Payments on account
If you’re newly self-employed, you need to know about payments on account. These are little-known payments that have bitten many freelancers over the years.
Payments on account kick-in when your self-assessment tax bill is over £1,000. When this happens – which might be in your first tax year – you’ll be asked to make two additional payments towards the upcoming year’s tax bill.
Each deposit is 50% of your current tax bill and you pay:
- The first with your January tax bill
- The second by the end of July
How it works #
Let’s imagine that we’re submitting a tax return in January 2020 for the year 2018–19 and our tax bill comes to £2,000. Our tax bills would look like this:
- January: £3,000 – £2,000 + £1,000 (first 50% payment on account)
- July: £1,000 – second 50% payment on account
Payments on account are offset against the upcoming tax bill. Returning to our example, if our tax bill for 2019–20 was £3,000, our tax bills would look like this:
- January: £2,500 – £3,000 (2019–20 tax bill) + £1,500 (first 50% payment on account) – £2,000 (previous payments on account)
- July: £1,500 – second 50% payment on account
Are they unfair? #
Payments on account are not popular: they’ve caught lots of sole traders out because they’re not well-advertised. They also require some forward-planning, especially if you have a spike in earnings.
But – and this might be an unpopular opinion – if you’re short on money for the payment on account, it probably means you’re behind on tax saving.
Why? If your business runs April–April and you submit your return each January, you should have a pretty good idea about your earnings for the upcoming year.
In our example above, we’re submitting our 2018–19 tax return nine months after our tax year ended. At this point, we know what we’ve earned for 75% of the year and should have set aside the tax for that period already.
Of course there are exceptions to this: highly seasonal businesses or those with different accounting dates spring to mind. Broadly speaking, many businesses should be in a good position to anticipate and make payment.
Payments on account work on the assumption that your business will earn at least what it earned the year before. If it looks like you won’t earn as much (e.g. due to a dip or because you’ve formed a limited company), you can ask to reduce the upcoming payment.
Be careful, though: if you underpay, HMRC may charge interest.