What are payments on account?
Sole traders and partners have to file a self-assessed tax return by 31st January each year, and pay income tax and Class 4 National Insurance (“class 4 NIC”) on the business’s profits.
If the bill for your tax and class 4 NIC was under £1,000 for the tax year ended 5th April 2010 (“2009-10”), you can stop reading now and grab a coffee, because you won’t have to make payments on account for 2010-11.
And if, for 2009-10, your tax and class 4 NIC bill came to over £1,000 but more than 80% of your income was taxed at source – for example, if you ran your business in your spare time and most of your income came from a full-time job where you’re an employee taxed under PAYE – then you won’t have to make payments on account for 2010-11.
But if your tax and class 4 NIC bill came to over £1,000 for 2009-10, and you paid tax at source on less than 80% of the income you earned in that tax year, then you will have to make payments on account, and the second one is due on 31st July 2011.
How are payments on account worked out?
They’re half of the previous tax year’s income tax and class 4 NIC liability.
Let’s take an example.
David is a self-employed copywriter. His tax and class 4 NIC liability came to £2,500 for 2009-10, which was the first year he was in business.
David paid that £2,500 in full on 31st January 2011.
But because that’s over £1,000, and because none of David’s income is taxed at source, he must also make payments on account for the tax year 2010-11.
Each of these will amount to £1,250, and they’re due for payment on 31st January 2011 and 31st July 2011.
So on 31st January 2011, poor David had to pay a total of £3,750 to HMRC! There is often this sting in the tail in your first year of business as a sole trader!
And he’ll have to pay £1,250 by 31st July 2011, as his second payment on account.
Because that’s a Sunday, if David is paying by cheque, he must make sure his cheque reaches HMRC by Friday 29th.
What happens when the 2010-11 tax return is prepared?
When you prepare and file your 2010-11 tax return, you’ll know your tax liability for 2010-11. If you’ve paid too much on account for 2010-11, HMRC will refund the excess to you.
David prepares his tax return for 2010-11. His tax and class 4 NIC bill for that year comes to £2,000, so he would receive a repayment of £500 from HMRC – but he would still have to pay £1,000 on account on 31st January 2012 and 31st July 2012.
But if you’ve not paid enough, then you have to make up the difference with what HMRC call a “balancing payment”, which is due by 31st January 2012.
Let’s say that instead David’s tax and class 4 NIC bill for 2010-11 comes to £3,000.
He’s already paid £2,500 towards that (£1,250 on 31st January 2011 and £1,250 on 31st July 2011), so he’ll pay a balancing payment of £500 on 31st January 2012.
But he must also make his first payment on account for 2011-12 on the same day, which will be half of £3,000, therefore £1,500.
So on 31st January 2012 he’ll pay £2,000 altogether, his balancing payment of £500 plus his first payment on account.
Can I reduce my payments on account?
If you think your payments on account are too high, then you can apply to HMRC to reduce them.
This might be because you know your income may fall, for example, because you’ve lost a big customer.
Or it might be that you no longer have to pay class 4 NIC this year, because you reached State Pension age during the tax year 2009-10.
Filling in the form
When you fill in the form to reduce your payments on account, the amount that you need to fill in is half of your total tax and class 4 NIC for 2010-11.
If you’re filling in the form before 31st July 2011, don’t put into the “Amount” box the difference between what you’re due to pay for 2010-11 and what you’ve already paid on 31st January 2011 on account for that year.
So, if David knows that his liability for 2010-11 will be only £2,000, he would put £1,000 in the amount box on the form – not £500.
Beware though, if you reduce your payments on account too far then HMRC will charge you interest, and potentially penalties as well.
If you prepare your 2010-11 tax return before 31st July 2011 then you’ll know for certain how high your payments on account should be!
Disclaimer: The content included in this blog post is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this blog post. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.