If you have been paying your income tax and Class 4 national insurance by self assessment then you are likely to be familiar with the HMRC term ‘payment on account’. Or if this is your first time submitting a tax return you really do need to be aware of the self assessment payment on account. It’s one of those payment deadlines the affects anyone who pays tax through the self assessment system and is an additional two dates for your tax diary.
What are HMRC Payments on Account?
In a nutshell, HMRC ask that you pay your income tax (including Class 4 national insurance) in advance of the usual payment date we all know 31 January – 50% on 31 January and the other 50% on 31 July. Let’s get into the details because the mechanics of how it works is generally where the confusion begins. Let’s roll things back to when you first became self employed and needed to submit your very first tax return.
It’s 31 January 2016..
We are all familiar with the 31 January self assessment deadline where your tax return for the previous tax year needs to be submitted. Your friendly accountant would have calculated how much your profit was for the previous tax year ended 5 April 2015 and how much tax you need to pay as a result. Your accountant is going to ask you to pay the tax he/she calculated PLUS 50% on top – this is your payment on account towards what you need to pay on 31 January 2017. So say your tax bill was £5,000 for the tax year ended 5 April 2015, you will need to pay this £5,000 plus £2,500 payment on account. That’s a whopping total of £7,500!
It’s 31 July 2016
You have been getting those brown envelopes through the door for a while now and have seen the billboards. It’s time to make another payment to HMRC! Using the example above that’s another payment of £2,500, so altogether you have now paid £5,000 towards your tax bill for the tax year ended 5 April 2016.
It’s now 31 January 2017
We are back at that time of year again and your friendly accountant has worked out your tax bill for the year ended 5 April 2016 ready for the all important filing deadline. Your accountant has worked out your tax bill is £5,500.
Great news! You have paid £5,000 of this already! £2,500 last January and a further £2,500 in July. So you now need to pay £500 to settle up this tax bill.
Annoying news! You still need to continue the process of making payments on account for the next tax year. So you need to now pay slightly more than last year, £2,750 (that’s 50% of your latest tax bill of £5,500).
So based on this example you will pay £3,250 on 31 January to HMRC.
Looking forward to 31 July 2017
Better make a diary note, under the payments on account system you are going to have to make another payment – £2,750 which is 50% of your last tax bill of £5,500.
What a difference a year makes
You paid a total to HMRC of £7,500 paid on 31 January 2016 but £3,250 on 31 January 2017.
Going out on your own (becoming self-employed) is a great thing, but your first tax bill is a hard hitter and it’s so important for everyone to be aware of payments on account. Getting advice before you step out on your own is really valuable. But once you are through this first year, things will settle.
Saving for that tax
It’s so easy to forget about the payment on account. The best thing we can suggest is to tuck a little away each month. Keep an eye on your earnings and ask your account to help you estimate how much to put away each month in a deposit account, so it’s there ready and waiting.
Who needs to make HMRC payments on account
Anyone whose tax bill is over £1,000
Anyone who pays 80% of the tax they owe through the payroll system (it has been deducted at source)
What if your earnings suddenly decrease
In our example, everything settled out because the tax due was a similar level across the two tax years. But what if you can see that your earning have suddenly decreased and know that the payment on account is far too much?
HMRC can be reasonable, you can apply to reduce your payment on account. But be warned if you reduce it too much they will charge you interest on what you should have paid. So we would always recommend you seek a little advice before doing this.