When you become self-employed, the way you pay your tax can be confusing at first: Terms such as ‘payment on account’ and ‘balancing payments’ need to be understood, as well as two different deadlines to take into consideration.
The Payments on account which you make are staggered payments during the year, which are contributions towards the tax you will owe from your Self Assessment tax return. Because they are paid in two instalments, they help you to avoid having to make a huge payment at the end of the tax year.
Self Assessment – your first year
The first year of being self-employed is always the most difficult when it comes to payments on account. A few months after the end of your first tax year, HMRC will inform you of what they are expecting you to pay and when.
They will expect you to pay the full amount of your tax bill for your first year, plus 50% of that sum towards any tax you will owe for the next tax year. This 150% will have to be paid by 31st January in the year following the end of your first tax year as a self-employed worker, and late payment will result in penalties and charges.
For example, if your first self-employed tax bill for the tax year 2019-2020 was £10,000, you will need to pay £10,000 plus £5,000 – a total of £15,000 by midnight on 31st January 2021. Then you need to pay another £5,000 by midnight on 31st July 2021, as your second payment on account.
Therefore you will have paid your tax in full for the first year of trading, plus £10,000 towards tax which might be due for your second year of trading.
At the end of your second tax year, you will have your £10,000 already paid towards your tax bill, based on the fact that your tax bill was £10,000 for the first year. If your earnings were less than anticipated and therefore your tax bill is less, you will receive a tax rebate.
If your earnings in the second year, or subsequent years, remain the same as in your first year, you will still make payments on account twice a year, based on the previous year’s tax bill, by 31st January and 31st July.
Using our example above, your next payment on account due by 31st January would be £5,000, followed by a second payment on account of £5,000 by 31st July.
However, if you have earned more than anticipated in the second year, you will owe more tax.
This extra tax owed on the higher earnings for the second year must be paid by midnight on 31st January 2022.
This payment will be the difference between the £10,000 you have already paid and the balance due from the extra earnings and is known as your ‘balancing payment’.
You would need to make this balancing payment on top of the estimated payment on account for the next tax year.
Here’s how it works :
Year one - Tax year 2019 – 2020 - £10,000 tax bill
£10,000 to be paid in full by 31st January 2021 - Plus £5,000 first payment on account for the tax year 2020-2021
£5,000 to be paid in full by 31st July 2021 as second payment on account for the tax year 2020-2021
Year two - Tax year 2020-2021 - same tax bill of £10,000
HMRC has already received £10,000 towards this bill.
£5,000 first payment on account for the tax year 2022-2023 to be paid in full by 31st January 2022.
£5,000 to be paid in full by 31st July 2022 as second payment on account
Year two - Tax year 2020-2021 - higher tax bill of £20,000
HMRC has already received £10,000 towards this higher tax bill.
The difference of £10,000 to be paid in full by 31st January 2022 - Balancing payment
Plus £10,000 first payment on account for the tax year 2022-2023
£5,000 to be paid in full by 31st July 2021 as second payment on account for the tax year 2022-2023
Year two - Tax year 2020-2021 - lower tax bill of £8,000
HMRC has already received £10,000 towards this tax bill.
The difference of £2,000 will be repaid to you as a tax rebate
£4,000 to be paid in full by 31st January 2022 first payment on account for the tax year 2022-2023
£4,000 to be paid in full by 31st July 2022 second payment on account for the tax year 2022-2023