What is payment on account?
Definition of payment on account
Who has to make payments on account
If your Income Tax and class 4 National Insurance totals more than £1,000 for a tax year and you don't pay tax at source on more than 80% of your income, you'll have to make payments on account.
'Paying tax at source' is when the tax is taken off and paid over to HMRC before you receive the income - like your employer does if you are paid wages.
Payments on account are due on 31st January and 31st July, and are worked out as half the previous year's tax and class 4 National Insurance liability.
Class 2 National Insurance does not count towards payments on account.
Example of a payment on account:
Susan is a self-employed seamstress. She has Income Tax and class 4 NI of £1,200 to pay for 2014/15, her first year of business. This is all due to be paid to HMRC by 31st January 2016.
Because her liability is over £1,000 and she does not pay tax at source, she must also make payments on account for 2015/16. These are due on 31st January 2016 and 31st July 2016, and are calculated as £1,200 / 2 each.
That means that on 31st January 2016, Susan must pay £1,200 + £600 = £1,800 to HMRC!
When Susan actually does her tax return for 2015/16, let's say her liability for that year was actually £1,300. She'll already have paid £1,200 on account for that, so she has only £100 to pay to make up the difference. This is called the 'balancing payment' and will be due by 31st January 2017.
She will also have to make payments on account for 2016/17 of £1,300 / 2 = £650 each, on or before 31st January 2017 and 31st July 2017.
Frequently Asked Questions
Do I have to make payments on account?
Yes, you do! There's no get-out clause if you are in the early years of your business or are short of cash.
You can apply to reduce your payments on account if you know your tax and class 4 NI bill will be lower next year, for example if you've lost a big customer or you pass State Pension age and no longer have to pay class 4 NI. But if you reduce your payments on account too far, HMRC treat that as unpaid tax and charge you interest, so leave a margin for error when you work out the reduction.
Paying your Income Tax bill
If you're a sole trader, FreeAgent enables to find out how much Income Tax you owe and then submit your tax return directly to HMRC. As you go about your daily business FreeAgent works away, calculating your Self Assessment liability. When it's time to file, FreeAgent fills up to 90% of the Sole Trader Self Employment form and you can submit your tax return directly to HMRC!
Got questions? Ask Emily!
FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.