Payments on Account: Why Your First Tax Bill Is Bigger Than You Expected

The first January after you start trading can ask for around one and a half times the tax you were expecting. Nothing has gone wrong — but nobody warns you.

The most common call an accountant takes in late January is some version of: "This cannot be right, it is nearly double what I put aside." It usually is right, and the reason is a feature of the system nobody explains when you register.

What they are

Payments on account are advance instalments towards next year's tax bill. HMRC assumes next year will look roughly like this year, so it asks for the same amount again, in two halves, before the year has even been assessed.

They apply when your Self Assessment liability is more than £1,000, unless at least 80% of your tax was already collected at source through PAYE.

Why the first January is heavy

Say your first year of trading produces a tax and Class 4 National Insurance bill of £6,000. On 31 January you pay:

• £6,000 — the balancing payment for the year just ended
• £3,000 — the first payment on account for the current year

That is £9,000 in one day. A further £3,000 follows on 31 July. You have not been overcharged; you have been moved onto paying as you go, and the transition costs one extra half-year of tax in a single month.

From the following year it settles down. Each January you pay the balance plus the first instalment, and because the instalments have already covered most of the liability, the balancing figure is usually small.

Reducing them

If you know the coming year will be worse — you have taken a job, lost a contract, or scaled back — you can claim to reduce the payments on account. It is a straightforward application.

The catch is that it is a claim, not a guess. If the year turns out better than you predicted and the reduced payments fall short, HMRC charges interest on the difference calculated from the original due dates, as though you had underpaid all along. Reduce on evidence, not on hope.

What to actually do

Set money aside monthly rather than facing the total in January. Take your expected tax and National Insurance for the year, add half again for the first year of trading, divide by twelve, and move it to a separate account on the day you get paid.

Our self-employed calculator will give you the annual figure in under a minute. The discipline of moving it monthly is what turns January from a crisis into a transfer.

Getting help with this

AJH Accountants handles self assessment for clients across the UK. We deal with HMRC, tell you what you can claim, and file on time, so nothing rests on you remembering a deadline. See how the service works, ask for a fixed-fee quote, or call the office on 01204 840303.

Originally published at ajhaccountant.co.uk/blog/payments-on-account-explained.