When you’re self-employed, the tax you owe on any money you earn isn’t automatically deducted (unlike the PAYE system, where tax is taken away from your earnings before they reach you).
Instead, you’ll have to pay any tax you owe via your self-assessment tax return. This usually includes what’s known as ‘payment on account’ – HMRC’s way of making sure sole traders spread out the cost of the upcoming year’s tax.
For those filling in a self-assessment tax return for the first time, this advance payment can come as an unwelcome surprise. Here’s everything you need to understand about payment on account.
What is payment on account?
Payments on account are essentially advance payments towards your tax bill that you have to make twice a year if you’re self-employed.
HMRC introduced payment on account to help sole traders keep on top of paying the tax they owe – and to stop self-employed people benefiting from paying tax in arrears, rather than as they earn.
Who does payment on account affect?
If you’re self-employed, you’ll have to make payments on account (including Class 4 National Insurance), unless:
- your last self-assessment tax bill was less than £1,000
- you paid more than 80% of the previous year’s tax you owed (through your tax code, for example).
These payments are usually due by midnight on 31 January (the deadline for submitting your self-assessment tax return) and 31 July.
How is payment on account calculated?
Your payments on account will be determined by your previous year’s tax bill. HMRC uses that year’s earnings to predict what you might earn the following year, and estimates the amount of tax you’ll owe accordingly.
Because the amount is split over two payments, your first instalment will usually be 50% of your previous year’s tax bill.
Gov.uk uses the below example to show how payments on account are worked out:
Your bill for the 2020 to 2021 tax year is £3,000. You made 2 payments of £900 each (£1,800 in total) on account towards this bill in 2020.
The total tax to pay by midnight on 31 January 2022 is £2,700. This includes:
- your ‘balancing payment’ of £1,200 for the 2020 to 2021 tax year (£3,000 minus £1,800)
- the first payment on account of £1,500 (half your 2020 to 2021 tax bill) towards your 2021 to 2022 tax bill.
You then make a second payment on account of £1,500 on 31 July 2022.
If your tax bill for the 2021 to 2022 tax year is more than £3,000 (the total of your 2 payments on account), you’ll need to make a ‘balancing payment’ by 31 January 2023.
Payments on account include Class 4 National Insurance contributions, but not student loan repayments or Capital Gains Tax.
Check your payment on account
You can check your payment on account at any time by signing into your online account and reviewing your latest self-assessment tax return.
There, you’ll be able to see any payments you’ve already made, as well as any that are outstanding.
Can I reduce my payment on account?
If you expect to earn less in the coming tax year than you did the previous one (for example if you’ve entered full-time employment or you’ve cut down the amount of clients you work for), you might be able to reduce your payment on account.
Be careful about reducing your payment on account if you’re not sure how much you’ll earn, though: if you end up owing the same amount or more as HMRC predicted, you’ll be charged interest.
If you’re tempted to reduce your payment on account because you can’t afford the payment, it’s wise to get in touch with HMRC as soon as possible to set up a ‘Time-to-Pay’ agreement instead.
And, if you do end up overpaying, HMRC will refund you. Speak to your accountant if you’re at all uncertain.
Get ahead with smart planning
If you’re not prepared for it, payment on account can be stressful, leaving you facing a tax bill that’s 50% higher than you expected.
But with proper planning, making payments on account can make it easier to budget, as your payments are spread throughout the year.
We always advise that you fill out your tax return as soon as possible – and making sure you’ve got enough money set aside to make payments on account when they’re due is another good reason to do so.
For more help understanding payment on account, it’s best to speak to an accountant for tailored advice.