HMRC payments on account can be one of the most surprising tax bills for the self-employed, especially when filing their first tax return. Here’s everything you need to know about them, how they work and how to budget for them.
Due to the current Coronavirus Crisis, HMRC have waived payments on account that would normally be due on 31 July 2020.
What are HMRC Payments on Account?
In a nutshell, HMRC requires you to make 2 advance payments towards your income tax and Class 4 national insurance due for the next tax year. These two payments are due each year by:
- 31 January
- 31 July
The amount you pay is based on your current tax year bill. Then when you file your next tax return, you’ll need to make a balancing payment if necessary.
An Example of HMRC Payments on Account
Here’s an example of HMRC payments on account to demonstrate how it works. 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..
It is time to file your tax return for tax year 2014/2015 and pay tax due of £5,000.
It addition to this payment, you’ll need to pay an HMRC payment on account of £2,500 towards your 2015/2016 tax bill.
That’s 50% of your current bill so the total owed to HMRC is £7,500.
It’s 31 July 2016
A second HMRC payment on account is due. Again that is £2,500 (50% of your 2014/2015 tax bill).
By this date you would have paid £5,000 towards your 2015/2016 tax bill.
It’s now 31 January 2017
Your next self assessment tax return form for 2015/2016 is due for filing.
You work out that your tax bill for this tax year is £5,500. That means you have already paid £5,000 towards this bill so need to make a balancing payment of £500. Great news!
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 a total of £3,250 on 31 January 2017 to HMRC.
Looking forward to 31 July 2017
Better make a diary note, under the HMRC 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. That’s because you basically had to pay two years worth of tax upfront in your first year of becoming self-employed.
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 HMRC payments on account. But once you are through this first year, things will settle.
Saving for that tax
It’s so easy to forget about HMRC payments on account. The best thing advice I can give is to tuck a little away each month. Keep an eye on your earnings and estimate how much tax to put away each month in a deposit account, so it’s there ready and waiting.
Who needs to make HMRC payments on account
Here’s the HMRC criteria to help you work out if you need to make a payment on account:
- Anyone whose tax bill is over £1,000.
- Anyone who pays less than 80% of the tax they owe through the payroll system (it has been deducted at source).
How to Calculate Your Payment On Account
Your payment on account will be 50% of your current year tax bill, so if you want to check how much you will owe on top of your tax bill then use my sole trader tax calculator for an estimate.
What if your earnings suddenly decrease
In this 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 HMRC payment on account is 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 always seek advice before doing this.
How Can I Reduce My HMRC Payments On Account?
There are two ways you can apply to reduce your payment on account:
By Logging into Your Online Account
Log into your self assessment online account and click on ‘Reduce Payments on Account’
By Submitting a SA303 by Post
You can submit a form called an SA303 to reduce your payments on account by post. You can complete the SA303 online and then print it off to send it to HMRC. You will need your UTR number (Unique Tax Payers Reference), National Insurance number or employers reference to complete the form.
Note: you can face penalties and interest if you opt to reduce your payments on account too much, so be careful when applying.