What is payments on account?

Introduction:

If you’re a UK taxpayer who receives a portion of your income through self-employment or other non-salary sources, you may be familiar with the term ‘payments on account.’ If you file a Self Assessment tax return, HMRC may ask you to make payments on account towards your next tax bill. You usually need to make them unless (a) the tax you owed last year was less than £1,000, or (b) you already paid more than 80% of the tax you owed outside Self Assessment (for example through PAYE).

In this article, we’ll break down the complexities of payments on account, outlining the exemptions, payment deadlines, and strategies for reducing your payments on account, as well as explaining the process for payments on account refunds.

What are payments on account?

Payments on account are advance payments towards your estimated tax liability for the upcoming year, based on your previous year’s tax bill. Payments on account are advance payments towards your estimated tax liability for the upcoming year, based on your previous year’s tax bill. They include Income Tax and Class 4 National Insurance (if you’re self-employed), but do not include Capital Gains Tax or Student Loan repayments.

When are payments on account due?

HMRC uses your previous year’s tax bill as a basis for estimating your upcoming tax liability, which is usually split into 2 instalments. They’re due by midnight on 31 January and 31 July.

At this time, you will also need to settle any outstanding balance from the previous year, known as a balancing payment, and pay your first Payment on Account for the upcoming year. The second Payment on Account is due on 31st July, in the middle of the year.

What happens if your earnings change?

If your earnings exceed your predicted income for the year, so does your tax bill. To cover the difference between your Payments on Account and your actual tax liability, you will need to make an additional ‘balancing payment’.

On the contrary, if your earnings turn lower than expected, you can request HMRC to reduce your payment on account or refund the overpaid amount.

An Example to Illustrate the Process

Here’s a quick example to make sense of the rules explained above.

If you are a Self-Employed Individual:

Let’s consider a scenario where you start your self-employment journey in May 2023 and submit your first Self-assessment return for the 2023/24 tax year. HMRC calculates that you owe £500 in tax for that year, which is below the £1,000 threshold for payments on account. You breathe a sigh of relief, as you don’t have to worry about making advance payments for the next tax year.

The Payment on Account Process Kicks In:

Fast-forward to the 2024/25 tax year, and your business takes off. Your profits surge, and your tax bill for the year comes to £2,000. This exceeds the £1,000 threshold, triggering the payment on account process for the 2025/26 tax year. You’ll need to make an additional payment towards your tax liability for the 2025/26 tax year, known as your first payment on account. This payment is calculated as half of your previous year’s tax bill (2024/25 – £2,000), which is £1,000.

Why January can feel like a ‘double payment

On 31 January, you may need to pay your balancing payment for the previous tax year plus your first payment on account for the next year which can feel like a ‘double payment.

Receiving a Refund and Planning for the Next Year

When you submit your Self-Assessment tax return for the 2025/26 year and your tax bill comes to £1,800, If your payments on account are more than your final liability, your Self Assessment record may become overpaid. HMRC will normally keep overpayments on your record to set against future liabilities unless you request a repayment.

When Payments on Account Are Not Required

While payments on account are a common requirement for many self-employed individuals, certain circumstances exempt you from making these advance payments. If your tax bill for the previous year was £1,000 or less after tax deductions at source, you won’t need to make a payment on account. Additionally, if 80% or more of your tax was deducted at source in the previous tax year, you’re also exempt from making these payments.

To illustrate this exemption, let’s consider an example. If your tax liability for 2023-24 is under £1,000, you’ll make a single payment on 31st January 2025, rather than two payments on account.

It’s also worth noting that Class 2 National Insurance Contributions (NIC) are not factored into the calculation of payments on account.

When Can You Reduce Payments on Account?

The size of your payment on account is determined by your tax bill for the previous tax year. HMRC assumes that your income and tax liability will remain consistent, so the payment on account is essentially a pro-rated estimate of your upcoming tax bill. However, if your circumstances change, you may be able to reduce your payment on account.

If you’re taking on full-time work or expect most of your earnings to be taxed at source, you might be eligible to reduce your payment on account. This can help alleviate some of the financial burden associated with making advance payments. However, it’s essential to exercise caution: reducing the payment and underpaying tax can result in interest and penalties from HMRC.

While payments on account can seem daunting, they can make it easier to budget for your tax bill throughout the year. By spreading your tax liability across two payments, you can avoid a large lump sum payment in January and reduce the financial strain. This highlights the importance of setting aside enough money for your tax bill and filing your Self-assessment tax return as early as possible, especially if you’re newly self-employed.

Conclusion

Now that you’ve grasped the basics of how HMRC calculates payments on account, you’ll be better equipped to anticipate and prepare for your next tax bill.

It is always recommended to submit your Self-Assessment tax return as soon as possible after the end of the tax year. This proactive approach will give you ample time to settle any outstanding balancing payments without incurring interest or late payment penalties. By staying ahead of the curve, you can maintain a stress-free tax experience and focus on growing your business or managing your finances effectively.

Do you have questions or concerns about payments on account or your tax bill? Our experienced team is here to help. Contact us today on 0333 023 1303 to discuss your options and explore ways to potentially reduce or defer your tax payments. We’ll work with you to find a solution that suits your needs and helps you stay on top of your tax obligations.