What Is A Payment On Account? – Sole Trader Guide to Self-Assessment
Once you embark upon your journey of self-employment as a sole trader, you begin to immediately understand a common difference between self-employment and PAYE tax deductions and that is you are not required to pay tax on your income as it comes in.
This means as a self-employed freelancer or consultant, you will receive your “first tax bill” on the 31st of January of each year – the end of the tax year (which will continue until April 5th). This is a big benefit of being self-employed.
How Does It All Work?
To explain this in a simpler way, here is an easy example.
Let’s say you started working as a self employed individual in May 2018, then your first tax year will run from the April 2018 to April 2019. You tax return would have to be filed and paid by the deadline of the 31st January 2020.
That’s the easy bit. However, HMRC have a system called “Payment On Account”. This system is designed for individuals who pay most of their tax through the Self-Assessment route. If their Self-Assessment tax bill tops £1,000, then you will be asked to make a “payment on account.”
Payment On Account – What Is It?
So, going back to deadlines. If you start your sole trading business in May 2018, you don’t have to pay any tax until the self-assessment deadline for 2018/19 which is January 31st, 2020.
That being the case, under the “Payment on Account” terms, you will need to pay you tax bill by midnight on January 31st, 2020 but you will also need to pay half of what is expected in 2019/20 on the same deadline. The other amount due will be required by HMRC on the 31st of July 2020.
Let’s say your tax bill was £5,000 for 2018/2019 then you would pay:
|2018-2019 Tax Due||£5,000|
|2019-2020 1st Payment on account||£2,500|
|Total to pay by 31st January 2020||£7,500|
|2019-2020 2nd Payment on Account|
Due by the 31st July 2020
The downside of this HMRC rule is that if you’re a newly registered self-employed worker, your tax bill will in all probability be 50% more than you anticipated originally!
What happens to the payments on account?
Simply but it’s just a deposit on your 2019-2020 tax bill, which will be even less as you have already paid some money towards it or maybe you paid too much and you get some back.
Back to our example you now have £5,000 in credit with HMRC and you are ready to do your 2019-2020 self-assessment. But this year you earnt a bit more money and your tax bill is £8,000
|2019-2020 Tax Bill||£8,000|
|Deposits on account||-£5,000|
|Total 2019-2020 Tax Due||£3,000|
Now you will pay
|Total 2019-2020 Tax Due||£3,000|
|2020-2021 1st Payment on account||£4,000|
|Total to pay by 31st January 2021||£7,000|
|2020-2021 2nd Payment on Account|
Due by the 31st July 2021
Penalties – What Do You Need to Know?
Not a lot of people know about “payment on account” when they start their self-employed journey. The idea that if you were expecting a tax bill of £5,000 and then suddenly your accountant tells you that you now need a further £2,500 it can all seem daunting, scary and difficult to comprehend!
As anyone who watches prime-time television in January knowns, if you can’t pay your tax bill by the deadline of 31st of January then you’ll get a penalty charge loaded with interest that will hurt.
However, the way this is calculated by HMRC is based on your previous year. So, if you made £5,000 during the last financial year, the bean counters at HMRC thinks you’ll do the same during the next financial year.
What Can Be Done About It?
If you expect a large part of your earnings to be taxed through PAYE then you can mitigate the Payment on Account and reduce the payment. However, if you reduce the sums and HMRC finds out you earned more outside of PAYE then you could end up paying more tax as a penalty.
But remember, once you jump this first obstacle, the on-going payment on account will be easier to navigate and manage. As your tax bill will thereafter be spread across the entire tax year which will make it incredibly easier to budget.
What Payment on Account really highlights is the crucial part tax returns play in your personal tax experience. If you file early as possible, especially during the first twelve to twenty-four months, you can help circumvent that horrid surprise that so many January freelance first-timers face.
Why Not Get In Touch With Prestige Business Management?
At Prestige Business Management, we understand how Payment on Account can sound daunting and unfair. Yet, we can help you plan, we can help give you the support you need to make sure this doesn’t come back to bite you financially in January.
If you’d like to know more about Payment on Account, why not call us directly on 0203 773 2927 today?