What is 'Payment on Account'?
Some self-employed business owners have to make 'Payments on Account' after the first year of submitting a self-assessment tax return. It sounds like jargon, but what it really means is making a tax payment on account or “advanced payment towards your next tax return”. You are putting money on your account - keeping it in credit towards the next tax year. Simples.
It only becomes complicated because the amount of advanced payment (payment on account) varies based on your last tax return.
When Do Payments on Account Apply?
You will make a payment on account twice a year in January and July and each payment should equal 50% of your most recent tax bill.
Why Payment on Account is a Benefit
Basically payment on account stops you getting behind on your tax payments. It stops you receiving a nasty tax bill that you cannot afford to pay in one lump sum. It’s basically a simple savings or ‘lay away’ scheme that helps you to manage your tax payments and keeps you from getting into any cash flow bother with HMRC.
We appreciate that not everyone needs this kind of scheme to stay on top of their taxes, but from our experience of working with small and medium businesses it is actually a pretty helpful system for most business owners.
The great news is that these payments on account are set against your next tax bill so providing you are growing and making a steady profit, you are never going to need to play too much ‘catch up’ on your tax bills.
When Does Payment on Account Start?
Not until you have been trading for over a year and submitted your first self assessment tax return before the end of the following January. Then you will pay any taxes due for your first year, plus your first payment on account for the current trading year (which is set against your next tax bill).
So if your first year of trading is the tax year 2019-2020, which ended on 5th April 2020 you must file your self assessment tax return and pay your tax bill by 31st January 2021. You will also have to make your first payment on account at the same time. Then you will pay the second payment on account in July 2021.
An Example of Payment on Account
Still confused? Let’s look at an example...
Madge’s tax bill for 2019-2020 is £2,000 and therefore her estimated tax bill for 2020-2021 is taken to also be £2,000.
In January 2021 she must pay HMRC:
2019-2020 Tax Bill £2,000
2020-2021 Payment on Account £1,000
Total January payment £3,000
In July 2021 she must pay HMRC:
2020-2021 Payment on Account £1,000
So in total Madge has paid £2,000 towards her 2020-2021 self assessment tax bill. She has £2,000 on her tax account.
When Madge submits her 2020-2021 self assessment tax return her actual tax may be higher or lower than the £2,000 she has already paid and this under or overpayment will then be adjusted in her January 2022 payment. This adjusted amount will be used to estimate the following year’s tax payment and this becomes the new figure for her payment on account.
When do payments on account apply?
What if My Profits are Small?
If your profits are small and your tax bill is less than £1,000 then you are not required to make any payments on account.
Assuming your tax is always over £1,000 you will always make payments on account in January and July.
What if My Profits Go Down?
If your taxable profits go down or you’re closing your business:
If you know your income and therefore your next tax bill is going to be lower you can apply to HMRC to reduce your payments on account
What if My Profits Go Up?
If your income and therefore tax bill turns out to be higher than the previous year you will have a balancing amount to pay in January and the next year’s payments on account will be higher.
This can be a bit of a financial shock to some business owners, so it’s worth carefully monitoring your expected profits to plan and manage your payments on account. Using a bookkeeping software such as Xero or even a simple spreadsheet can help you to do this.
If you have some questions about how to manage your Self Assessment and Payments on Account then give us a call to see how we can help you.
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