How do payments on account work
How do payments on account work
Payments on account is one of the more confusing elements of an individual’s tax return

If you’ve recently registered as self employed, you’ve probably been keeping aside 20% – 40% of your earnings to prepare for your very first tax payment. If you’ve just had your tax return as well, you may also suddenly be shocked by the amount of tax you needed to pay this January. One of the big reasons for this surprise may be the payment on account system, that is rarely explained when someone first registers as self employed.

It’s a conversation I make sure I have with all of my clients who come to us for help with setting up as self-employed, as the less surprises around tax season, the better. It’s also one of the more confusing elements of an individual’s tax return each year, so the more the system is discussed, the easier it is to understand.

In essence, the payment on account system works as follows.

Each year, when you complete your tax return, you are liable to pay any tax/national insurance on your self employed profits for that year. In addition, you are then required to pay an additional 50% of your current year tax liability toward the next tax year’s liability. These payments are due no later than the 31 January. A further 50% of your current year liability is then due for payment on 31 July as the second half of your payment towards next year.

So, if this is your first year as self employed, you are in effect paying 150% of your tax liability for your first payment, which is why the first tax bill is often one of my least favourite to deliver!

The logic of the system is to try and spread tax payments out into more manageable payments, rather than a large lump sum once a year. This is because, once you clear the first large payment, if your income remains roughly the same, then your payments each January and July will be around the same. This is because by the time you get to your next payment, you’ve already paid up the liability for the year, and so you are only required to make the next payment on account.

At this point, it is probably useful to demonstrate this with some figures.

Dr Dentist is a recently qualified associate, who is preparing to file her first tax return. She has earned £50k of profit in the tax year. Her tax payments will consist of the following:

Actual tax liability on £50k profit for year 1

£11,000

First payment on account for year 2

£5,500

Total payment due 31 January

£16,500

Second payment for year 2 due 31 July

£5,500

Dr Dentist is now preparing to file her second tax return. Her profits have remained at roughly £50k for her second year as self employed. Her tax payments will consist of the following:

Actual tax liability on £50k profit for year 2

£11,500

Payments on account already made

(£11,000)

First payment on account for year 3

£5,750

Total payment due 31 January

£6,250

Second payment for year 3 due 31 July

£5,750

Whilst the payment on account system is likely to factor into the majority of dental tax returns, there are certain situations where payments on account may not be required. These are:

  1. Your tax liability for the year is less than £1,000 in total, or;
  2. You’ve already paid 80% of the tax due at source (e.g. through employment PAYE).

If you are recently qualified and looking for assistance with registering as self-employed, and to predict what your first tax payment may look like, please get in contact with Hive today.

The information contained in this article is based on the opinion of Hive Business and does not constitute formal tax advice. Any tax outcomes will be based on individual circumstances, tax legislation and regulation, which are subject to change in the future. You should seek specific advice before embarking on any course of action. Hive Business does not provide regulated Financial Advice, including advice on investment, insurance or lending products or their suitability for you. This article is provided for information only and does not constitute, and should not be interpreted as, investment advice or a recommendation to buy, sell or otherwise transact, or not transact, in any investment including Bitcoin and other crypto. Any use you wish to make of any information contained within this article is, therefore, entirely at your own risk.

By Connor Smith Accountant
If you have any questions or comments about this article, please get in touch.
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