The deadline for the second payment on account is fast approaching on July 31 2024. So, in this article, we will explain what payments on account are and why they provide an advantage to the self-employed over the employed.

What are payments on account?

If you’re self-employed or a director of a limited company, you’ve likely heard about HMRC's payments on account. These are compulsory advance payments towards your tax bill. These comprise the tax you owe and Class 4 National Insurance contributions.

Every year, HMRC wants you to make 2 payments on account toward your likely tax bill. They estimate these with each amounting to half your previous year’s tax bill. You need to pay the:

• First payment on account by midnight on 31 January
• Second payment on account by midnight on 31 July

Since these are based on last year’s tax bill, it’s unlikely they will match your actual tax bill exactly. This is where the ‘balancing payment’ comes into play:

• If your actual tax bill is higher than your combined payments on account (already-paid), then you must make a ‘balancing payment’ by midnight on 31 January the following year. 
• If your actual tax bill is lower than your combined payments on account, HMRC will issue you a payment on account refund.

Note: Payments on account don’t include anything you might owe for capital gains or student loans - you’d pay those in your ‘balancing payment’.

You can see what you owe and make these payments by signing into your Government Gateway account here.

The only time you wouldn’t need to make payments on account is if:

• Your last Self Assessment tax bill was below £1,000
• You paid more than 80% of the previous year’s tax you owed (for example via your tax code or in cases where your bank had already deducted interest on your savings)

If you'd like our help with your self assessment payments on account or with your accounting in general, get in touch today.

Example of payments on account:

‍Year 1 of business (202A/202B):‍

In the first year, you won’t have payments on account because there is no prior reference point to base them on.

For the year ended April 5 202B, your self-assessment tax bill is £8,000.

You must pay this tax bill by midnight on 31 January 202C.

However, at the same time, since you now have a prior tax bill, you will also pay the 1st payment on account for the 202B/202C tax year. Therefore by 31 January 202C, you will pay £12,000, made up of

• Your first year’s tax bill (‘balancing payment’) of £8,000 for the 202A/202B tax year
• Your first payment on account of £4,000 towards your future 202B/202C tax bill

Year 2 of business (202B/202C):‍

Based on your previous year’s tax bill (202A/202B) of £8,000, you need to make the:

• First payment on account of £4,000 by midnight on 31 January 202C (as stated above)
• Second payment on account of £4,000 by midnight on 31 July 2024

This means, in 202C, you have paid £8,000 in payments on account towards your 202B/202C tax bill.

Now after 202C is over, let's say your tax bill is actually £10,000 - this means you have underpaid (in payments on account) and need to make a balancing payment of £2,000 (£10,000 - £8,000) by midnight on 31 January 202D. 

At the same time though, you need to make the first payment on account for the following (202C/202D) tax year. At half the previous (202B/202C) tax bill this amounts to £5,000 (£10,000/2). Therefore, on 31 January 202D, you will pay HMRC £7,000, made up of:

• Your final ‘balancing payment’ of £2,000 for the 202B/202C tax year
• Your first payment on account of £5,000 towards your 202C/202D tax bill

You will then make a second payment on account of £5,000 on 31 July 202D.

If your tax bill for the 202C/202D tax year is more than £10,000 (your combined payments on account), you’ll make a ‘balancing payment’ by 31 January 202E.

Advantages of self employed payments on account‍

While payments on account can feel hefty at the time of payment, especially in your first year when you will be paying your full tax bill and your very first payment on account, they are in fact advantageous when compared to how employees pay tax.

The Time Value of Money (TVM) recognizes that a pound today is worth more than a pound at a future date because:

• It has earning potential in the interim - The additional funds at the business owners disposal can be reinvested within the business to enable it to grow faster
• Inflation and other factors may lessen its purchasing power - A pound in the future may not buy what it can today.

Short explanation

In essence, if you can pay (the same amount) later, the value of that amount is less. So, because someone who is self employed doesn't need to pay tax as they earn, they are technically at an advantage when compared to someone in full time employment:

• Full time employee - Pays taxes every month (deducted from pay)
• Self employed person:
  • Pays 1st payment on account on January 31 during the tax year: 4-10 month TVM advantage
  • Pays 2nd payment on account on July 31 after the tax year: 4-10 month TVM advantage
  • Pays ‘balancing payment’ (final tax bill) on January 31 after the tax year: 10-22 month TVM advantage

Detailed explanation

We will use this tax year which runs from April 5 2024 to April 6 2025 and assume your earnings remain relatively the same year-on-year.

A self employed person only needs to make the first payment (1st payment on account) for this tax year on January 31 2025. At half last year’s tax bill, this payment relates to 6 months (half) of the tax year. Relating it to the initial 6 months of the tax year (April 2024 - September 2024), this provides a 4 - 10 month TVM advantage over an employee. 

The employee paid tax in April, May, June, July, August and September. A self-employed person doesn’t pay anything during these months and they pay for these 6 months, 4 months later, on January 31st.

A self employed person makes the second payment (2nd payment on account) for this tax year on the 31st July 2025. At half last year’s tax bill, and relating this to the latter 6 months of the tax year (Oct 2024 to March 2025), this provides a 4-10 month TVM advantage over an employee. An employee paid tax in Oct, Nov, Dec, Jan, Feb and March (6 months). In addition, a self-employed person only needs to make this payment on July 31st 2025, that’s almost 4 months after the 5th of April 2025.

Lastly, as a self employed person you only make the ‘balancing payment’ on January 31 2026. That’s 10 months after April 5. So, if your earnings increase in the 2024/25 tax year, this provides you a 10-22 month TVM advantage on when you pay the tax for these additional earnings.

Last Word

Hopefully this article has helped you define and undertand the term "payment on account.' Although it may not seem like it at first, payments on account represent a clear advantage over monthly tax bills. The big dates you need to remember are 31 January and 31 July. Most importantly, don't forget to make your payment on account by the deadline, otherwise you might face penalties and/or interest from HMRC.

On the downside, this system does present an opportunity for you to spend that additional money instead of keeping it aside for your tax bill. If you wish to mitigate this risk, check out how to make a payment plan with HMRC.

If you'd like our help regarding payments on account or with your accounting in general, get in touch today.

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