Payments on account explained: avoid the double tax bill

If you are self-employed, or you earn income that is not taxed before it reaches you, there is a good chance HMRC will ask you to pay some of next year’s tax in advance. These advance payments are called payments on account.

They are the single most common cause of the “why is my tax bill bigger than I expected?” phone call. Not because the system is unfair, but because nobody warns you it exists until the first bill lands.

What payments on account are

Payments on account are advance payments towards your next Self Assessment bill. HMRC assumes your income next year will look like your income this year, so it asks you to pay next year’s tax in two instalments before the year is even finalised.

The intention is sensible: it stops taxpayers falling a full year behind. The experience, for anyone who did not see it coming, is a bill that appears to have doubled overnight.

Who has to make them

Broadly, payments on account apply when your Self Assessment bill passes a certain level and most of your income has not already been taxed at source, for example through PAYE. The exact conditions are set out in HMRC’s guidance on payments on account.

In practice, that tends to include:

• Sole traders and freelancers
• Company directors taking dividends
• Landlords with rental income

If most of your tax is collected through an employer’s payroll, you will usually escape. If you work for yourself, assume you are on the list until your accountant tells you otherwise.

How the two payments work: a worked example

You make two payments a year, each usually equal to half of your previous Self Assessment bill:

• First payment: 31 January
• Second payment: 31 July

Say your bill for year one comes to £4,000. Here is what HMRC asks for:

• By 31 January: the £4,000 for year one, plus £2,000 as your first payment on account for year two. Total: £6,000.
• By 31 July: another £2,000, the second payment on account for year two.

Then, the following January, your year two return is finalised. If your actual year two bill was more than the £4,000 you paid in advance, you pay the difference as a balancing payment. If it was less, you get the overpayment back or set against what is due. Either way, the first payment on account for year three lands at the same time.

Why the first year stings

The pain is concentrated in the first January after a decent year of profit.

You budgeted £4,000 because that is what the tax worked out to be. The demand says £6,000. The extra £2,000 is entirely legal, entirely standard and, for most people, entirely unannounced.

That is the trap. It is not a penalty and it is not a mistake. It is simply the system moving you from paying tax a year in arrears to paying it partly in advance, and the transition year carries one and a half years’ worth of tax.

Once you know it is coming, it stops being frightening. It becomes a number in your cash flow plan.

Can you reduce them?

Yes, if you genuinely expect your income to fall.

If next year’s profits will be lower, you can apply to reduce your payments on account, either through your HMRC online account or on form SA303. This is worth doing when you have real evidence: a lost contract, a planned break, a deliberate step down in work.

The warning is just as important. If you reduce your payments and your income does not fall, HMRC charges interest on the shortfall. Reducing payments on account to ease this month’s cash flow, with nothing behind the estimate, just moves the pain and adds interest to it.

Run the numbers properly, or have your accountant run them, before you touch the figure.

Building them into your cash flow

Payments on account stop being a problem the moment they are planned for. A few habits do most of the work:

• Set aside money for tax every month, in a separate account, rather than hoping January sorts itself out. This is the heart of the Profit First approach I use with clients: allocate the tax money when the income arrives, not when the bill does.
• File your tax return early. Filing in the summer does not change when you pay, but it tells you months in advance exactly what January and July will cost.
• Put both dates in your forecast. 31 January and 31 July are as predictable as rent. Treat them that way.

None of this changes what you owe. It changes whether the bill is a crisis or a calendar entry.

If you would like help planning for your tax payments so January stops being a shock, book an initial chat and we can map out what is coming.