Self-employed workers pay income tax differently to employees, who have PAYE tax deductions made on their regular wage payments, usually once a month to pay for their income tax and National insurance contributions. PAYE stands for pay as you earn. However as a self-employed worker, you are not required to pay tax on your income as it comes in.
What Is A Payment On Account?
This means that as a self-employed freelancer or consultant your tax bill is due to be paid by 31st of January. HM Revenue and Customs (HMRC) uses the figures from your self-assessment filed for the previous year, to forecast how much tax you will owe for the upcoming year. From this they will calculate how much you will be due to pay. This is known as a payment in account. These payments on account are due twice a year for self-employed workers, by the deadlines 31st January and 31st July. This is in order to spread the cost of your forthcoming year’s tax bill.
How Does It All Work?
HMRC receives your income figures once a year. Your tax bill is calculated when you submit your self-assessment tax return, due by 31st January following the end of the previous tax year. This is also when your tax bill is due, so it pays to file your self-assessment early, so you can know in advance how much you owe. Payment on account spreads the cost of the total bill, allowing you to pay two instalments over the year towards your total tax bill. HMRC explains that payment on account helps self-employed workers to stay on top of payments. Making payment on account is a legal requirement, so it’s not a choice that you can make. It’s best to know how much you owe and when it’s due as far in advance as possible and then set this aside in monthly increments, so that you are truly spreading the cost. The payment on account system prevents you from benefiting from interest earned on the amount held in your account up until you pay your bill in arrears. Yet it also saves you running the risk that you won’t have the full amount when you reach the deadline.
For example if you started working as a self employed individual in May 2020, then your first tax year will run from April 2020 to April 2021. Your tax return would have to be filed and paid by the deadline of the 31st January 2022. That’s the easy bit. If your Self-Assessment tax bill is over £1,000, then you will be asked to make a “payment on account”. If you started your sole trading business in May 2020, then your first payment deadline will be the 31st January 2022. That being the case, under the “Payment on Account” terms, you will need to pay your tax bill by midnight on January 31st, 2022 but you will also need to pay half of what is expected in 2022/23 on the same deadline. Your second payment on account will be due by 31st of July 2022.
Be Prepared as a Start-Up
Payment on account has a habit of catching out those who are new to self-employment. 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. It’s never much fun to be presented with a bill that’s a lot higher than you’re expecting. The additional prepayments drive up the bill in the first year. Which levels out after your first twelve months trading, because come next January, you will have made two payments towards that bill already. Payments on account include Class 4 National Insurance Contributions where applicable, but not student loan repayments or Capital Gains Tax. Each of the two payments on account will normally be 50% of your previous tax bill.
This is how HMRC will calculate your bill:
|2020/21||Total tax and National Insurance Due||£3,000|
|1st Payment on Account||£1,500|
|Total Due 31st January 2022||£4,500|
|2nd Payment on Account – Due 31st July 2022||£1,500|
Then in the following tax year your payments on account are subtracted from the money you actually owe.
|2021/2022||Payments on Account Received||-£3,000|
|Total tax and National Insurance Due||£6,000|
|Balancing payment||Total tax due for 2021/2022||£4,000|
Finally you have your new payment calculation for the 2021/2022 tax year
|2021/2022||Balancing Payment (as above)||£4,000|
|1st Payment on Account||£3,000|
|Total Due 31st January 2023||£7,000|
|2nd Payment on Account – Due 31st July 2023||£3,000|
Simply put, payment in account a deposit on your 2021/22 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.
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. 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. 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.
How to Make a Payment on Account
You’ll need to use your payment reference when you pay your payment on account. This is your Unique Taxpayer Reference (UTR) number followed by the letter ‘K’. You will be sent your UTR when you register for self-assessment.
Accepted Payment Methods
- online using a debit card or corporate credit card
- bank transfer (online or phone banking)
- Direct Debit (make sure you leave enough time for a Direct Debit to go through – five working days the first time you set one up, or three the next time you pay using the same bank details)
- at your bank or building society (if you still get paper statements from HMRC, or you have the paying-in slip HMRC sent you)
- by cheque through the post
Making Tax Digital
If you file your return on paper, you’ll get a paper bill along with a Bank Giro form that you can use to make a payment. HMRC is moving as much of the tax paying process online as possible with their Making Tax Digital scheme. This means that from April 2024, Self Assessment taxpayers will need to keep digital records and send returns using the appropriate software. This will also apply to landlords with annual business or property income above £10,000 from 6 April 2024. VAT-registered businesses with a taxable turnover above the VAT threshold (£85,000) are now required to follow the Making Tax Digital rules by keeping digital records and using software to submit their VAT returns. The government confirmed in November 2020 that Making Tax Digital (MTD) will be extended to apply to corporation tax. It was announced that MTD for corporation tax will come into practice in 2024 and will be enforceable from 2026. Making Tax Digital (MTD) makes it mandatory for businesses to keep digital accounting records and complete their VAT submissions to HMRC via an Application Programme Interface (API), utilising MTD compliant software. This came into force in April 2021.
Reducing your Payment on Account
Income can fluctuate year on year for the self-employed. If you think that your income will be lower than the previous tax year, you can apply to have HMRC reduce payment on account for your business. You can reduce payment on account by logging into your online HMRC account and clicking ‘Reduce payments on account’. Or, you can send form SA303 to your tax office. If you adjust your payment on account and incorrectly go under the amount due, then HMRC will charge you interest on the difference. Reducing your payment on account should only be done if you are confused it would be significantly less. If it turns out later that you have made an overpayment you will receive an HMRC payment on account refund. Credit should then show up in your Self Assessment account, which you can then request to be repaid either online or by calling HMRC.
At Prestige Business Management we can help your Business
Talk to Prestige Business Management about all aspects of managing your cash flow, how and when to reduce your payment on account and ways to achieve tax efficiency. Find out what we can do for you. Call us today on 0203 773 2927.