What is payment 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.’ For those who pay less than 80% of their income tax at source and have a tax bill exceeding £1,000, HMRC may require them to make advance payments towards their future tax liability.

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. These payments include Income tax & Class 4 National Insurance contributions, but do not include student loan repayments or Capital Gains Tax.

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 two instalments, with the first payment due when you pay and submit your Self-Assessment tax return. This deadline is usually midnight on 31st January.

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.

The Double Payment Scenario

On 31 January 2026, you’ll need to pay a total of £3,000: £2,000 towards your 2024/25 tax bill and £1,000 as your first payment on account for the 2025/26 tax year. Later, on 31 July 2026, you’ll make your second payment on account for the 2025/26 tax year, which is also £1,000. By this point, you’ve paid a total of £2,000 towards your 2025/26 tax bill.

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, you’ll be owed a refund of £200 (the difference between the £2,000 you’ve paid on account and your actual tax bill). For the next tax year, your first payment on account for the 2026/27 tax year would be £900 (half of your 2025/26 tax bill), which you’ll need to pay by 31st  January 2027 and similarly, the second payment on account of £900 will be due by 31st July 2027.

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.