How do payments on account work?

Jun 6, 2024 | Tax

If you are self-employed or submit a self assessment tax return, you might be exposed to HMRC’s payments on account system.

It can take you by surprise, as it triggers once your tax bill exceeds a certain threshold, at which point you will need to make advance payments towards your next tax bill.

This article will demystify payments on account, helping you understand their purpose, calculation and impact on your tax liabilities.

What are payments on account?

Payments on account are advance tax payments made by self-employed individuals and businesses towards their upcoming tax bill.

The tax system requires taxpayers to make these payments based on their previous year’s tax liability, helping to spread the cost of taxes over the financial year.

In essence, payments on account are a way for the government to ensure that taxpayers consistently contribute towards their tax obligations, rather than facing a bigger lump sum payment at the end of the tax year.

Essentially you pay a portion of your anticipated tax liability ahead of time.

Who needs to make payments on account?

Payments on account are typically required if your previous year’s self assessment tax bill was more than £1,000, and less than 80% of your tax liability was collected at source (for example, through PAYE). However, there are some exceptions to this rule.

For instance, if you are in your first year of self-employment or your previous year’s tax bill was less than £1,000, you may not be required to make payments on account.

How are payments on account calculated?

The calculation is based on your previous year’s tax liability. The total amount you are required to pay in advance is typically equivalent to 100% of your previous year’s tax bill (split evenly across two payments).

For example, let us say that your tax liability for the 2024/25 tax year was £10,000. In this case, your payments on account for the 2025/26 tax year would be calculated as follows.

  • First payment on account (due 31 January 2026): £5,000 (50% of the previous year’s tax bill)
  • Second payment on account (due 31 July 2026): £5,000 (remaining 50% of the previous year’s tax bill).

When you then come to file your self assessment tax return for the 2025/26 tax year, you will calculate your actual tax liability for that year.

If your tax bill is higher than the payments on account you have already made, you will need to pay the difference, known as the balancing payment, by 31 January 2027.

Conversely, if your actual tax liability is lower than your payments on account, you will be entitled to a refund.

Challenges and considerations

While payments on account offer several benefits, there are also some challenges and considerations to keep in mind.

  1. Estimating future tax liabilities: As payments on account are based on the previous year’s tax liability, they may not always accurately reflect your current financial situation. If your income has decreased compared to the previous year, you may be overpaying your taxes through payments on account.
  2. Cashflow management: Making advance tax payments can strain your cashflow, particularly if your business is experiencing a slower period or if you have other expenses to cover.
  3. Balancing payment and penalties: If your actual tax liability is higher than your account payments, you will need to make a balancing payment. Failing to do so by the deadline can result in interest charges and penalties.

Strategies for managing payments on account

So, how do you manage payments on account effectively? Here are three key points.

  1. Plan ahead: Incorporate payments on account into your planning and budgeting process. By setting aside funds regularly, you can ensure that you have sufficient resources to cover your tax obligations when they are due.
  2. Review your financial situation: If your income has changed compared to the previous year, you may be able to apply to reduce your payments on account. This can help align your advance payments more closely with your tax liability.
  3. Seek professional advice: Engaging with a qualified accountant or tax professional can help you manage your tax obligations effectively, particularly if your tax bills are complex or the bill is high.

Take control of your payments on account

Payments on account are a fact of life for many self assessment taxpayers.

However, once you grasp how they work and plan ahead, you will be well on your way to mitigating their challenges.

At Business Partners, our team of experienced accountants understands the unique challenges and opportunities of managing self assessment tax paying for self-employed individuals, directors, landlords and so on.

If you have any questions about payments on account or need assistance with your tax planning and management, please do not hesitate to contact our friendly team.

Contact us today to learn more.

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