Settle down, find a comfy chair, and turn the background music down a notch or two. You’ll want to concentrate on this one. Why? Well, because it affects almost EVERYONE who files a tax return ,and almost NO ONE understands payments on account. It’s nobody’s fault (we’ll debate this in a different blog). Payments on account are a notoriously mind-bending concept to grasp, and the reality is, no one really enjoys thinking about their large tax bills. We’re going to try break it down in a way that makes sense and helps you plan for the bills that come your way with cool, calm confidence.
The Payments On Account Basics
Definition: paying your tax in advance. Kind of. We always pay self-assessment tax way after we made the money anyway, so it’s not really in advance. But it is in advance of the usual January 31st deadline. The official word on the subject can be found on HMRC’s website here .
Here’s a 101 list of Payments On Account:
- It’s one bill split into two
- The first payment is in January, the second in July
- Total tax bill is based on the profit you made from April 6th – April 5th the year before
- The first year on payments on account is VERY difficult if you are unprepared.
- Almost anyone who earns enough through self-assessment to be taxed over £1,000 will automatically need to pay their tax through the payments on account system.
How Does HMRC Estimate The Bill?
Like everything HMRC does, it’s not left to chance. It’s estimated on the amount you paid the previous year. So if you paid a total of £1,000 of tax in 2024/25, then HMRC will estimate you will owe £1,000 of tax in 2025/26. However, there are no loose ends; each year’s tax is precisely tallied, and if at the end of 2025/26, it turns out your tax bill was actually £1,200, then your next bill will have the extra £200 added. Alternatively, if your 2025/26 tax bill was actually £800, then you’ll get a lovely refund to do with what you want.
Alex’s Case Study
Meet Alex. Alex is a freelance designer in Chester. She likes mango mojitos on Friday night after work and going for countryside walks with her rescue greyhound. For the 2023/24 tax year Alex did really well at work but unfortunately had a £2,000 tax bill. This is the first time her tax bill has exceeded £1,000. Alex (like a numpty) paid her tax at the last possible moment – January 31st, 2025. At that point Alex is also asked to pay her first payment on account for the 2024/25 tax year, which is 50% of her 2023/24 tax bill – £1,000. This means she actually has to pay £3,000 on January 31st, 2025. Then she is asked to make a second payment on account of £1,000 by 31st July 2025.
When Alex does her 2024/25 tax return, it turns out business was a little worse than last year and she actually only owes £1,800 for the year. She’s already paid £2,000, so she will be due a refund of £200 once her tax return is filed. However, she can’t get off the rollercoaster yet. On January 31st 2026 the process starts again, so she needs to pay her first payment on account for the 2025/26 tax year, which is 50% of her 2024/25 tax bill – £900. And then another £900 by July 31, 2026. So on and so forth.
A Timeline Of Alex’s Introduction To Payments On Account
- [1] 6th April 2023 – 5th April 2024 – Alex earns about £20,300 in profit = £2,000 tax to pay. She now earns enough to have to make payments on account.
- [2] 31st January 2025 – Alex pays £2,000 tax bill + £1,000 payment on account for the 2024-2025 tax year
- [3] 31st July 2025 – Alex pays her second £1,000 payment on account for 2024-2025 tax year
- [4] 6th April 2024 – 5th April 2025 – Alex earns £19,500 in profit = £1,800 tax to pay
- [5] 31st January 2026 – Alex gets a refund of £200 but also has to pay £900 payment on account for 2025-2026 tax year = £700 to pay
- [6] 31st July 2026 – Alex pays £900 payment on account for the 2025-2026 tax year
- [7] 6th April 2025 – 5th April 2026 – No change in Alex’s earnings, tax bill remains the same at £1800
- [8] 31st January 2027 – Alex pays £900 payment on account
And so on……
How Proactive Accounting Makes Payments On Account Better
All these advance payments on estimated future tax guesstimate bills can get overwhelming. It’s easy to feel a bit lost as to where you are and where you’re going. Taking a proactive approach to your accounts is the best way to take ownership of the process. This means calculating in advance what you think you might owe and then budgeting each month to make sure you have enough to make the payments every January and July. Tax surprises are almost never nice, and being proactive puts you back in control of your finances and reduces the confusion over “another tax bill”.
The Early Bird Avoids Tax Anxiety
Another way to stay in control is to make sure you file your tax return nice and early. If you file it enough in advance of the second payment on account deadline (July 31st) and your tax is lower than the year before, then HMRC will adjust your payment on account to reflect the actual amount of tax due. Take the example of Alex above. If she had filed her 2024/25 return nice and early, then in July she would only need to pay £800 instead of a £1000. If when you file you owe more tax than the previous year, your July payment on account will not increase, and you will know exactly how much will be due next January.
Save for Payments On Account in Advance
When your tax bill starts to go over £1000 and you now need to start paying payments on account for the first time, the first year can be very difficult for cash flow. Looking at the example of Alex, her tax bill was £2000 but she had to pay £3000 (her 2023/24 tax of £2000 plus her first payment on account of £1000). Then she has to pay another £1000 just six months later. If she wasn’t prepared for this, it could cause her significant cashflow problems. The key is to be organised and well prepared so 1) you knew this was going to happen and 2) you had saved up for the big tax bills.
A few specific things we do to help our clients feel more in control of payments on account include:
- Estimating their tax as the year progresses so there is no surprise
- Warning clients when they’re likely to be required to first pay payments on account – i.e. their tax bill is going to be over £1000
- Walking through and explaining their specific tax bill and how this will look with each payment on account
- Payment date reminders well in advance
- Helping them make applications to reduce payment on account if there’s a reduction in income
- Assisting clients to file their tax return nice and early to make their second payment on account as accurate as possible
- Provide regular advice and tips on making efficient tax-friendly decisions
If you’ve had enough head-scratching mystery tax bills, it sounds like you need us in your life. Get in touch with the best accountant near you via WhatsApp here: +44 151 662 0669, or if you’re ready to take the next step, set up a meeting here.
