What is payment on account?

by Felicity Hannah on 27 January 2012  |  3 comments
Tweet

Could your tax bill be 50% bigger than you expect? Here's everything you need to know about payment on account.

There are some things in life that should be simple but aren’t. The clocks changing is one, timing a Sunday roast is another, and self-assessment taxation is yet another. It may not have to be taxing but it all too often is. 

As a freelancer, I’ve been filling out a tax return for many years. That means that every January, I get increasingly panicked phone calls from friends who’ve left filing their return to the very last minute and have been hit with a much higher bill than they expected. 

The final deadline has been extended to the 2nd February, meaning thousands of people will be filing last-minute tax returns at the moment. 

Now, it may not be sensible to leave the paperwork to the last minute (although I’m often guilty of that myself), but my friends aren’t crazy. Throughout the tax year, they have carefully saved 20% of their earnings to keep the tax man happy. So they are understandably horrified when the bill is even bigger. 

If you’re an old hand at filing a tax return then stop reading, and go and do it – the deadline is the end of the month and there’s talk of a strike on the very last day. But if this is your first time then read on as I explain payment on account… 

What is payment on account? 

By the end of the month, anyone who has to fill out a self-assessment tax return needs to have settled their bill for the financial year ending 5th April 2011. 

Most people will also need to make a ‘payment on account’ for the current financial year, which will be offset against their tax return due next January. 

This payment will usually be half of the current amount owed, as the tax man expects you will earn a similar amount this year as you did last year. 

You will also be expected to make a further payment in July. If your earnings have remained broadly the same year on year, then this means you’ll have settled your 2011-2012 tax bill. The following January, the only self-assessment tax you’ll need to pay is another payment on account. 

Normally this isn’t a problem, as you’re only ever expected to make a half-payment. However, if this is your first year filing a return then you could have to pay your year’s tax plus 50%. And that can really catch people out. 

Of course, if you’ve carefully saved your taxes as you’ve earned, then there’s no problem. But not everyone is quite that sensible. 

Show me an example 

Okay, say you owe £5,000 on earnings between 6th April 2010 and 5th April 2011. You need to make that payment by the end of the month. But you also need to pay an extra £2,500 at the same time, and then again by the 31st July. 

Then, when you file your return for the following financial year, you’ll already have paid £5,000 towards it. If you’ve overpaid you’ll be given a rebate and if you’ve underpaid then the rest is owed by January 31st 2013, and your payment on account will increase. 

Assuming nothing has changed, you’ll simply pay £2,500 every January and July, which should feel much more manageable. 

Why would the taxman do that?! 

For many people, this is entirely necessary. You don’t want to be saving for last year’s tax bill out of this year’s earnings. 

After all, that would trap you in a cycle of tax, where you’d be constantly working to pay off the previous year’s tax bill. You’d never be able to stop working, unless you saved double the tax in your final year. 

However, some cynics suggest that it’s also to give the government a bit of a financial boost in the middle of the year. 

Does everyone have to pay it?

You have to make a payment on account if your tax during the previous financial year was more than £1,000. However, that’s not the case if more than 80% of that year’s tax was taken off at source, for example, through PAYE. 

Can I lower my payment on account? 

If your earnings for the current tax year are likely to be less than the previous year, don’t panic, it’s easy to let the tax man know. 

There’s a fairly simple form to fill out (http://www.hmrc.gov.uk/sa/forms/sa303.pdf ), letting you state that your business profits are down, or that there’s another reason you owe a reduced amount. 

You can fill out this form online by logging into the self assessment website, selecting ‘customer services’, clicking on the ‘Request Us’ option and selecting ‘Reduce your payments on account’. 

I can’t pay, what can I do? 

What do you do if you’ve completely messed up? If you failed to save enough and simply cannot pay? 

It’s probably very tempting to just ignore the whole problem, but you can’t afford to. The tax man will charge you £100 for filing a late return, then another penalty at three months, six months and 12 months. If you delay by that long, you could have to pay more than £1,600. 

So, even if you can’t pay the outstanding amount, you need to file your return. 

If you don’t pay the money you owe then the tax man charges steep interest. After 30 days, you pay 5% of the tax you owe at that date, then again at six and 12 months. 

However, if you earn less than you did in the previous year then you’ll be charged less penalty interest on the outstanding payment on account. 

You need to get in touch with HMRC as soon as possible if you can’t pay, as you may be able to avoid any penalties and even spread your repayments over a period of time. But you need to talk to someone to arrange that; ignore the problem and it will get bigger and bigger. 

Of course, if you have a reasonable excuse, like you’ve suffered a life-threatening illness or a bereavement, the tax man can be lenient. Make sure you let the tax office know as soon as possible, by filling out the reasonable excuse claim form http://www.hmrc.gov.uk/online/excuse-missed-deadline.htm.

More: How the taxman could be misleading you  |  Taxman under fire over small firm crackdown