Many self-employed workers could be facing unexpectedly high tax bills under the UK’s payments on account system, a rule that requires certain taxpayers to pay part of their bill in advance for the next tax year.
HM Revenue & Customs (HMRC) expects millions of new entrants to self-assessment to make these upfront payments by the end of January. The measure is designed to ensure individuals keep up with their tax liability but can lead to larger than expected outlays, particularly for those unfamiliar with the rules or those experiencing variable incomes.
Ignoring these requirements may result in interest charges or penalties, making it essential for self-employed individuals to understand how the system works and what options are available if they are unable to pay.
Understanding payments on account
Payments on account are designed to ensure self-employed workers pay their tax bill not only for the previous year but also make advance contributions towards the current year.
Under the system, individuals must pay up to 150 per cent of their previous year’s bill by 31 January if they are liable, with a further 50 per cent due the following July.
This mechanism applies to those whose tax bill from self-employment exceeds £1,000 and who have not paid more than 80 per cent of their tax through other means, such as the Pay As You Earn scheme.
Who is affected by advance tax payments
The payments on account requirement predominantly affects individuals who have become newly self-employed and who owe significant income tax and National Insurance contributions.
The rule can come as a surprise to those filing their first self-assessment tax return, leading to potentially challenging cash flow situations at the start of the new year.
According to Sam Dewes, a partner at HW Fisher accountancy firm, “self-employed workers pay 150 per cent of the tax due for the previous year in one go” in their first year of self-assessment responsibility. In subsequent years, the system aims to level out payments.
Calculating the January tax bill
For example, a taxpayer owing £10,000 in combined income tax and National Insurance would be required to pay £15,000 by 31 January. This represents the previous year’s liability plus a 50 per cent advance towards the next year’s estimated tax bill.
An additional payment of 50 per cent equivalent to £5,000 in the given example would then fall due by 31 July, bringing the total payments up to date for the estimated current-year tax.
Purpose and challenges of the system
HMRC intends the payments on account system to keep self-employed individuals from falling behind on their annual tax obligations and to align their contributions more closely with those paid by employees via monthly payroll deductions.
However, the system assumes future earnings will match the previous year. For many self-employed workers, especially those with variable or seasonal incomes, this can create issues where estimated tax is not in line with actual earnings.
Options for those struggling to pay
Taxpayers who cannot afford the full payment at the January deadline may be able to arrange a “time to pay” plan with HMRC, allowing for instalments over an agreed period. Claire Thackaberry of the Low Incomes Tax Reform Group recommends this as a way to avoid penalties and debt recovery actions.
However, she notes, “interest charges will continue to apply” on outstanding balances. It is also possible for taxpayers to ask for their advance payments to be reduced if they expect to owe less tax in the coming year. Those applying for a reduction should proceed with caution, as underestimating tax bills without a valid reason may result in interest charges or even penalties.
Final Summary
The payments on account system represents a significant financial commitment for the newly self-employed, requiring advance payments that can take taxpayers by surprise. While intended to streamline the process and keep payments in step with those made by salaried workers, the scheme’s assumptions about steady income do not always reflect reality.
Those unable to meet their full obligation on time have options such as discussing a time to pay arrangement or requesting an adjustment, but they must be mindful of interest and penalty risks.
For a clearer overview of self-employment tax obligations and key deadlines, many workers turn to digital tax management tools like the Pie app to stay organised.
