Your Tax Shop have noticed that many self-employed individuals, otherwise known as sole traders, who complete their Self-Assessment tax return for the first time, are left somewhat baffled and confused when their tax bill is much bigger than originally expected.
This occurs when they calculate their tax liability and then discover that they need to make a ‘payments on account’ towards the next tax year.
So what actually are payments on account and what are the key things you should know about them…?
- 1) HMRC state that they use the payments on account system to ensure that it collects at least some of the tax you owe during the current tax year. The payments on account then sit on your account until the tax eventually becomes due.
- 2) Payments on account are calculated and based on your earnings collected in the previous tax year. If your profits are high, payments on account can actually make it easier to afford and pay your tax bill at the end of the current tax year.
- 3) When you complete your Self-Assessment tax return for the previous year, you’re actually nearly at the end of the current tax year. So, you’re not actually paying the tax in much advance at all. For example:
- – The 2019/20 tax year finishes on the 5th April 2020 and the tax is due by 31st January 2021
- – The following tax year, 2020/21 finishes on the 5th April 2021 which is just over two months after the tax for the previous year and the first payment on account is due to be paid.
- – You would pay half of this tax bill on the 31st January 2021 (as mentioned above, 10 months into the current tax year) and the other half on the 31st July 2021 (four months after the end of the tax year).
- 4)If you’re self-employed, your payments on account will also include your Class 4 National Insurance contributions (NICs).
- 5) If your tax bill for the year in which you’re completing the Self-Assessment for is more than £1,000 then you’ll have to make payment on accounts towards the current tax year. However, if more than 80% of your income is taxed at source (e.g. if you’re a subcontractor working under the Construction Industry Scheme), you won’t.
- 6) Payments on account must be made in two equal instalments: one by the 31st January and the other by the 31st
- 7) When you come to calculate your actual tax liability at the end of the tax year, if you still owe tax after your payments on account have been taken into consideration, you must make a ‘balancing payment’ for the difference by the 31st January in the next tax year.
- 8) Payments on account won’t include amounts you owe for Capital Gains Tax or Student Loans (if you’re self-employed). You will pay these separately in your balancing payment.
- 9) If you’ve ceased trading or your profits are expected to be lower in the next tax year, you can request a reduction in your payments on account, although it may not allow you to reduce them fully to NIL.
- 10) If your payments on account mean you end up paying too much, because your actual tax bill is lower than originally anticipated, HMRC will issue you a refund. If you reduce your payments on account and end up underpaying tax i.e. reducing them too much, HMRC will charge you interest.
Your Tax Shop hopes that this blog helps you to understand payments on account in more detail and how these payments are calculated by HMRC.
Your Tax Shop’s aim is to help make tax easy to understand by simplifying technical terms and jargon into a much easier way for individuals to understand. We take great delight in offering an exceptional level of client care and are always on hand to help as your business grows and flourishes.
If you would like any further information or advice on payments on account then please get in touch with us on 0161 339 5689 or book an appointment to see one of our tax specialists.