This is one of our most frequently asked questions and we know both the question and answer can be overwhelming to understand. Don’t worry – you’re not alone.

We’ve explained it all in this blog as simply as we can, with an example. We’ll also go over any issues and concerns this usually raises. If you still feel confused or have questions then you can of course contact us at any time. We’re always happy to help!

What does ‘payment on account’ mean?

“Payment on account” are tax payments made in advance towards your tax bill, twice a year (if you pay most of your tax through Self Assessment). HMRC takes payment in advance to stop the self-employed from benefiting too much from paying tax in arrears. Payments on account are due by midnight on the 31st of January and the 31st of July every year. 

Every year you have to make 2 payments on account every year unless:

  • Your last Self Assessment tax bill was less than £1,000.
  • you paid more than 80% of the previous year’s tax you owed, for example through your tax code or because your bank had already deducted interest on your savings.

Example:

Lucy is self-employed as a plumber. For the tax year 2021 – 2022, she owes a total of £3000. Last year in 2021 she paid a total of £1400 in tax towards 2021-2022. This was made in 2 payments; one of £700 in January 21 and another £700 in July 21. 

Her January 2023 tax bill will comprise of two things; her ‘balancing payment’ and her ‘first payment on account’.

Balancing Payment.

Her balancing payment is what she owes for 2021-2022, minus what she paid the previous year toward the 2021-2022 tax year. 

This is:

£3000 

Minus £1400 (Paid in Jan 21 and Jul 21)

which equals £1600. 

Payment on Account.

Her first payment on account is half of what she owes for 2021- 2022. 

£3000 divided by two is £1500. 

The total she needs to pay by 31st January 23 is £3100.

Second Payment on Account – July 23

The next thing she needs to pay is her second payment on account which is:

Half of what she owes,

£3000 divided by two. 

Which equals £1500

She must pay £1500 by 31st July 2023. 

The total tax Lucy needs to pay throughout 2023 is £4600.

Explanation:

So, how come Lucy needs to pay £4600 but she only owed £3000?

 
When you pay taxes, every year you pay: 

**(Remember we are paying this tax liability in Jan 2023 so now working towards your payments on account for tax year 2023/24)

  • Half of what you owe for the following tax year year (23/24)- (Jan 23)
  • Balancing payment to meet any differences when this was done the previous year. – (Jan 23)
  • A further half of what you owe towards the following year. – (Jul 23)

If we do reverse maths, her tax bill should be: 

  • The total of her 2021-2022 tax bill = £3000 
  • Divide the £3000 by 2 – Half of this to go towards her 2022 – 2023 tax bill (payments on account) = £1500
  • The difference in what she did or didn’t pay last year (Jan and July 2022) towards her balancing payments (for 2021-22 tax to pay)
  • The amount should have been £1500 but she actually paid £1400
  • Therefore, she owes an additional £100.

Add these three numbers up and it comes to £4600. 

Sum:

£3000 (Tax liability)

  • £1500 (Payment on account)
  • £100 (Balancing payment)

£4600.00

This system means in your first year when you’re eligible to pay payments on account you will have to pay 150% of your tax bill in one year. This is something worth looking out for and being aware of! After this, however, it balances out and doesn’t make too much difference so long as your net profit is relatively stable year to year. If you also have a huge increase in income, you could also potentially be hit with this 150% tax bill again.

If your net profit isn’t stable or you know there’s going to be a change in your circumstances that affects how much income you generate then you can reduce or increase your payments on account.

How can I reduce my payments on account?

If you’re going to have a change in circumstances such as going into full-time work or taking parental leave then you might be able to reduce your payment on account. But if you reduce the payment and then end up underpaying tax as a result, HMRC can charge you interest and possibly penalties on the sum involved. 

To reduce your payments on account: 

If you overpay on your tax bill then HMRC will adjust what you owe the following year or you can have a refund.

Ultimately, payments on account highlight the importance of 

  • putting aside enough money for your tax bill
  • filing your Self Assessment tax return as early as possible – especially if you’re newly self-employed – to avoid any nasty January surprises. 
  • having a good handle on your net profit year to year and being able to make forecasts as a business owner.
  • Keeping up-to-date records of your bookkeeping (ideally monthly).
  • Having a knowledgeable and expert accountant and/or bookkeeper. 

If you’re looking for a bookkeeper or accountant, contact us here.