If you receive income that isn’t taxed at source, you’re probably familiar with self-assessment tax returns. However, one aspect that often causes confusion is the requirement to make a “payment on account”.
Payments on account ensure that taxpayers contribute towards their next year’s tax bill throughout the year. Understanding why this payment is necessary and how it works can help you manage your finances better and avoid unexpected tax bills.
What is a payment on account?
A payment on account is an advance payment towards next year’s tax liability. If your overall tax bill was £1,000 or more, you must make two additional installments of your previous year’s tax liability for the current tax year.
Why do I need to make a payment on account?
From HMRC’s perspective, payments on account ensure that tax revenues are collected in a more timely manner. It helps the government manage its cash flow and reduce the risk of taxpayers defaulting on their tax obligations.
Furthermore, payments on account are designed to help taxpayers manage their cash flow more effectively. Instead of facing a large tax bill in one go, you spread the payments over the year. By making payments on account, you reduce the amount you owe at the end of the tax year. This can prevent the shock of a large tax bill and make it easier to plan your finances.
How are payments on account calculated?
Payments on account are usually based on your previous year’s tax bill. If your bill was over £1,000 and you’ve paid less than 80% of the tax owed through deductions at source (like PAYE), you’ll need to make payments on account. These payments are typically made in two installments:
- First Installment: Due by 31 January (the same date as your previous year’s tax liability).
- Second Installment: Due by 31 July.
Each payment is typically 50% of your previous year’s tax bill.
Example:
If your tax bill for the previous year was £3,000, you would make two payments of £1,500 each. This would total £3,000 towards your next year’s tax bill.
Balancing payment
After the end of the tax year, if your actual tax liability is more than the payments on account, you’ll need to make a balancing payment by 31 January of the following year. Conversely, if your tax bill is less, you’ll receive a refund or the excess can be used to offset future payments.
Can I reduce my payments on account?
If you believe your income for the next year will be lower, you can apply to reduce your payments on account. However, you need to be careful with this option. If you reduce your payments too much and your actual tax bill ends up being higher, you’ll have to pay the difference plus interest.
To reduce your payments on account, you can log into your HMRC online account and amend your self-assessment details. You should seek professional advice from an accountant, like Taxsure, before reducing your payments on account.
Consequences of missing payments
Failing to make your payments on account can result in interest and penalties. HMRC charges interest on late payments, which can add up over time. Therefore, it’s crucial to keep track of your payment deadlines and ensure that you budget accordingly.
In conclusion
Payments on account can seem like an added burden, especially if you’re new to self-assessment. By understanding how they work and planning your finances accordingly, you can avoid surprises and keep your tax affairs in order. If you’re ever in doubt, get in touch with our personal tax accountants at Taxsure. We will provide you with clarity and ensure that you’re meeting your obligations correctly.