For many self-employed individuals and small business owners, navigating the UK’s tax system can feel like a maze. One area that often causes confusion (and sometimes frustration) is Payments on Account. As the 31 January self-assessment deadline approaches, you may notice these additional payments on your tax bill and wonder why you’re being asked to pay “in advance.” Let’s break it down and clarify why Payments on Account aren’t quite what they seem.
What Are Payments on Account?
Payments on Account are advance payments towards your future tax bill. If you owe more than £1,000 in income tax for the tax year and don’t have more than 80% of your tax collected at source (e.g., through PAYE), you’re required to make these payments. They are intended to spread the cost of your tax liability, making it easier to manage rather than facing one large bill in January.
You make two Payments on Account each year:
- The first by 31 January (along with any balancing payment for the previous tax year).
- The second by 31 July.
Each payment is 50% of your previous year’s tax bill. These advance payments are then credited against your total tax liability for the current tax year.
Why It Feels Like You’re Paying in Advance
Many business owners view Payments on Account as an “extra” cost or feel they’re paying for income they haven’t earned yet. But these payments reflect your expected tax liability based on the income you’ve already earned.
Let’s look at the payment on accounts due by 31 January 2025. This is a payment on account due for the tax year 2024/25 and by the time you pay it, we will be nine months into the tax year, so it is tax paid on money earned. In fact, you are better off then your employed family and friends who have no choice but to pay their taxes monthly through PAYE.
How Payments on Account Work in Practice
Here’s an example to help illustrate how Payments on Account function:
Tax Year 2023/24: Your income tax bill is £6,000.
You made payments on account for this year as follows: –
31 July 2024 £2,500
31 January 2025 £2,500
A balancing payment of £1,000 is due by 31 January 2025.
Tax Year 2024/25: You make two Payments on Account of £3,000 each (one in January 2025, one in July 2025) towards your 2024/25 liability.
Balancing Payment: If your actual tax liability for 2024/25 turns out to be more or less than £6,000, the difference will be settled with a balancing payment (or refund) by the following 31 January.
The Benefits of Payments on Account
Although Payments on Account can feel burdensome, they come with several advantages:
- Cash Flow Management: Spreading your tax liability across two instalments helps you manage your cash flow more effectively than paying a large lump sum in January.
- Avoiding Penalties and Interest: Making Payments on Account ensures you stay on top of your tax obligations, reducing the risk of late payment penalties or interest charges.
- Reduced Balancing Payment: When the next January rolls around, your balancing payment will be much smaller (or even non-existent) because you’ve already covered a significant portion of your tax liability.
Tips for Managing Payments on Account
To make the process smoother and avoid any financial surprises, here are some practical tips to manage your payments on account:
- Plan: Set aside money for your tax payments throughout the year.
- Use Separate Accounts: Keep your tax savings in a separate account to avoid accidentally dipping into them for other expenses.
- Review and Adjust: If your income changes significantly, contact HMRC to adjust your Payments on Account. This can prevent overpayment or reduce the risk of underpayment penalties.
- Seek Professional Advice: If you’re unsure about your tax obligations or how to manage Payments on Account, working with an accountant can provide peace of mind and help you avoid costly mistakes.
If you have questions about Payments on Account or need help with your self-assessment, we’re here to guide you. Get in touch today and let us help you simplify your tax journey and plan for a financially healthy year ahead.