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After the January 31st deadline passes, self-employed people across the country prepare themselves for their tax bill. For many of them, it seems that no matter how often their good intentions promised that they would put money aside for it, the tax deadline is a period of real financial difficulty.
To help spread the cost of your tax and lower the chance of a financially debilitating bill, HMRC devised payment on account, a way of paying your tax in advance to avoid difficulty. Of course, having to pay your due tax plus an additional amount for the following year doesn’t help as much as might have been intended.
Those who make less than £1,000 profit in a year do not have to make tax payments on account, but once over this threshold, payment on account is mandatory for all individuals. This is one of our most often asked FAQs, so we thought we’d write a blog on it, to hopefully make it easier to understand.
What is payment on account?
It’s really not a complicated system. Payment on account happens twice throughout the year (at the end of January and the end of July) and each is a 50% payment of the previous years’ tax. The idea is that when the next self-assessment bill is due, a significant portion will already have been paid.
Ultimately, the payments on account for the following year will then be due, so it doesn’t really help the problem, and for self-employed people approaching their very first tax bill, it simply makes the bill 50% larger than they would like which is extremely painful especially when you are first setting up.
Payment on account turns paying your bill once it is due, into paying a significant portion in advance each year.
An example of payment on account
Tom started his business in February 2017, part of the 16/17 tax year. By April 2017, he had only earned a few hundred pounds and any earnings from his previous employment had already been taxed under PAYE. His self-assessment in January 2018 was simple and there was no tax to pay.
Business grew well, and in the 17/18 tax year, Tom’s profits (after expenses) totalled £34,000. Without any special tax planning, Tom was expecting to pay income tax at the end of January 2019 of £4,300:
- Personal allowance of £12,500 = £0
- 20% of £22,500 = £4,300
Tom’s actual bill for January 31st, 2019 however, was £6,350:
- £4,300 for tax year 2017/18
- £2,150 as 50% payment on account for tax year 2018/19
Tom also had to pay a July 2019 payment on account of £2,150 for the other 50%.
In the 2018/19 year, Tom’s profits grew to £52,000. His owed tax is calculated as £10,800:
- Personal allowance of £12,500 = £0
- 20% of £25,000 = £5,000
- 40% of £14,500 = £5,800
The final payment due January 2020 would be calculated as follows:
- Calculated tax of £10,800
- Payment on account of 50% = £5,400
- Previous paid tax on account of £4,300
- Total tax bill: £11,900
Tom will also face a July 2020 tax on account payment of £5,400.
The pros and cons of tax on payment on account
It is hard to see the positives of having to pay tax in advance, and in truth, despite the government’s attempt to make payment on account a way to spread the hit of the tax bill, a simple (and properly managed) savings account would accomplish the same benefit and also be a lot more flexible.
One could argue that if your activity is lower in the following year, resulting in less tax due, your payment on accounts will be reduced and in fact you could be due back some money from HMRC. However, if you were asked; would you prefer cash in your pocket today or the same amount in a years’ time you are likely to universally get the same answer, now!
The truth is that paying tax in advance really is only good for HMRC themselves.
National Insurance (NI) on account
The example provided above shows the calculation for income tax alone, however, your self-assessment tax return also includes a figure for NI and, in an identical fashion to tax on account, HMRC will also expect payment of NI on account.
This can add a considerable amount of class 4 NI contributions to many self-employed people’s January payment and is worth calculating in advance to avoid a surprise addition to your end of year bill.
To navigate the complexities of self-assessment tax returns, especially when factoring in National Insurance contributions, consider seeking guidance from a self-assessment accountant to ensure accurate calculations and avoid unexpected costs.
Moving from sole trader to limited company
Of the many advantages that exist for moving from a sole trader to a limited company is the different method of tax that you pay. Limited companies do not have to pay tax on account, and if you are of a suitable business size, making the change can lead to a drop in your tax bill, in addition to limitation of liability and an enhanced (perceived) reputation. However, if you draw down high levels of dividends you will continue to fall under the payment on account regime personally.
Payments on Account and Coronavirus
We did our best not to mention the C********** word in this blog, but even Payments on Account are impacted here.
If you are on payments on accounts for 2018/19, meaning your second payment on account is ordinarily due by 31 July 2020, this date is automatically deferred until 31 January 2021. Whilst we welcome this as a short-term cashflow help (effectively a six-month extension), don’t forget it is still due, so some of our client’s will be paying it as usual to avoid having to pay even more by 31 January 2021.
Black and White Accounting – here to help you
At Black and White Accounting, we can help you with your end of year tax return, as well as looking at your complete financial situation and giving you professional advice on how to ensure you are paying the correct amount of tax. Too many small businesses struggle and can end up overpaying without even realising – we’re here to ensure you never pay more tax than you need to and help you structure your business in the most suitable way.
We’d love to hear more about you and your business, email us, complete the ‘Got a Question’ form on the right hand side, or call us today on 0800 140 4644. We look forward to talking further with you.
