What are payments on account?
Payments on account (POA) are payments made towards next year's tax bill in advance. They are automatically calculated as part of your annual Self Assessment Tax Return if you meet certain conditions. To find out more, read on below.
Many people find that POA are an unwelcome surprise when it comes to paying their taxes, especially in the first year that they have to pay them. With the 31st January personal tax deadline fast approaching, we thought it would be useful to provide a summary on what are payments on account and how are they calculated.
How are payments on account calculated?
Payments on account (POA) are calculated as 50% of the total income tax and national insurance due from the preceding year. Note: This does not include any capital gains.
For example, if your total income tax liability for the year ending 5th April 20XX is £6,000, then your POA towards 5th April 20XY will each be £3,000 (50% of £6,000).
Why do we need to make payments on account?
We aren’t privy to the decision making at HMRC, however, we suspect that the reason payments on account were introduced was to improve HMRC’s cash flow and to make the tax system fairer.
How do POAs make the tax system fairer?
They do this by removing the advantage that self-employed people had as, before the introduction of POAs, they could pay their tax bill up to 9 months after the financial year ended.
On the contrary, somebody who is fully employed pays all of their taxes via PAYE each month BEFORE they receive their salary each month. Meaning that someone who is self-employed effectively has an interest-free loan from the government.
Is there a disadvantage to being self-employed if you need to make payments on account?
Although being asked to pay your taxes PLUS an additional 50% in advance may feel like a disadvantage, it still provides a small cashflow advantage to the self-employed individual as the financial year ends on 5th April and their taxes plus the first POA aren’t due until 9 months later. Since the POA is equal to 50% of their tax bill this means they’re only paying an estimation of 6 of the 9 months that have already passed. This means the self-employed individual is still receiving a 3 month cashflow advantage compared to someone who is employed.
When do you need to make payments on account?
If you meet the following two conditions you will be required to make payments on account.
- If your tax liability for the year is greater than £1,000
- Less than 80% of your tax is deducted at source (e.g. via PAYE)
If you meet both of the above then you will be required to make payments on account.
What dates do you need to make payments on account?
The first payment on account is due by the 31st January (usually with your regular tax bill).
The secondary payment on account is due by the following 31st July.
What if your payments on account are different to your final tax bill?
As the payments on account are estimations based on your previous years tax bill, there is always likely to be a difference between the estimations and the actual tax bill.
When we calculate your tax bill we calculate the difference and let you know whether you have anything additional to pay or a rebate.
What if your payments on account are lower than your final tax bill?
If your payments on account are lower than the final tax bill, then you will owe a balancing amount, plus the payment on account for the next year.
What if your payments on account are higher than your final tax bill?
If your payments on account are higher than the final tax bill (i.e. you have paid too much), then, you will owe next year's payment on account minus the balancing amount.
If you no longer meet the conditions for making payments on account and your payments on account are higher than the final tax bill, then you will be due a cash rebate from HMRC.
What if you expect next year's tax bill to be significantly lower or non-existent?
There are a number of reasons that you might expect next year’s tax to be significantly lower than the current tax year. For example, if you were a sole trader and you’ve converted to a limited company, you had rental income and sold your property or you expect to have less dividend income.
If this is the case, then you can manually elect to override your payments on account. To do this you should tick box 10 on page TC1 of the tax return. You will then need to input the value you wish to override the automatic 50% figure with in box 11.
Important: If you override the payments on account calculation and then your tax bill is higher than the amounts you overrode it by, you may owe interest and late payment penalties on the payments on account that should have been due. Therefore, you should only manually override the POA figures if you genuinely believe your income will be lower.
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