As another tax payment deadline approaches, we’re unpicking the system and offering three key tips to help you prepare.
The accountancy and tax world is dictated by rigid filing and payment deadlines. Known as payments on account, this system applies if you’re a self-employed individual, but it’s a process that can feel confusing (to say the least) to many.
On 31 July, you’ll be due to make your personal tax payment or payment on account. If you’re a sole trader, you’ll come up against two tax payment dates each year (31 January and 31 July), but if you also operate a limited company you’ll have a third payment deadline just for fun.
Company tax can be something of a moveable feast, with the deadline to pay your tax liability varying depending on the date your accounts are drawn up to – but beyond this, the ways companies are taxed is relatively easy to understand. Companies earn profits, and then pay tax at 19% on the amount once a year, nine months after the year-end: simple.
However, HMRC hasn’t made the process quite as straightforward for personal tax. They describe the system as follows:
“Each payment is half your previous year’s tax bill. Payments are usually
due by midnight on 31 January and 31 July.
If you still have tax to pay after you’ve made your payments on account, you
must make a ‘balancing payment’ by midnight on 31 January next year”.
Crystal clear? Not really. On the face of it, this sounds feasible, but often it’s when you start thinking about your own situation that doubt creeps in. You may start to ask yourself questions that you don’t readily know the answer to. What was last year’s tax bill? How do I know if I still have tax to pay?
We’ve previously explored the example of ‘Dr Dentist’, an associate preparing to file her first tax return. This scenario demonstrates that if your income remains roughly the same each year, your payments each January and July will also be roughly the same. However (yep, we’ve hit a snag), with the upheaval caused by Covid-19, this isn’t likely to be the case for many associates.
In fact, if your profits fluctuate, the result of this confusing system can be some particularly high and unexpected tax bills.
So, accepting the system as it is, how can you best prepare yourself?
1. Save in real time and NOT for the payment deadline
Tax payment deadlines are so far removed from when you actually earned the money that it’s extremely easy to enjoy high profits for a period, spend the money, and then get caught out when HMRC hits you with a £50k tax bill. As a way to circumvent the confusion of the system, we suggest setting aside a percentage of your income each month in a tax savings account. This way, the funds are always there come payment day and you don’t get caught in the hamster wheel of using current tax savings to pay last year’s tax bill. We can help you to confirm what percentage of your income you need to set aside.
2. Make the most of your limited company
If you operate a limited company, it’s far easier to avoid peaks and troughs in personal income, which are further compounded when translated to payments on account due. Work with your accountant to design a bespoke plan of what you draw from your company and when at the beginning of any tax year. That way, you not only avoid needlessly tipping into nasty tax rates, but it could also smooth out those January and July payments so that you know what’s coming far in advance. Most of our clients have minimal and unsurprising tax bills each January and July.
3. Finally, get organised
You usually have at least nine months from the end of your financial year in order to have your tax payments calculated and relevant accounts filed. However, this doesn’t mean you have to wait for the deadline, or even the year-end; engage with your accountant halfway through the year. It’s not everyone’s favourite thing to do, but the earlier you can get a handle on your tax payments, the better. As a bonus, this might also help us to identify extra ways for you to save money in tax. Action now can impact your current year’s profits and subsequent tax liability.
There’s no denying that the payments on account system can be bewildering at best; even more so during the fluctuations of the past 18 months. Ultimately, it’s not necessary to have an accountant’s level of understanding when it comes to calculations or processes. It may even be the case that you never fully understand it, and that’s fine. Simply knowing these three ways to avoid its pitfalls will stand you in perfectly good stead (and avoid any nasty payment surprises).
And of course, as your advisors we can do our best to simplify this for you, and to make sure you’re ticking all the boxes each year. If you need any help – with incorporation, calculations or sheer tax frustration – do let us know.