What are payments on account?
TAX PAYMENTS FOR THE SELF EMPLOYED
When you start working for yourself as a sole trader, one of the main benefits is that you don’t have to pay tax as money comes in – unlike the PAYE system (which you’ll be in if you’re in employment), in which employees’ earnings have tax deducted at source each month or week when they’re paid.
As a self-employed person, your first tax bill is likely to be due on the 31st January that falls after the end of your first tax year (which runs until 5th April).
So, if you started as a sole trader in, say, November 2019, you wouldn’t have to pay tax until the Self Assessment deadline for the 2019/20 tax year, which is 31st January 2021.
Limited company directors also have to submit an annual Self Assessment tax return to declare all the income they receive through dividends from their own company or other sources - there’s no getting out of it that easily!
GREAT..SO WHAT ARE PAYMENTS ON ACCOUNT?
You may have heard friends saying things like “I had to pay my tax twice”. I have lost count of the amount of times I have sent a client their self assessment to approve and they are shocked to find they need not only pay their tax liability for the year but also need to pay in advance for next year!
HMRC operates a system called “payments on account” for those who pay the majority of their tax through Self Assessment. If more than 80% of your income gets taxed through PAYE, then this won’t apply to you. Otherwise, if your Self Assessment tax bill is more than £1,000, you’ll need to make payments on account.
This means that, in addition to the 2019/20 bill that you need to settle by midnight on 31st January 2021 (but PLEASE pay it sooner, you don’t need the last minute stress!), you also need to pay half of your total expected tax for the 2020/21 year tax by the same deadline.
The other half of the 2020/21 tax bill is then due on 31st July 2021.
HERE IS A PRACTICAL EXAMPLE if it’s your first year of trading
Each of the two payments on account will normally be 50% of your previous tax bill. Gov.uk uses this example:
Your bill for the 2019 to 2020 tax year is £3,000.
The total tax to pay by midnight on 31 January 2021 is £4,500. This includes:
your ‘balancing payment’ (the amount needed to clear your tax liability) of £3,000 for the 2019 to 2020 tax year
the first payment on account of £1,500 (half your 2019 to 2020 tax bill) towards your 2020 to 2021 tax bill
you have to pay your second payment on account of £1,500 by midnight on 31 July 2021
Payments on account will include Class 4 National Insurance Contributions where applicable, but not student loan repayments or Capital Gains Tax.
and now let’s look at year 2…
Let’s assume you’re doing great and your profits have gone up in year 2 (go you!)
Your bill for the 2020 to 2021 tax year is £4,000.
The total tax to pay by midnight on 31 January 2021 is £3,000. This includes:
Your ‘balancing payment’ (the amount needed to clear your tax liability) of £1,000 for the 2020 to 2021 tax year (£4,000 tax liability minus the 2 x £1500 you already paid in advance towards this in Jan/July 2020).
the first payment on account of £2,000 (half your 2020 to 2021 tax bill) towards your 2021 to 2022 tax bill
you have to pay your second payment on account of £2,000 by midnight on 31 July 2022
Reducing your payment on account
Often your income might fluctuate (or hopefully just increase) from year to year. If you think that your income for the next tax year will be lower than in the previous tax year, you can apply to have your payment on account reduced.
You can do this via your government gateway account or chat to your accountant about it.
If you reduce your payments on account and you end up owing the tax HMRC may charge you interest.
WHAT IF YOU CAN’t pay your tax bill?
HMRC actually delayed the payment on account due by 31st July 2020 until 31st Jan 2021 due to Covid so don’t panic. If you can’t pay your tax on time it’s important to tell HMRC as soon as possible. They are usually very understanding (despite what you may think) and can setup payment plans to help. Don’t just avoid contacting them as they will likely add fines and interest to your overdue payments which will only make the amount you owe higher.
Keep an eye on my resources page for more practical ways to manage your money.
Of course it would be remiss of me to mention that I can help! Get in touch to chat about how I can support you and your business.
