When a person first becomes self-employed, the first tax bill can have an extra sting in it if they are required to make “payments on account”. There is a lot of confusion about what these represent, and when they are due for payment, so we hope to make them a little clearer in this blog and show you how to reduce payment on account.
If your tax bill exceeds £1,000, not only are you required to pay the full tax bill by the following 31st January, “payments on account” in January and six months later in July must also be made towards next year’s tax bill. Each payment is equal to half the previous year’s tax bill. An example is the best way of illustrating how this works:
Imagine an individual’s tax bill is £1,200.00 for the year ended 5th April 2015. Because this amount exceeds £1,000, payments on account are due towards the 5th April 2016 tax return. The payments on account are automatically calculated at 50% of the 2014/15 year’s tax bill: 50% of £1,200 is £600. The individual’s tax bills will be as follows:-
|Tax in respect of 5th April 2015||£1,200|
|1st payment on account in respect of 5th April 2016||£600|
|Due for payment on 31st January 2016||
- 2nd payment on account in respect of 5th April 2016 £600
- Due for payment 31st July 2016
As can be seen from the above illustration, the January payment is a large sum to pay. It represents one and a half year’s tax to pay all in one go. If the above tax payer’s earnings were £1,000 less for 5th April 2015, his tax bill would be just £900 in January 2016. That extra £1,000 earnings have effectively doubled his tax bill in January as he has had to pay half the next year’s estimated tax bill a year in advance.
If you have recently become self-employed or your tax bill is usually low enough not to require payments on account, it is well worth preparing your accounts and calculating your tax bill soon after 5th April to give you as much warning as possible if payments on account are suddenly required. Once that initial payment on account is out of the way, providing the tax liability remains relatively constant, subsequent tax bills are more regular amounts and, therefore, easier to manage. This becomes evident when you consider the following year’s tax liability:-
When the 5th April 2016 tax return is prepared, if the tax due is more than £1,200 the balance is paid on 31st January 2017. So, for example, if the actual tax for 5th April 2016 turns out to be £1,300, then since £1,200 has been paid on account, a £100 balance is due in January 2017. Of course, payments on account are once again required. 50% of £1,300 is £650. This results in the following:
January 2017 Payment
|Balance of tax in respect of 5th April 2016||£100|
|1st payment on account in respect of 5th April 2017||£650|
|Due for payment 31st January 2017||£750|
July 2017 Payment
- 2nd payment on account in respect of 5th April 2017 £650
If less than £1,200 is due re 5th April 2016, the overpayment is deducted from the payment on account that is due in January 2017 (if a payment on account needs to be made).
You can reduce payment on account if the tax liability is expected to be less than the estimated amount. However, interest will be payable if the payments on account are reduced by too much.
Payments on account are not due is where at least 80% of the estimated tax liability is deducted at source during the tax year, for example, from wages, investment income or pension.
We hope this has been of assistance to you. Please bear in mind that individual circumstances vary and so the above is intended as a general guide only.