When you become self-employed, a lot of your income (e.g. dividends) won’t be ‘taxed at source’. In short, this means you have the benefit of not paying tax immediately on your earnings like employees do under the PAYE system. However, this needs careful cash flow planning, not just for the tax liability, but also potentially for your first of two ‘Payment on Accounts,’ which is an advance tax payment towards next year’s Self Assessment (personal income) tax bill.
These advanced tax payments are made twice a year and are each typically 50% of your previous year's tax bill. HMRC created this system with the intention to help reduce the burden of a single large payment, by spreading the cost over the year.
However payments on account can often come as a nasty surprise for many people (especially when becoming self-employed for the first time). So in the article we break down exactly what payments on account are and how they work.
Payments on account are advance payments toward your estimated self assessment tax bill for the next year, including Class 4 National Insurance but excluding student loan repayments or capital gains.
HMRC calculates your payments on account from your previous year’s self assessment tax bill. It then divides this estimated tax bill into two equal instalments. The first payment is due when you submit your Self Assessment tax return, and the second payment is due mid-year.
Important Note: To be clear, payment on account means you can effectively pay 150% of your tax bill by the January 31st deadline. For example, you pay 100% of the tax liability for the tax year that you are filing, then a 50% advance payment (i.e. the first payment on account) for the following tax year. A further 50% is then paid prior to the July 31st deadline. If you’re unaware of payments on account, the additional payments can come as a nasty shock and may seem unfair, but rightly or wrongly, it’s the way the tax system currently works.
Payments on Account are required for all UK self-employed individuals that pay tax through self assessment.
The exceptions to this are if:
Payments on Account are calculated based on your tax bill from the previous year, with HMRC assuming your earnings will remain fairly consistent. However, as we all know it’s very common for self-employed people’s income to fluctuate from year to year.
Therefore if your income for the current year exceeds HMRC’s estimate, you will need to make an additional ‘balancing payment’ to cover the shortfall in tax. Conversely, if you earn less than last year, you can request that HMRC reduce your payments or issue a refund if you’ve overpaid.
If you've overpaid your tax, you can claim a refund for the excess amount.
As a Self Assessment taxpayer, you claim this refund through the Self Assessment process. Overpayments are processed once you submit your next tax return. After HMRC reviews your return, they will inform you if you have overpaid.
You can then choose how you’d like to receive the refund, either by cheque or bank transfer. Alternatively, you can apply the overpaid amount towards your next Payment on Account tax bill.
How to reduce payments on account:
If you anticipate a lower tax bill than the previous year, perhaps due to a change in circumstances such as moving into permanent employment, reducing time spent on work or fewer clients, you can ask HMRC to reduce your Payments on Account to avoid overpaying.
You can do this online: Sign into your HMRC online account, select your latest Self Assessment return, and choose the ‘reduce payments on account’ option.
Mighty tip: However, you should be very cautious when reducing your Payments on Account and only press ahead with this if you are very confident your income will reduce. The reason being is that if you end up underpaying vs. your actual tax bill as a result of this reduction in payments on account, HMRC will charge interest on the underpaid amount.
Let's consider Sarah, who became a freelance UX designer in May 2023 working through her own limited company.
Based on her tax bill for 2023/24 being above £1,000 and less than 80% tax being paid at source, she will be required to make payments on account for the 2024/25 tax year. These payments are split into two instalments.
1. First Payment on Account:
2. Second Payment on Account:
Suppose Sarah’s actual tax liability for the tax year 2024/25 turns out to be £4,000 instead of the estimated £3,000.
Balancing Payment:
Conversely, if Sarah’s actual tax liability for 2024/25 is only £2,500, she will have overpaid by £500. She can request HMRC to:
31st January 2026:
By understanding these payments on account, Sarah can better manage her cash flow throughout the year and avoid any surprises at the end of the tax period. It’s important for everyone that’s self-employed to plan ahead and set aside money for these tax obligations to ensure smooth financial management.
Note: Your self-assessment/personal income tax is calculated from April 6th to April 5th the following year (i.e. it is independent from your company’s tax year).
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