If you're self-employed or have other untaxed income, your first Self Assessment tax bill can come with a bit of a shock. You've calculated what you owe for the last tax year, only to see the total is much higher than you expected. The likely culprit? Something called 'Payment on Account'.
It's a common point of confusion, but it doesn't have to be. This guide will walk you through exactly what Payments on Account are, why they exist, and how you can manage them effectively.
What Exactly is a Payment on Account?
Think of Payments on Account as advance payments towards your next tax bill. Instead of paying all your tax in one large lump sum after the tax year ends, HMRC splits it into two instalments.
This system helps you spread the cost of your tax bill and ensures the government receives tax revenue more regularly, much like the Pay As You Earn (PAYE) system does for employees.
Why Do I Have to Pay It?
You’ll be required to make Payments on Account if two conditions are met:
- Your last Self Assessment tax bill was more than £1,000.
- Less than 80% of your income was taxed at source (for example, through a PAYE salary).
This mostly affects sole traders, freelancers, landlords, and partners who pay most of their tax through Self Assessment.
How Much Do I Have to Pay? An Example
The calculation is straightforward. HMRC assumes your income for the next tax year will be the same as the previous one. Each Payment on Account is 50% of your previous year's tax bill.
Let's look at an example:
- For the 2024/2025 tax year, your total tax bill is £5,000.
- You pay this £5,000 by the deadline of 31st January 2026. This is called your 'balancing payment'.
- At the same time, you must also make your first Payment on Account for the next tax year (2025/2026). This is 50% of the £5,000 bill, which is £2,500.
- Your second Payment on Account (the other 50%) of £2,500 is due later in the year.
This is the part that often catches people out. On 31st January 2026, your total bill wouldn't just be £5,000 – it would be £7,500 (£5,000 for 24/25 + £2,500 first payment for 25/26).
When Are the Deadlines?
The deadlines are fixed every year. Mark these dates in your calendar:
- First Payment: By midnight on 31st January
- Second Payment: By midnight on 31st July
Can I Reduce My Payments on Account?
Yes, you can. If you know your income in the current tax year is going to be lower than the previous year, you shouldn't have to overpay tax and wait for a refund. You might reduce your payments if:
- You've lost a major client.
- Your business profits are down.
- You've taken on a part-time job where you're now paying tax via PAYE.
- You've retired or ceased trading.
How Can I Reduce My Payments?
You can ask HMRC to reduce your payments either:
- Through your HMRC online account: When you file your Self Assessment tax return online, there's an option to reduce your Payments on Account for the following year.
- By post: You can fill in form SA303 ('Reduce payments on account') and send it to HMRC.
A word of caution: Be realistic and careful with your estimate. Don't reduce your payments just to improve your cash flow if you don't expect your income to fall.
I Reduced My Payments, but My Income Was Higher Than Expected. What Happens?
This is a very common scenario. You might reduce your payments anticipating a quieter year, only to land a big project that boosts your income. You were liable for the original Payment on Account, but incorrectly reduced it based on a genuine estimate.
So, what are the consequences? It's crucial to understand the difference between interest and penalties.
HMRC Interest Charges
If you made a genuine mistake and underpaid, HMRC's standard response is to charge interest on the amount of tax you paid late.
- How it works: The interest is calculated on the shortfall from the original due date of each Payment on Account (31st Jan and 31st July) until the date you settle the bill in full (usually the following 31st January).
- Why? This is not a fine. It's a commercial charge to compensate HMRC for not having the money when they should have. You can always find the latest late payment interest rates on the GOV.UK website.
For a genuine miscalculation, you will simply pay the tax you owe plus this interest.
HMRC Penalties
Penalties are more serious and are not applied for genuine errors of judgement. HMRC will charge a late penalty if they believe you acted carelessly or deliberately when reducing your payments. Late payment penalties are applied automatically by HMRC if tax is not paid on time. If you believe a penalty has been charged unfairly, you can write to HMRC and explain your reasons.
For example, if you reduced your payments on account because you expected your income to be lower, you will need to provide evidence to support this decision. It is then at HMRC’s discretion whether to accept your explanation and cancel or reduce the penalty.
What are the Penalties for Not Paying on Time?
This is different from underpaying due to a miscalculation. If you simply fail to pay your required Payments on Account by the deadline without communicating with HMRC, you will be charged both interest and late payment penalties.
The penalty system is based on how late the payment is:
- 30 days late: 5% of the tax due.
- 6 months late: A further 5% of the tax due.
- 12 months late: Another 5% of the tax due.
These penalties can stack up quickly, so it's vital to pay on time or get in touch with HMRC if you are struggling to pay.
Key Takeaways
- Payments on Account are advance tax payments, each being 50% of your previous year's bill.
- The deadlines are 31st January and 31st July.
- Your first payment is due at the same time as your main tax bill, which can lead to a large initial payment.
- You can reduce your payments if you expect your income to be lower, but be careful.
- If you reduce them too much by genuine mistake, you'll owe interest on the shortfall. Penalties are rare in these cases.
- If you simply pay late, you'll face both interest and penalties.
Understanding Payments on Account is key to managing your finances as a self-employed person. Always try to set aside money throughout the year so you're prepared for these deadlines. If you're ever in doubt, speaking to an accountant can provide peace of mind and ensure you're doing everything correctly.
