Understanding the UK tax system can be tricky, especially if you’re self-employed or have extra income from things like renting out property or investments. One important part of this system you need to understand is Payments on Account. This blog post will help break down what payments on account are, who needs to make them, how they are worked out, and tips for managing them without stress.
What Are Payments on Account?
Payments on account are advance payments you make towards your income tax bill for the next tax year. They are designed to help ease the financial burden by spreading out your tax payments instead of paying a large sum all at once. Here’s a deeper dive into why they exist and how they work:
Why Do Payments on Account Exist?
The purpose of payments on account is to make it easier for taxpayers to manage their cash flow. For many self-employed individuals and those with significant untaxed income, having to pay their entire tax bill in one go can be challenging. By splitting the payments into smaller, more manageable amounts, it helps to prevent financial strain and allows for better budgeting throughout the year.
Who Needs to Make Payments on Account?
You might need to make payments on account if:
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- You’re self-employed: This includes sole traders and partners in a business partnership.
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- You have additional income: This could be from renting out property, investments, or other types of untaxed income, where you owe more than £1,000 in tax.
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- Your tax isn’t collected automatically: For example, if you have significant untaxed income that isn’t covered by PAYE (Pay As You Earn).
How Are Payments on Account Calculated?
Payments on account are based on your previous year’s tax bill.
Here’s how it works:
Calculation: The payments are usually half of what you owed in tax the year before, not including any capital gains tax or student loan repayments.
Payment Schedule: You make two payments each year:
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- The first payment is due by 31 January.
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- The second payment is due by 31 July.
For example, if you owed £2,000 in tax last year, you would make two payments of £1,000 each for the current year – one by 31 January and the other by 31 July.
Balancing Payment
If your actual tax bill for the current year is more than the payments on account you’ve made, you’ll need to make an extra payment called a balancing payment. This is due by 31 January after the end of the tax year. If you’ve paid more than you owe, you can get a refund or use the extra amount towards next year’s payments on account.
Adjusting Your Payments on Account
If you think your income will be much lower this year than it was last year, you can ask HMRC to reduce your payments on account. This adjustment can help ensure you’re not overpaying and tying up money that could be used elsewhere. Here’s how you can do it and what to consider:
How to Reduce Your Payments on Account
Through Your Self Assessment Tax Return:
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- When filling out your Self Assessment tax return, you’ll have the option to request a reduction in your payments on account. There is a specific section where you can enter your estimated lower income and explain why you believe your tax bill will be lower.
Contacting HMRC Directly:
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- You can also contact HMRC directly to request a reduction. This can be done online through your HMRC account, by phone, or by writing a letter to HMRC. Be prepared to provide details and reasons for your expected decrease in income.
What to Consider
Accuracy of Your Estimate:
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- Ensure that your estimate is as accurate as possible. If your income turns out to be higher than you anticipated and your payments on account were too low, you will need to pay the difference by 31 January following the end of the tax year, which could result in a larger-than-expected bill.
Penalties and Interest:
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- Be aware that if you reduce your payments on account too much and end up owing more than you paid, you might have to pay interest on the underpaid amount. However, if you genuinely believe your income will be lower, reducing your payments can prevent unnecessary financial strain throughout the year.
Keeping HMRC Informed:
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- If your financial situation changes again and you expect higher income, you should inform HMRC to adjust your payments accordingly. This can help avoid large balancing payments at the end of the tax year.
Steps to Request a Reduction
Log in to Your HMRC Account:
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- Access your account on the HMRC website. Navigate to the Self Assessment section and look for the option to reduce payments on account.
Provide Estimated Income:
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- Enter your new estimated income for the current tax year. You’ll need to explain why you believe your income will be lower, such as a drop in business profits or a reduction in additional income sources.
Submit the Request:
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- After providing the necessary information, submit your request. HMRC will review your application, and if accepted, your payments on account will be adjusted.
Confirmation and Monitoring:
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- Once HMRC processes your request, they will confirm the new payment amounts. Keep track of your income and tax obligations throughout the year to ensure your estimates remain accurate.
Example Scenario
Imagine you’re a freelancer whose income fluctuates. Last year, you had a particularly good year and owed £4,000 in taxes. Based on this, HMRC would expect you to make two payments on account of £2,000 each for the following year. However, this year, you anticipate earning significantly less due to a drop in client work. You can request to reduce your payments on account to reflect your expected lower income, perhaps estimating that you’ll owe only £2,000 in total for the year, thus making each payment on account £1,000 instead of £2,000.
By understanding and utilising the option to adjust your payments on account, you can manage your finances more effectively and avoid overpaying tax when your income decreases.
Tips for Managing Payments on Account
Here are some simple tips to help you manage your payments on account:
Budgeting: Regularly save some money to cover your tax payments. You might want to set up a separate savings account just for your tax money.
Record Keeping: Keep good records of all your income and expenses. This will make it easier to work out how much tax you owe.
Get Professional Help: A tax advisor or accountant can help, especially if your income changes a lot or your tax situation is complicated.
File Early: Try to complete your tax return early. This will give you a clear idea of how much you need to pay and help you plan your payments.
Conclusion
Understanding and managing payments on account is important for anyone with untaxed income in the UK. By staying informed and organised, you can avoid unexpected tax bills and keep your finances under control. Whether you’re self-employed, a landlord, or have other sources of untaxed income, knowing how payments on account work will make dealing with your taxes a lot easier.
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