When a person first becomes self-employed, the first tax bill can have an extra sting in it if they are required to make “payments on account”. There is a lot of confusion about what these represent, and when they are due for payment, so we hope to make them a little clearer in this blog and look at how to reduce payment on account.
Imagine an individual’s tax bill is £1,200.00 for the year ended 5th April 2019. Because this amount exceeds £1,000, payments on account are due towards the 5th April 2020 tax return. The payments on account are automatically calculated at 50% of the 2018/19 year’s tax bill: 50% of £1,200 is £600. The individual’s tax bills will be as follows:-If your tax bill exceeds £1,000, not only are you required to pay the full tax bill by the following 31st January, “payments on account” in January and six months later in July must also be made towards next year’s tax bill. Each payment is equal to half the previous year’s tax bill. An example is the best way of illustrating how this works:
|Tax in respect of 5th April 2019||£1,200|
|1st payment on account in respect of 5th April 2020||£600|
|Due for payment on 31st January 2020||£1,800|
- 2nd payment on account in respect of 5th April 2020 £600
- Due for payment 31st July 2020
As can be seen from the above illustration, the January payment is a large sum to pay. It represents one and a half year’s tax to pay all in one go. If the above tax payer’s earnings were £1,000 less for 5th April 2019, his tax bill would be just £900 in January 2020. That extra £1,000 earnings have effectively doubled his tax bill in January as he has had to pay half the next year’s estimated tax bill a year in advance.
If you have recently become self-employed or your tax bill is usually low enough not to require payments on account, it is well worth preparing your accounts and calculating your tax bill soon after 5th April to give you as much warning as possible if payments on account are suddenly required. Once that initial payment on account is out of the way, providing the tax liability remains relatively constant, subsequent tax bills are more regular amounts and, therefore, easier to manage.
HM Revenue and Customs (HMRC) have confirmed that both Payments on Account for the next tax year do not have to be paid until 31st January 2020, with no interest charged providing both the July and January payments are made by then.
When the 5th April 2019 tax return is prepared, if the tax due is more than £1,200 the balance is paid on 31st January 2020. So, for example, if the actual tax for 5th April 2020 turns out to be £1,300, then since £1,200 has been paid on account, a £100 balance is due in January 2020. Of course, payments on account are once again required. 50% of £1,300 is £650. This results in the following:
January 2020 Payment
|Balance of tax in respect of 5th April 2019||£100|
|1st payment on account in respect of 5th April 2020||£650|
|Due for payment 31st January 2020||£750|
July 2019 Payment
- 2nd payment on account in respect of 5th April 2019 £650
If less than £1,200 is due re 5th April 2019, the over-payment is deducted from the payment on account that is due in January 2020 (if a payment on account needs to be made).
You can reduce payment on account if the tax liability is expected to be less than the estimated amount. However, interest will be payable if the payments on account are reduced by too much.
Payments on account are not due is where at least 80% of the estimated tax liability is deducted at source during the tax year, for example, from wages, investment income or pension.
We hope this has been of assistance to you. Please bear in mind that individual circumstances vary and so the above is intended as a general guide only.
Mirandus Accountants supporting local businesses in the City of London and Greater London area, providing accounting and tax services to SMEs and OMB clients and access and training on QuickBooks.
Why not give us a call to see how we can help you be tax efficient.