Explaining why you pay personal tax on account
When your self-assessment tax bill goes over £1,000, you switch from the standard method of making one payment a year to making 2 payments a year on the payments on account system. The payments on account system for self-assessment makes sense on its own but the transition from standard payments to payments on account can cause significant financial issues for people. Standard payments are made over 9 months in arrears while payments on account are closer to ‘real-time’ so during the transition, you’ll pay a year and a half of tax in one go to catch up.
The diagram below shows the effect of the transition:
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Paying tax when your bill is under £1,000
Paying self-assessment tax when your tax bill is under £1,000 is simple as you’ll be able to use the standard payments method. This involves no estimates, no balancing payments and a minimum of 9 months before you’ll have to pay tax on income you receive. The standard payments method means that you simply pay all of the tax due for a given year by the end of the January after the tax year (about 9 months later).
The transition year
The dreaded ‘transition year’ where you effectively pay 18 months of tax at once with another 6 months of tax to pay 6 months later often comes as a surprise and people rarely prepare for it. When the normal 31st January deadline approaches for your first tax bill over £1,000, you’ll be expected to pay all of it as usual but with an extra 50% of that tax bill as a payment towards the tax for the current year. Then you’ll need to pay the other 50% of the previous year’s tax bill by 31st July. If this doesn’t cover the next tax bill, you’ll need to pay a balancing payment by the next 31st January along with the first payment on account for that year.
Paying tax when your bill is over £1,000
When you’re regularly paying on account it’s usually easier, to keep on top of taxes because you pay every 6 months rather than every 12. Each year HMRC will want a payment by 31st January during the tax year equivalent to 50% of the previous year’s tax bill and another equal payment by 31st July after the tax year end. If there is any under/over-payment, this will need to be paid/refunded by the following 31st January.
What happens if you can’t pay?
People regularly struggle to pay self-assessment tax on time during the transition year but there are 2 main options that could help out:
· If the increased tax bill was a one-off, and your income is likely to drop in the next year you can ask your accountant to manually reduce your payments on account. HMRC usually accept this but if your tax bill turns out higher than the payments you’ve made, you’ll be subject to pay interest on the difference.
· If you can’t reduce your payments on account, you can arrange a payment plan in order to pay the tax over several months. HMRC are likely to ask you why you can’t pay on time and also why you will be able to pay in the future so it’s a good idea to prepare for these questions. You can apply for a payment plan online here but with another tax bill 6 months after the 31st January deadline, the maximum you’ll usually get is a 6-month payment plan.
If your tax bill has historically been below £1,000 but you think it might go over this year, speak to your accountant as early as possible so you can plan for the extra expenditure.