always due at the same time as the payment for this year’s bill – 31st January.
- The second payment on account that you’ll need to make is due 31st July that year.
Missing these deadlines, or any HMRC deadlines in fact, is never advisable and likely to result in penalties. If you’re really struggling, contact HMRC as soon as possible!
Will Making Tax Digital affect payments on account?
With the Making Tax Digital (MTD) changes underway and the approach of MTD for Income Tax Self-Assessment (MTD for ITSA), many business owners are wondering how this impacts payments on account.
Although Making Tax Digital will see many changes come into play, payments on account are one of the things that will remain the same. So no, MTD for ITSA will not affect payments on account or the deadlines by which you’re expected to pay them. This is expected to remain the case for the foreseeable future.
Making Tax Digital (MTD) is a government scheme that aims to simplify how business owners manage their taxes. The initiative is being rolled out in phases, including Making Tax Digital for Income Tax Self Assessment, which will change how self-employed people report income and expenses.
Once you’re set up for MTD, you’ll swap the traditional Self Assessment Tax Return for digital financial records that you’ll submit to HMRC on a quarterly basis using compatible software. You will also be required to submit a final end-of-period statement (EOPS), along with a final declaration of income.
How do I make payments on account?
Settling your payments on account is simple and is largely similar to paying your tax bill any other time, including using a:
- Debit card or credit card
- Bank transfer (online or over the phone)
- Direct Debit
- By cheque via the post
- At your bank or building society (where applicable)
Just remember that once the Making Tax Digital changes come into effect, paper-based methods will be removed in favour of online payment methods.