You will make two payments on account each year if:
Your Income Tax and Class 4 NI bill totals more than £1,000.
You don’t pay tax at source on more than 80% of your income. Paying tax at source means that the tax is deducted from your income before you receive the payment, and then paid to HMRC on your behalf. For instance, if your employer pays through PAYE.
If you fall under these categories, you will need to make payments on account.
How do I work out payments on account?
Each payment on account is half of your tax bill from the previous year. Watch our video below, which explains how to work out payments on account, or carry on scrolling for an example of payments on account in action.
Payments on account will always be more of a financial burden the first time you pay them. Let’s look at a business that owes £1,000 in tax in their first year, and £1,500 in the second.
The first tax year ends 5th April 2019 and £1,000 tax is due before 31st January 2020. Payments on account will also be due towards the 2020-21 tax year, because HMRC assume you will owe an identical amount the following year.
The first half is due before 31st January 2020, and the second would be due before 31st July 2020. It means that you’ll pay:
£1,500 in January: The £1000 that you owe from one tax year, and then half of what you owe from the following tax year based on the assumption that you’ll owe the same amount again.
£500 in July: The remaining balance of what HMRC assume you will owe.
In the tax year ending 5th April 2020 the business owes £1,500 in tax, but £1,000 of this has already been paid. The first payment due in January will be £500 plus the first payment on account (for the 2021 year) of £750. That’s a total of £1,250 in January 2021 and the second payment on account of £750 due in July 2021.
Payments on account and cash flow
Payments on account can be a problem for cash flow if your business profits drop. This is because you are paying more than you will owe towards a future year.
HMRC do allow you to reduce your payments on account if you think this is likely to happen. Just be careful that you don’t reduce them too much, though! If you underpay then HMRC will demand the difference straight away, and you may have to pay interest on top.
Are payments on account a requirement?
If you fit the criteria to make payments on account, you must pay. There are, however, some ways to reduce them.
You can apply to reduce your payments on account if you know your tax and Class 4 NI will be lower next year. You may know this if you’ve lost a large client, for example, or if you pass State Pension age.
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About The Author
MAAT and ICPA accountant, with a passion for making accountancy and bookkeeping accessible. Other interests include cloud-based software development for web and mobile access, keeping fit, reading, and entrepreneurship.