Everything you need to know to prepare for payments on account

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Sometimes, freelancing can feel like you’re living your best life. Want to work in your favourite cafe this morning? You can do that. Need a lie in after a late night? You do you. All this to say, you’re in control.

But all of a sudden it’s the new year and you’re also expected to have control over your taxes. Especially in the first few years of freelancing—when you’re finding your feet and focusing on growing your list of clients—sorting your tax return tends to get left to the last minute.

However, it pays to be prepared, even more so if HMRC moves you to payment on account for the first time. This system of tax for self-employed people spreads out your tax payments across the year, but if this is your first year on the system, you might be shocked to receive an unexpectedly hefty tax bill.

What is payment on account?

Payments on account allows freelancers to split their tax bill into two portions, to be paid in January and July each year. You’ll be moved onto this system as soon as your yearly tax bill exceeds £1,000.

The system works by estimating your current tax bill from the previous year’s figures. This number will be split, and you’ll have to pay 50% of the total by January 31st (the ordinary deadline for Self Assessment) and 50% by July 31st.

However, if you haven’t paid the previous year’s tax bill yet—as many don’t until January—this means that you will be stuck with a tax bill of 150% in the January of your first year of payments on account.

If this sounds confusing, it’s because it is. And though HMRC created payment on account to make paying tax simpler and more affordable for freelancers, the truth is that an unexpected move to payments on account can be tough if you have limited savings.

What does payment on account look like?

So, you’re currently completing your Self Assessment for the 2020-2021 tax year (the extension of the deadline means you can file by the 28th February 2022 without receiving a penalty).

Your total tax bill is £2,000. This means you cross the threshold to be moved to payments on account.

Your tax payments in 2022 will look like this:

  • 1st payment: £2,000, plus 50% of £2,000 as advance payment for next year’s bill = £3,000 due at the later date of 1st April 2022, though you will be charged interest 
  • 2nd payment: £1,000 to cover the rest of your advanced payment of next year’s bill, to be paid by 31st July 2022

In subsequent years, you will continue paying 50% of your estimated tax bill in January and 50% in July. After you first payment on account, you will not receive another bill for 150% of your tax figure.

If you’re dreading the thought of a massive tax bill and wondering whether you can kindly decline to be moved to payment on account—the answer is no. All freelancers who go over the £1,000 threshold will be automatically moved to payments on account as soon as you submit your Self Assessment tax return.

The only exception will be if you have already paid 80% or more of your tax bill already—for example, if you were employed for a portion of the last tax year and payed tax through PAYE.

Preparing for payments on account

The easiest way to get ahead with payment on account is to take accurate estimates of your tax bill throughout the year. If you have an accountant, they can help you estimate your tax bill for you, but as an early-stage freelancer you’ll likely be on your own in managing your finances.

Keep a spreadsheet of your earnings each month and track your income tax and National Insurance contributions (NICs)—likely to be both Class 2 and Class 4 NICs. You can also use HMRC’s Self Assessment tax calculator to get an estimate for your total tax bill for the current year. This calculator uses your weekly or monthly average earnings.

So, now you can predict your tax bill, and know that you’re likely to be moved to payment on account. But how can you make sure you’ll have enough money to pay your tax bill?

General consensus is that putting aside 30% of your profits each month should be enough to cover your bill. Remember, you should also be saving 10%-20% of your earnings each month for your pension.

If at the end of the year you find that setting aside 30% has resulted in more savings than your tax bill—great! Treat yourself for getting through another year of freelancing. It’s always better to put aside more than you need, unless this is affecting your ability to pay basic bills like rent.

What if my freelance income changes?

Payments on account works by estimating your tax bill for the year ahead from your previous year’s bill. So what happens if you think you’ll earn more or less in the upcoming year?

Well, you’re probably going to be more concerned if your earnings have taken a hit. In this case, find the ‘Reduce Payments on Account’ section in your online tax account. You’ll have to download and print a form to send to your tax office.

Alternatively, you could also pay your tax bills as they are. Then, after you’ve submitted your tax return, you’ll get a refund from HMRC. This is preferable to telling HMRC that you’ve earned less but actually you earned more, as then you’ll have to pay interest on the amount that’s still owed.

Payment on account might sound scary, but it’s designed to make it easier for you to budget your tax bill. As long as you’re prepared and have saved through the year, you’ll be fine. 

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