If you’re self-employed and submitting your Self Assessment tax return, you may not have realised that you might need to make an additional payment called a payments on account (POA). Payments on account are payments made in advance towards your next year’s tax liability.
If your tax liability, taking into consideration income tax and Class 4 NICs due, is above £1,000, you will be asked to make an additional payment towards your next tax liability and this is called a POA. The POA is calculated as half of your tax liability and is payable twice in the year – once by 31 January alongside your tax due and again by 31 July.
If this is the first year that your tax has crossed this threshold you will effectively be paying your tax liability 1.5 times in January or 150% of your tax liability in one go. The POAs made will then be deducted off the following year’s liability.
As an example, your tax liability is £2,000 and this is the first time it’s been above the £1,000 threshold. The amount due by 31 January will be £2,000 + £1,000 (half of the amount due) = £3,000. The amount due by 31 July will be £1,000.
Your next tax liability totals £2,500. Of this, you have already paid £2,000 so the total amount due by 31 January will be £2,500 – £2,000 = £500 + £1,250 (half of £2,500) = £1,750. The amount due by 31 July will be £1,250.
If you’re new to Self Assessment, payments on account is not something that is widely understood and may catch you by surprise. If your tax liability is currently under £1,000 but you expect it to cross £1,000 in the next tax year, it would be advisable to budget for the additional tax due so you have enough funds saved.
The general rule of thumb would be to put aside an additional 50% of the amount you currently put aside to meet your January liabilities. Based on the first example above, if you put aside £166.67 a month to meet the £2,000 liability, you should put aside an additional £83.33 to meet the POA due for January. In cases where you can’t pay the whole tax liability by the deadline, you are likely to face interest charges on any outstanding amount. If this is the case, get in touch with HMRC to arrange a payment plan.
If you are switching jobs, freelancing or operate within particular trades your income may fluctuate. If you suspect that your income for the next tax year will be lower than the previous tax year, you can ask HMRC to reduce your payment. This can be done via your HMRC online account by selecting ‘Reduce Payments on Account’ or you can send the SA303 form. In cases where your income is higher the following tax year, you will be required to make what’s known as a balancing payment.
A warning however: if you reduce your payments on account to below the level of the next year’s tax liability, HMRC will charge you interest from the date that the payment on account should originally have been paid. At the time of writing (January 2023), the HMRC late-payment interest rate is 6%, so underpaying payments on account could result in quite a significant interest charge.
In the example above, the £500 payment is the balancing payment; this is the process of reconciling your tax liability for the year with the payments on account you have paid. Any amount still outstanding after POAs have been taken into account is known as a ‘balancing payment’. You will likely have a balancing payment every year, as it is very unlikely that your tax liability will be precisely the same amount as your POAs.
In other words, if you’ve made a payment on account of £2,500 towards your next year’s tax liability and you find that you’re actually due to pay £2,750, you will need to make a balancing payment of £250 to HMRC when you do your next tax return. Similarly, if your tax liability for the year is less than the POAs you have paid, HMRC will refund the difference to you.