Payments on Account: What It Is and How It Works

Payments on accounts. In the immortal words of Taylor Swift, “It’s me, hi, I’m the problem, it’s me.”

We’re joking - sort of. With the rise of side hustles, self-employment and people starting their own businesses, payments on account are one standard part of the UK tax system that catches everyone out. 

Whether embarking on a new business voyage or steering an established enterprise, grasping the nuances of payments on account ensures you're not only compliant with HMRC regulations but not shelling out hundreds or thousands in tax you hadn’t accounted for.

It’s time to demystify payments on account so you’re armed with the knowledge and confidence to manage this aspect of your self-employed finances. Let’s get into it.

What are payments on account?

Payments on account are advance payments towards your Self Assessment tax bill, including Class 4 National Insurance Contributions if you’re self-employed. Think of them as a way of budgeting for your tax bill, paid in two instalments to spread the financial impact over the year.

The rationale behind this system is simple yet effective: it helps manage cash flow for both the taxpayer and HM Revenue and Customs (HMRC). By paying in advance, you avoid the burden of a large tax bill in one go, and HMRC ensures a steady flow of tax income.

So, who needs to navigate these waters? Payments on account are typically required if your last Self Assessment tax bill was over £1,000 and if less than 80% of that tax was collected at source, like through your PAYE coding. This often applies to sole traders, freelancers, and small business owners.

From a self-employed individual’s perspective, payments on account often catch out people new to the game - especially in the first year they have to do it. That’s why it’s always best to consult a professional tax expert if you’re unsure whether you qualify.

Calculating payments on account

Calculating payments on account may seem like trying to make your way through a maze, but it's actually straightforward once you understand the basics. Each payment is half of your previous year's tax bill. So, if your last tax bill was £4,000, you'll make two payments of £2,000 each for the current year.

Let's illustrate this with an example: imagine you're a freelance designer, and your tax bill for the last financial year was £3,000. Your payments on account for the current year will be two instalments of £1,500 each.

However, the waters can get a bit choppy in special circumstances. For instance, in your first year of trading, you won't have made any previous payments, so this rule doesn't apply. Similarly, if you have a significant change in income, you might need to adjust your payments. We’ll cover what to do in this instance later on.

Deadlines and payment methods

When it comes to payments on account, timing is everything. Mark your calendars for two critical dates: 31st January and 31st July. The first instalment is due by the end of January, coinciding with your Self Assessment tax return, and the second by the end of July. These dates are pivotal to your financial year, so don’t forget them.

HMRC offers a variety of convenient options for paying the tax. You can pay online using your bank account, set up a direct debit, or even use a debit card. For those who prefer traditional methods, paying by cheque through the post is still an option, though it requires extra time for postal delivery.

But beware of late payments. Missing these deadlines can lead to interest charges and potential penalties. It's like a snowball rolling downhill - the longer you delay, the bigger the financial impact. Staying on top of these dates ensures smooth sailing through your fiscal responsibilities.

Adjusting payments on account

Navigating fluctuating income streams is a common challenge for businesses. If your income dips, you can adjust your payments on account. To do this, you'll need to inform HMRC about your estimated current year's tax bill, which they'll use to recalibrate your payments. Your accountant can help you determine how much the new payment on account should be.

The process involves filling out a form SA303 or adjusting through your online HMRC account. It's vital to base your estimates on realistic figures to avoid underpaying, as this can lead to interest charges. On the flip side, overpaying means you're essentially giving HMRC an interest-free loan, which you'll eventually reclaim or offset against future tax bills.

How an accountant can help

Payments on account are a fundamental part of the UK tax system for any freelancer, sole trader or self-employed business owner. With a solid understanding and timely action, you can ensure these payments work smoothly within your business financial cycle, avoiding shelling out on tax payments you weren’t prepared for.

Our team at BXD Accounting is always here to help you chart a course through the intricacies of tax planning and management. Contact us today for a free chat on how to manage your payments on account.