Self-assessment – what are payments on account?

Payments on accounts are part of the self-assessment process and mean that you have to pay your next year’s income tax liabilities in advance, based on the amount you owed on your last tax return.

The amount you have to pay is based on your previous year’s tax bill and is paid in two equal instalments. The first payment is due by 31st January, and the second by 31st July.

How it works

If your total income tax liability for the 2021/22 tax year was £20,000, you would have to settle this liability in full by 31st January 2023.

Unless you inform them otherwise (see below), HMRC presumes you will earn the same amount in the current tax year (2022/23).

As a result, you need to make payments on account of this presumed future tax liability; the first installment at the same time as the original payment. So, in this example, an extra £10,000 is due on 31st January 2023. The second payment of £10,000 is due by 31st July 2023.

If you are new to contracting, and self-assessment, it may come as a shock the first time you are required to make payments in advance – but it is something you should budget for from day one.

However, once you have passed the first annual cycle of payments on account, you will be effectively in credit for the next self-assessment deadline.

What’s a balancing payment?

Your payments on account are based on your earnings for the previous income tax year. But, if your earnings end up being higher, you will be required to make a ‘balancing payment’.

So, if for example, you owe income tax of £30,000 rather than £20,000 in the current tax year, despite already paying £20,000 in advance via payments on account, you must pay the extra £10,000 by the January 31st deadline.

And, your total payments on account will also increase to £30,000, in the presumption that your increased earnings will continue into the subsequent tax year.

It can get pretty confusing, especially if you’re new to the world of self-assessment!

Exceptions

You won’t need to make two payments in a given year if your tax bill was less than £1,000 for the previous year, or if you’ve already paid 80% or more of any tax you owed (for example, through deductions at source) for the previous year.

Note that tax due for capital gains or a student loan will be included in the balancing payment.

What if your tax bill is likely to be lower than last year?

As every limited company owner knows, earnings can fluctuate from one year to the next and it’s not always easy to predict how your business will perform in the months ahead.

However, if you are pretty sure your income is going to take a hit in the next year, you can ask HMRC to reduce your payments on account.

• Simply Log on to your HMRC account and view your latest Self Assessment return.
• You’ll be able to see your current tax status, including payments already made and payments due in the future.
• Select the option to ‘reduce payments on account’, or you can do this in writing via form SA303.

If you pay an accountant to process your tax return, they can do this on your behalf.

It can be tempting to lower your immediate tax burden this way but think it through carefully first.

After all, if your income is about the same or even higher in the new tax year, you’ll end up paying the tax anyway.

Remember that HMRC can charge you interest if you underpay your tax. On the other hand, if you don’t reduce your payments on account and your tax bill is lower, you will get a refund.

Putting money aside and paying your bill

You can set up a direct debit with HMRC for payments on account, or you can pay online, by cheque, through your bank or post office. See the full list of available payment methods here.

Just remember that if the deadline for payment falls on a weekend or holiday, you should make sure your payment arrives by the last working day at the latest!