Understanding Payments on Account: A Guide for the Self-Employed in the UK

If you’re a self-employed individual in the UK, you may have come across the term “Payment on Account.” It’s a part of the self-assessment tax system designed to help manage the way you pay your taxes. If you fall under this system, it’s crucial to understand its workings to ensure you’re making timely and accurate payments.

When you file your tax return, you’ll be required to make two payments on account towards your tax bill for the upcoming year. These payments are based on the previous year’s tax bill and are calculated at 50% of the total amount owed. You’ll make the first payment on account by January 31st and the second by July 31st.

It’s important to note that not everyone is required to make payments on account. If your last self-assessment tax bill was less than £1,000, or if 80% or more of your tax was deducted at source through PAYE, you won’t be required to make payments on account. However, if you do fall under the payment on account system, it’s important to understand how it works and how to make the payments on time to avoid any penalties or interest charges.

Understanding Payments on Account

Definition and Purpose

Payments on Account are advance payments towards your tax bill, including National Insurance and Capital Gains tax, if applicable. They are based on your previous year’s tax bill and divided into two equal instalments. The first payment is due by January 31st, and the second by July 31st. However, not everyone needs to make these payments. If your last self-assessment bill was less than £1,000 or 80% of your tax was deducted at source, you might not be required to pay on account. More details on this can be found in the Complete Self Assessment Tax Return guide.

How It Relates to Self Assessment

Being a significant part of the self-assessment tax system, Payments on Account affect many self-employed individuals. If you’re completing a self-assessment tax return and your bill exceeds £1,000, prepare to make these payments. It’s vital to ensure your payments align with your actual tax bill, which can fluctuate based on income changes. A comprehensive understanding of how these payments work is crucial for accurate tax planning. Learn more about how this ties into national insurance with the detailed guide on Self-Employed National Insurance Explained.

Calculating Payments on Account

When it comes to calculating payments on account, there are a few things to keep in mind. In this section, we will cover the estimation of payments based on your previous year’s tax, as well as the inclusion of National Insurance and Capital Gains.

Estimation Based on Previous Year’s Tax

To calculate your payments on account, HMRC will use an estimation based on your previous year’s tax. This estimation is calculated by taking your previous year’s tax bill and dividing it into two equal payments. These payments will be due on January 31st and July 31st of the current tax year.

It is important to note that this estimation is only a rough calculation. Your actual tax bill for the current year may differ from this estimation. If your payments on account do not cover your total tax bill for the year, you will have to make an additional balancing payment.

Inclusion of National Insurance and Capital Gains

Payments on account also include National Insurance and Capital Gains tax. National Insurance is a tax on earnings, and it is paid by both employees and self-employed individuals. Capital Gains tax is a tax on the profit made from selling assets such as property or shares.

When calculating your payments on account, it is important to include these taxes in your estimation. If you are unsure about how much National Insurance or Capital Gains tax you will owe, you can use HMRC’s tax calculator to get an idea of the amount.

Calculating these payments involves estimating your tax for the year based on the previous year’s bill. This includes all your tax dues such as National Insurance and any Capital Gains tax. It’s wise to account for these elements to avoid under or overestimating your payments. For insights into how your business expenses can affect your tax calculations, consider reading about What Business Expenses Can a Sole Trader Claim?.

Deadlines and Payment Methods

Key Dates for Payment

Mark your calendar for the two key payment dates: January 31st and July 31st. HMRC provides several payment methods for convenience, from online banking to traditional cheque payments. Ensure you’re familiar with all the options and choose the one that best suits your circumstances. Keep informed about the latest tax rates and allowances with the guide on Tax Rates and Allowances 2023-24.

Accepted Payment Channels

HM Revenue and Customs (HMRC) offers various convenient payment methods for settling your payments on account. You can opt for direct debit, online banking, bank transfer, or CHAPS (Clearing House Automated Payment System) to make your payments. Alternatively, if you prefer traditional methods, you can still utilise cheque payments. Ensure you choose a method that aligns with your preferences and allows you to meet the payment deadlines effectively.

Managing Overpayments and Underpayments

If you have overpaid or underpaid your tax bill, you may need to adjust your payments on account. Here’s what you need to know:

Adjusting Payments on Account

If you have overpaid your tax bill, you can reduce your payments on account for the following year. To do this, you will need to fill out the SA303 form, which you can find on the HMRC website. You will need to provide details of your tax bill and your payments on account, and explain why you are reducing your payments.

If you have underpaid your tax bill, you may need to increase your payments on account. This will help you to avoid a large tax bill at the end of the year. You can do this by contacting HMRC or by filling out the SA303 form.

Dealing with Refunds and Balancing Payments

If you have overpaid your tax bill, you may be entitled to a refund. HMRC will automatically send you a refund if they owe you money. However, if you have reduced your payments on account, you may need to contact HMRC to request a refund.

If you have underpaid your tax bill, you will need to make a balancing payment. This is the difference between your tax bill and your payments on account. You will need to pay this amount by the deadline to avoid penalties.

If you find yourself having overpaid or underpaid, adjustments can be made to future Payments on Account. This process involves informing HMRC of the necessary changes. A detailed explanation is available in the Payment on Account Pay guide.

Penalties and Interest Charges

If you fail to make a payment on account by the due date, you will be charged interest on the unpaid amount. Interest is charged at a daily rate of 2.6% (from 6 April 2022) until the payment is made. This interest is charged on top of any late payment penalties.

Late Payment Penalties

If you do not pay your payment on account by the due date, you will be charged a late payment penalty. The penalty is 5% of the unpaid tax that was due on the payment due date, plus an additional 5% if the tax remains unpaid after 30 days, and a further 5% if it remains unpaid after 6 months.

It is important to note that the penalties for late payment are separate from the interest charges. This means that if you are late in paying your payment on account, you will be charged both penalties and interest on the unpaid amount.

Interest on Unpaid Tax

If you do not pay your payment on account by the due date, you will also be charged interest on the unpaid tax. The interest is charged at a daily rate of 2.6% (from 6 April 2022) until the payment is made.

It is important to note that the interest charges are separate from the late payment penalties. This means that if you are late in paying your payment on account, you will be charged both interest and penalties on the unpaid amount.

Late payments attract interest and penalties, so punctuality is key. Understanding the implications of late payments is crucial to avoid unnecessary charges. For more information on the consequences and how to avoid them, refer to the comprehensive outline of HMRC and Companies House Penalties for Late Filing and Late Payment 2020/21.

Professional Advice and Assistance

If you are unsure about your tax liabilities or have any questions about payments on account, it may be helpful to consult with an accountant or advisor. They can provide guidance on your tax code and help you understand your obligations to HMRC.

When to Consult an Accountant or Advisor

It is a good idea to seek professional advice if you are self-employed or have a complex tax situation. An accountant or advisor can help you navigate the tax system and ensure that you are paying the correct amount of tax. They can also assist you with your self-assessment tax return and help you meet your deadlines.

Understanding Your Tax Code and Liabilities

Your tax code determines how much tax you pay on your income. It is important to understand your tax code and ensure that it is correct. If you think your tax code is wrong, you should contact HMRC as soon as possible.

Your tax liability is the amount of tax you owe to HMRC. It is important to keep track of your tax liability and ensure that you are paying the correct amount of tax. If you are unsure about your tax liability, you should consult with an accountant or advisor.

You can access your tax information online through your HMRC online account. This can help you keep track of your tax liabilities and ensure that you are meeting your obligations to HMRC.

Navigating tax obligations can be complex, particularly with Payments on Account. Seeking advice from a professional can be invaluable. They can provide tailored guidance based on your specific circumstances. Consider consulting the A Guide to Choosing the Right Type of Accountant and explore services specifically designed for self-employed individuals like Limited Company Accountants.

Special Circumstances

If you have special circumstances, you may not have to make payments on account. These circumstances include:

Trading and Business Profits

If you’re self-employed and your trading and business profits have reduced, you can apply to reduce your payments on account. To do this, you will need to estimate your tax bill for the current tax year and contact HMRC. They will then review your situation and determine whether you need to make payments on account or not.

Student Loans and Class 4 National Insurance Impact

If you have a student loan or you make Class 4 National Insurance contributions, your payments on account may be affected. This is because these deductions are taken into account when calculating your tax bill.

If you have a student loan, your payments on account may be reduced. This is because student loan repayments are deducted from your income before your tax bill is calculated. If you make Class 4 National Insurance contributions, your payments on account may be increased. This is because Class 4 National Insurance contributions are not taken into account when your tax bill is calculated.

Your payment requirements might vary based on specific circumstances, such as changes in business profits or additional deductions. It’s crucial to stay informed and possibly seek professional guidance when encountering such scenarios. More information is available in the guide on Limited Company Statement Financial Position (Formerly Balance Sheet).

Frequently Asked Questions

Reducing Payments on Account

If you think that your tax bill for the upcoming year will be lower than the previous year, you can apply to reduce your Payments on Account. You can do this by logging into your HMRC online account and filling out the form SA303. You will need to provide an estimate of your tax bill for the upcoming year, and if HMRC accepts your request, your Payments on Account will be reduced.

It is important to note that if you reduce your Payments on Account too much and end up underpaying your tax bill, you may be charged interest and penalties by HMRC.

Setting Up a Payment Plan

If you are struggling to pay your tax bill, you can set up a payment plan with HMRC. This will allow you to pay your tax bill in instalments rather than in one lump sum. You can set up a payment plan by logging into your HMRC online account or by calling the HMRC Payment Support Service.

When setting up a payment plan, you will need to provide details of your income and expenditure, as well as an estimate of how much you can afford to pay each month. HMRC will then review your application and let you know whether or not your payment plan has been accepted.

It is important to note that if you do set up a payment plan, you will still be charged interest on any outstanding balance. However, the interest rate charged by HMRC is usually lower than the interest rate charged by credit card companies or other lenders.

Overall, reducing your Payments on Account or setting up a payment plan can help you manage your tax bill more effectively. If you are struggling to pay your tax bill, it is important to contact HMRC as soon as possible to discuss your options.