What is a payment on account and do I have to pay it?

When you start working for yourself as a sole trader, one of the initial benefits is that you don’t have to pay tax as money comes in – unlike the PAYE system, in which employees’ earnings have tax deducted at source. However, you do need to plan ahead for your first ‘Payment on Account’, which is an advance charge made against your future tax bill. 

‍This payment can be a shock if you don’t know about it, so we’ve created this simple guide to payments on account to help you understand what it is, why it’s charged and how you can plan for it. 

When you’re self-employed, your tax liabilities are calculated via Self Assessment. This process determines how much you’ll pay in a given tax year and is generally based on profits after deducting things like expenses.

Because you don’t pay tax in the regular monthly way that someone on a PAYE system does, it can be easy to confuse payment dates and end up owing HMRC more money. Payments on account are designed to mitigate this risk, but they can be a tough pill to swallow if you don’t see them coming. 

Let’s explore what they are and how they work to help shed light on the best ways to stay on top of your sole trader taxes. 

What are payments on account?

Payments on account are advance payments based on your estimated tax bill for the coming year. This includes Class 4 National Insurance, but not student loan repayments or Capital Gains Tax. 

HMRC uses your previous year’s tax bill to estimate your upcoming one. This estimated bill is then split into two instalments, known as Payments on Account. You’ll pay the first instalment when submitting your Self Assessment tax return and the next in the middle of the year. 

If you earn more than predicted in the upcoming year, your tax bill will be higher than your Payments on Account total – so you’ll have to make an additional ‘balancing payment’. If you earn less, you can ask HMRC to reduce your payment or refund the difference if you’ve already paid. 

The deadline for your Payments on account fall at midnight on the following dates: 

• 31st January – the deadline for submitting your Self Assessment tax return. When you do, you need to resolve any outstanding balance from last year (balancing payment) and pay your first Payment on Account for next year’s estimated bill. 
• 31st July – the mid-year deadline for when you’ll need to pay your second Payment on Account towards next year’s bill. 

Important note: just in case this isn’t clear, Payments on Account can mean you have to pay ‘twice’ by the same deadline. For example, you’d have to pay any outstanding tax for the 2023/24 tax year AND make your first payment on account by the same deadline.

Who doesn’t need to make Payments on Account?

If you pay tax through Self-Assessment, you have to make Payments on Account unless you either earned less than £1000 in the previous tax year or you’ve paid more than 80% of your tax through PAYE. 

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What happens if I’m late with my payments on account?

Payment on account is not something that is widely known about among people who have never been part of the Self Assessment system. And if you’ve been expecting a tax bill of, say, £10,000, having to find an extra £5,000 to cover your first payment on account may simply be impossible.

If you can’t pay the whole tax bill by 31st January, you are likely to face interest charges on the outstanding amount. You should get in touch with HMRC as soon as possible to try to arrange a ‘Time-to-Pay’ agreement.

How can I reduce my payments on account?

The size of the payment on account is based on your tax bill for the previous tax year. HMRC assumes that you will continue to earn at the same rate and, therefore, you’ll pay roughly the same amount of tax in the following year.

If you’re going into full-time work or expect most of your earnings to be taxed at source, you might be able to reduce your payment on account. But if you reduce the payment and then end up underpaying tax as a result, HMRC can charge you interest and possibly penalties on the sum involved. Your accountant will be able to advise on the best course of action.

Once you’re over the initial hurdle, payments on account simply spread your tax bill across the year and can make it easier to budget.

Ultimately, it highlights the importance of putting aside enough money for your tax bill and also the value of filing your Self Assessment tax return as early as possible – especially if you’re newly self-employed – to avoid any nasty January surprises.

We take the pain out of Self Assessments

At Crunch, we’re experts at looking after life’s numbers, so you can trust us to make your Self Assessment as worry-free as it can be. Our expert Chartered Certified Accountants will take care of you, just like we did for over 7,500 clients in the last tax year. Check out our wicked Self Assessment service for a one-off fee.