Understanding Tax Payments on Account

This blog will help you with understanding Tax Payments on Account.

In a nutshell, in UK tax, a “payment on account” refers to the additional payment that some self-employed people need to make to contribute to their following Tax Year’s Tax and (class 4) National Insurance (NI) liability.

When will I have to make Payments on Account?

You will have to make Payments on Account if your:

• Last Self-Assessment tax bill was more than £1,000 and;
• You have already paid less than 80% of the total Tax owed (usually through PAYE)

No Payments on Account

Suppose you haven’t met the Payments on Account criteria as stated above. In that case, you will simply have to pay your outstanding Tax and NI Liability by 31 January following the Tax Year-End.

What happens the first time I have to make Payments on Account?

The first time you hit the criteria, then, unfortunately, you will have a whack to pay!

Effectively you will have to pay enough Tax and NI to cover the Tax and NI for the Tax Year you’ve just submitted the Tax Return for (the historic Tax-Year), and you will also have to pay a catch-up amount (put Tax and NI to one side) to cover half of the current Tax Years Tax and NI. i.e you pay one and a half of the Tax and NI liability.

The following July, you will also have to pay another half, i.e the second half of the current Tax Years Tax and NI liability.

But how do HMRC know your Tax and NI in the current Tax Year? They don’t; they simply assume you will earn roughly the same as you did the previous year.

So, let’s say this is the first year you meet the criteria, you submit your 5 April 2022 Tax Return, and you have a Tax and NI liability of £2,000. In January 2023, you will have to pay £3,000; in July 2023, you will have to pay £1,000. Effectively you have paid your 5 April 2022 Tax Liability and put £2,000 to one side for your 5 April 2023 Tax Liability.

Note: Payments on Account do not include anything you owe for Class 2 National Insurance, Capital Gains or Student Loans (if you’re self-employed) – you’ll pay those in your ‘balancing payment’ (see below).

What happens in the following Tax Years

Firstly, there’s an adjustment each year to account for the over or underpayment in Tax that you’ve paid – the balancing payment (BP).

Then you start to make Payments on Account for the following year (calculated with HMRC assuming you will have the same Tax liability as last year).

So, suppose you have already made two payments on Account, totalling £2,000 (as above). After the 5 April 2023, you complete your Tax Return and have a tax bill of £4,000; you are required to make a ‘balancing payment’ of £2,000 by 31 January 2024 (to bring the total paid for the Tax Year to £4,000) and make two payments on Account for the next Tax Year: £2,000 by 31 January 2024 and £2,000 by 31 July 2024.

Likewise, if you have paid more on Account than your tax bill, the ‘balancing payment’ will be a refund from HMRC.

Do I always have to make payments on Account if I hit the criteria?

There are some ways to change how you pay and how much you pay.

1. Reducing your Payments on Account

If you know that your tax bill will be lower than last year, you can lower your Payment on Account to avoid overpaying. You can do this on your Tax Return, in your HMRC Services online account, or by post with Form SA303.

If you underpay, you will be charged interest on the underpayment amount. So, reducing your payments on Account by too much is not penalty-free.

2. Paying through PAYE (if you’re Employed and Self-Employed)

Unless you specifically request to opt-out on your tax return, HMRC will automatically collect your Tax through PAYE if you meet the below criteria:

• You owe less than £3,000 on your bill
• You already pay Tax through PAYE income that is sufficient to cover your bill, and:
  • The amount collected would then not exceed more than 50% of your PAYE income
  • Nor would it double the amount of Tax you normally pay through PAYE
• Your online tax return was submitted by 30 December, or your paper Tax Return by 30 October

Self-employed individuals cannot pay Class 2 National Insurance through this method.

3. Paying Weekly or Monthly

If you are up to date with your previous Self-Assessment payments, the Budget Payment Plan is an excellent way to set aside funds for your next bill through regular monthly or weekly payments.

You can pause payments for up to 6 months if you need to, and any overpayments can be refunded at your request.

What if I can’t pay my tax bill on time?

You can set up a Time to Pay if you:

• have filed your latest tax return
• owe less than £30,000
• plan to pay the debt off within a maximum of 12 months
• are applying within 60 days of the payment deadline

HMRC will need to know further details, including your spending habits, savings, and income, before agreeing to a plan. HMRC will also charge interest, meaning the total you pay will be more than your initial tax bill.

Hopefully, you now how an understanding of Tax Payments on Account. If you’d like to discuss any of the above, we’d love to talk. Book a call with Rhys Edwards here today.

rhysedwards@edwardsofgwynedd.com

This information is subject to change and is not professional advice. Refer to our disclaimer for more details.