You’ve filed your Self-Assessment. You’ve paid your tax bill. Job done. Or so you thought.
Then a letter arrives from HMRC asking for more money.
Not next January. Now. And sometimes, another payment just six months after that.
If this has happened to you, you’re not alone. Payments on account catch a huge number of self-employed people and small business owners off guard.
The good news is that once you understand how the tax system works, it becomes much easier to plan for. This blog explains what payments on account are, why HMRC asks for them and what you can do to stay one step ahead.
What is a payment on account?
A payment on account is an advance payment towards your next tax bill. Rather than waiting until the end of the tax year to collect everything you owe, HMRC spreads the cost by asking you to pay in two instalments during the year, based on what you owed the previous year.
The thinking behind it is straightforward enough. If you owed £4,000 last year, HMRC assumes you’ll owe a similar amount this year. So, instead of one large bill landing in January, they split the expected liability in half and collect it across two payments, one in January and one in July.
It’s a system designed to smooth out tax collection. In practice, though, it can feel anything but smooth, particularly if it’s the first time you’ve encountered it.
Payments on account cover only Income Tax and Class 4 National Insurance. They don’t include any Capital Gains Tax or student loan repayments you might owe, which are collected separately.
Who has to make payments on account?
Not everyone who completes a Self-Assessment return has to make payments on account. HMRC applies them when two conditions are met:
- Your last Self-Assessment bill exceeded £1,000
- Less than 80% of your tax was collected at source (for example, through PAYE)
In practice, this means the people most commonly affected are the self-employed, business partners, landlords with rental income, and anyone with significant earnings outside of a salaried job.
If you’ve recently moved from employment to self-employment, or taken on a side income that’s grown beyond £1,000 in tax liability, this is likely the first year you’ll encounter them.
Companies aren’t affected. They follow different Corporation Tax rules. But for sole traders and partners, payments on account are very much part of the picture.
When are payments on account due?
There are two payment deadlines each year:
- 31 January – the first payment on account, due at the same time as your Self-Assessment submission and any balancing payment from the previous year.
- 31 July – the second payment on account, due halfway through the tax year.
If your final tax bill turns out to be higher than the two payments combined, you’ll need to make a balancing payment on the following 31 January. If you’ve overpaid, HMRC will refund the difference.
How are payments on account calculated?
HMRC takes your previous year’s Income Tax and Class 4 National Insurance liability and divides it equally between the two instalments.
So, if your total bill last year were £6,000, you’d pay £3,000 on 31 January and another £3,000 on 31 July. Then, when you submit your next return, HMRC works out whether you owe more or are due a refund.
The calculation itself isn’t complicated. What makes it feel complicated (and expensive) is the timing.
In your first year of making payments on account, you’re effectively paying last year’s tax and next year’s tax almost simultaneously. That January bill can include your balancing payment for the year just gone, plus the first instalment for the year ahead. If you weren’t expecting it, it can mean a bill twice the size you’d budgeted for. That’s where the shock usually hits, and why getting ahead of it matters so much.
Why payments on account catch people out
There are three reasons this part of the tax system tends to blindside people.
The first is the double hit in year one. As mentioned above, for the first time you become liable for payments on account, January brings both a balancing payment and your first advance instalment. If you’ve been putting aside money to cover what you think you owe, the reality can be significantly higher.
The second is pressure on your cash flow. Even if you know your payments on account are coming, finding two substantial sums, in January and July, requires careful planning. January is already a tight month for many small businesses. July can feel as awkward, arriving just as the summer gets going.
The third is what happens when your income drops. If you’ve had a quieter year than expected, your payments on account will still be based on last year’s higher income. You could end up overpaying. While HMRC will eventually refund it, it’s still money sitting with them rather than in your business in the meantime.
None of this is insurmountable. But it does require forward thinking, ideally with someone who’s seen it all before and can help you plan accordingly.
Can you reduce your payments on account?
If you know your income this year will be lower than last year, you don’t have to sit back and let HMRC collect based on outdated figures. You can apply to reduce your payments on account, either through your Self-Assessment online account or by contacting HMRC directly.
This can be a sensible move in the right circumstances. Perhaps your business has had a slower year, you’ve taken a career break, or a major contract has come to an end. In those situations, paying based on last year’s figures could leave you significantly out of pocket until HMRC processes your refund.
That said, it’s worth being cautious. If you reduce your payments too aggressively and your income turns out to be higher than expected, HMRC will charge interest on the shortfall. Getting the reduction roughly right, rather than simply minimising what you pay now, is the goal. A good accountant can help you make that call with confidence rather than guesswork.
How can Buckler Spencer help?
Payments on account aren’t a problem in themselves. They become a problem when they arrive without warning, when you’re not sure whether to reduce them, or when they create cash flow pressure at the wrong moment. That’s where we come in.
At Buckler Spencer, we work with self-employed individuals, business owners and landlords across South Derbyshire and beyond to make sure tax never catches them off guard. We’ll look ahead at your likely tax position well before the January and July deadlines, so you know exactly what’s coming and can plan your cash flow around it. If a reduction in your payments on account is appropriate, we’ll tell you, and we’ll make sure it’s calculated accurately, so you’re not creating a bigger problem down the line.
More broadly, we take the stress out of Self-Assessment from start to finish. From keeping your records in good order to submitting your return and handling any correspondence with HMRC, we’re with you every step of the way.
If payments on account have caught you out this year, or you want to make sure they don’t next year, we’d love to help. Get in touch with our team to see how we can help you maximise your wealth, minimise your stress and make sure HMRC never surprises you again.