When starting out as self-employed, you'll likely be fully aware that you'll have to complete a self-assessment tax return each year and pay the tax due by 31 January. However, you may not be aware that you also have to make additional self-assessment payments during the year - known as payments on account.
Put simply, payments on account are advance payments towards your tax bill; they need to be made twice a year by self-employed self-assessment taxpayers.
The amount due will be based on your previous year's tax bill, and payments must be paid by 31 January and 31 July. This means the first instalment is due on the same day as your payment for the previous year, so it's essential to have enough money set aside.
You will be required to make the two payments each year unless your last self-assessment tax bill was below £1,000 or you've already paid more than 80% of all the tax you owe, for example, through your tax code or because your bank has already deducted interest on your savings.
While having to clear your tax bill and make your first payment on account in January can be something of a financial challenge, especially in the first year of self-employment, the system is designed to help self-employed people keep on top of their payments, as well as to ensure they don't benefit too much from paying tax in arrears. In theory, staggered payments should help you to spread your bill rather than creating the pressure to make a single, larger payment once a year. This will only be the case if you're aware of the payment and it's factored into your financial planning, of course, so be sure to speak to your accountant about what you can expect to have to pay.
Your two payments on account will normally each be 50% of your previous tax bill. gov.uk explains the system using this calculation:
If your bill for the 2020 to 2021 tax year is £3,000. You made two payments on account last year of £900 each (£1,800 in total).
The total tax to pay by 31 January 2022 is £2,700. This includes:
Your 'balancing payment' of £1,200 for the 2020 to 2021 tax year (£3,000 minus £1,800) the first payment on account of £1,500 (half your 2020 to 2021 tax bill) towards your 2021 to 2022 tax bill
You will then need to make a second payment on account of £1,500 on 31 July 2022. If your tax bill for the 2021/22 tax year is more than £3,000 (the total of your two payments on account), you'll need to make a balancing payment by 31 January 2023.
It should be noted that payments on account include Class 4 National Insurance Contributions but do not include anything you owe for capital gains or student loans – you'll pay those in your balancing payment.
If you know your income will be lower than last year or if the tax relief you're entitled to goes up, you can ask HMRC to reduce your payments on account. The easiest way to do this is to sign in to your online account and click the option to view your latest self-assessment return. You can then select 'reduce payments on account'. You can also make the request by post by completing and returning form SA303. Be aware, though, that if you request a reduction, but your income is the same or higher in the next year, you'll still have to pay the tax; you've simply delayed the inevitable. If you underpay, HMRC can charge you interest and possibly penalties on the sum involved. If you overpay, HMRC will send you a refund.
You can check your payments on account anytime during the year by signing in to your personal tax account and again selecting the option to view your latest self-assessment return. If you click 'View statements', you'll be able to see any payments on account that have already been made, alongside payments that need to be made towards your next tax bill.
You can make payments to HMRC in several ways, including online using a debit or credit card, via bank transfer or direct debit or even by cheque through the post.
To make the payment, you'll need to use your 11-character payment reference. This is your 10-digit Unique Taxpayer Reference (UTR) followed by the letter 'K'. You can find your UTR by accessing your online account or looking on your paying-in slip if you get paper statements.
Be aware that you must allow five working days to process a Direct Debit the first time you set one up, so factor this in so that you don't get hit by a penalty payment. It should take three working days the next time if you're using the same bank details. You'll also need to set up single payments each time you want to pay by Direct Debit. Payment options such as online or telephone banking, CHAPS and card payments should be processed the same or the next day. You can check if your payment's been received by accessing your online account – it should show as paid between 3 to 6 working days later.