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.
As a self-employed worker, your first tax bill is likely to be due on the 31st January that falls after the end of your first tax year (which runs until 5th April).
So, if you started as a sole trader in, say, November 2019, you wouldn’t have to pay tax until the Self Assessment deadline for the 2019/20 tax year, which is 31st January 31 2021.
Limited company directors also have to submit an annual Self Assessment tax return to declare all the income they receive through dividends from their own company or other sources.
Payment on account
That’s the good news. The bad news is that HMRC runs a system called “payment on account” for those who pay most of their tax through Self Assessment. If more than 80% of your income gets taxed through PAYE, then this won’t apply to you. Otherwise, if your Self Assessment tax bill is more than £1,000, you’ll need to make a payment on account.
This means that, in addition to the 2019/20 bill that you need to settle by midnight on 31st January 2021, you also need to pay half of your total expected tax for the 2020/21 year tax by the same deadline.
The other half of the 2020/21 tax bill is then due on 31st July 2021.
This way, HMRC ensures that self-employed workers aren’t benefiting by being able to pay considerable amounts of tax many months in arrears. The result for many, newly self-employed people is that they typically face a tax bill which is roughly 50% higher than they had been expecting.
Delaying your payment on account due to Coronavirus (COVID-19)
On 20th March as part of its support for UK businesses affected by the COVID-19 pandemic the government announced that the second Self Assessment Payment on Account for the tax year 2019/20 due to be paid to HMRC on 31st July can be deferred until 31st January 2021. No interest or penalties will arise. Deferral is automatic and you do not need to apply to defer payment.
However, there could be financial implications by choosing to delay payment and you may find yourself with cash flow challenges in the new year.
To avoid increased costs in the future, you can still choose to pay your payment on account on 31st July as normal and HMRC are encouraging you to do this.
If you are in financial distress and owe outstanding tax, you can apply for a ‘Time to Pay’ arrangement. This provides a pre-agreed, time-limited deferral period to pay any tax you owe to HMRC.
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.
Adjusting the payment
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 are 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 filing your tax return as early as possible – especially if you are 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.