Please explain to me, in simple language, how self-assessment tax 'on account' works....

[MoneyMuppet]

DP's just been landed with a £25K tax bill from his self-assessment. It's such a big bill because he needs (I think) to pay off some tax from last year and then some in advance (on account). I

I don't get it. Is this right:
You pay your tax in advance and then whatever you actually should pay over that period is just deducted from that pot (i.e. what you've paid on account)?

Do you just have to wait until you stop doing self-assessment (so perhaps when you retire) to get the over-payment back?

I've looked on HMRC website but I can't make head nor tits of it.

Thanks for any insights anyone has!

When did he register as self employed? You normally only get the killer "here's the tax you owe and here's what we want you to pay on account" once - in the second year of being SE I think.

If your DH has been putting money aside to meet his tax bill then he should have enough to make the on account payment, as it is really just an estimate of the payment needed for tax on earnings in the first half of current tax year (ie since April 2023).

It will then be deducted from what he owes in his next tax return, when he’ll make a balancing payment for the remainder of this tax year and a payment on account for 2024.

So imagine you became self employed in April 2022. The first year for which you have to submit accounts is the 2022/23 tax year, and you have until Jan 2024 to do that (though you can do it sooner) which is quite a long time away from April 22 when you earned some of that money.

What HMRC then do is work out what you owe for 22/23, and then assume you'll earn the same in 23/24 so they want you to pay all of 22/23 and half of 23/24 by 31 Jan 24, and then the second half of 23/24 by 31 Jul 24.

Thereafter you are always paying your tax in the year that you earn the money - half in Jan, and half in July, based on last year's figures, and then you may need to make a small balancing payment with your Jan bill after you've done your tax return (and I assume, if you've overpaid they deduct it from what you owe).

Does that make any kind of sense?? I think the payments on account only kick in once your income is over a certain level (which it sounds as though your DH's is with that size of tax bill).

@Bramshott I'm not 100% sure but, yes, I think this is his second year of doing self-assessment. He had absolutely no idea about the 'on account' thing so the bill was quite a surprise 😂

Given he had no idea about the 'on account' thing, we'd under-estimated the tax to pay. So he hasn't been putting thing away specifically for it @SlipperyLizard
But we'll most definitely be starting to do so in February once the Big Bill is cleared!

That's helpful, @SlipperyLizard So one payment is an 'on account' payment and the next is a 'balancing' one, then repeat for the following two due dates?

This is a pain for me as last year I went onto paye. So would end up over paying. Need to work out how to tell them as the w website doesn’t make it easy

Basically.

They want half of your future next year's tax.

Then next year it will even out. Because you only need to pay 50% of last year's and 50% on account again

If there are extenuating circumstances and you know you will earn less the next year then you can pay less on account and write a note explaining this.

But you are paying 18 months late anyway. So if you have been keeping cash to the side then there should be enough to pay. It is only the first year you do the self assessment that there is such a big tax bill. The rest shouldn't be as much.

@Bramshott Yes, that makes a lot of sense, thank you so much!! I think I'm partly confused because I work April to April for finance things. But HMRC have now chucked January and July at me which hurts my brain.

Thanks @Finteq That makes a lot of sense - I thought you just kept paying on account basically until you retire 😂

If you have reason to believe you won't earn as much next year you can request not to pay on account. I did that when I had a bumper year due to a big job for a corporate client. Normally my clients are smaller companies or individuals and the income is pretty steady year on year so I argued against a whopping tax bill that wouldn't reflect real earnings.

PP who has now moved onto PAYE can argue for this too.

Thanks @WinterParakeets
DP's paid exactly the same amount each month for his self-employed work so predictions and earnings should be steady and realistic

It's horrible having to pay tax you haven't even earned the money on but this is how the tax system works. If you don't have the money speak to them quickly and they will come to an arrangement with you but you'll pay an additional overdue fee.

The first payment is tricky, because you pay what you owe, and half of what you owe for the next year. At the end of employment you'll have a light year, because you've already paid.

This is how mine works. Say my tax bill for 2021-2022 was £20k

If that was the first time I did POA I would pay the £20k I owed for 2021-22 - plus half of the next year's estimated tax bill, which would be 10k. So my total bill is £30k, due by Jan 31st 2023.

The next POA date is July 31st 2023. By this date I have to pay the remaining estimated £10k I owe for 2022-23.

Then I do the accounts for that year. (Can do these anytime from April 6th on). If my tax bill was £20k again, that would all be covered by the POA. However, I would need to pay half of next year's POA - £10k by Jan 31st 2024. Thé balance would be due on July 31st (also £10k). And so on.

However, say the business did less well that year, and the tax was only £15k. I'd have overpayed by £5k. My POA would also drop to £7.5k for half the next year. So HMRC owe me £5k, I owe them £7.5k. Total bill £2.5k.

Now imagine the business grew. So my tax bill rose to £25k. I've paid £20k in POA already, so I have a £5k bill, plus the POA will have risen to £12.5k for Jan and July. So I'll owe £17,5k in Jan, and £12.k in July.

At the end of self-employment, on my final tax return, I will have paid POA. So if my POA were accurate I have no bill at all. If they were low I'll pay the difference. If they were high I get a rebate.

Tax accountant here.

Say you owe £10,000 "balancing payment" for 2022-2023 (6th April 2022 - 5th April 2023. You pay the £10,000 by 31 January 2024.

Then you owe "payments on account" for 2023-24 (6th April 2023 - 5th April 2024) which are essentially prepayments of tax. HMRC assume your income will be the same so the two payments, due 31 January 2024 and 31 July 2024 are just your £10,000 balancing payment for 2022-23 split between the two dates. £5,000 each.

So 31 January 2024 you owe the £10,000 balancing payment plus £5,000 first payment on account, 31 July 2024 you owe the remaining £5,000 second payment on account.

31 January 2025 rolls around and you had a better year and owe £30,000 balancing payment for 2023-24. You deduct your two payments on account of £5,000 each meaning you have £20,000 balancing payment for 2023-24 to pay, plus payments on account of £15,000 in January and July (half your balancing payment).

If however, 31 January 2025 came around and you'd had a bad year and only owed £5,000 balancing payment, then after deducting your two £5,000 payments on account you would have a balancing refund of £5,000. Then your payments on account for 2024-25 would be £2,500 each (£5,000 balancing payment divided by 2).

Basically you will keep prepaying next years bill until your final year, where you would then claim to reduce the payment on account as you know your income will be less so you won't owe as much tax. You can claim to do this any year, but if you reduce them by too much and end up owing more you pay interest and they're charging something like 7% at the moment! A good accountant will as part of the service have a chat with you about what you expect profit levels to be like and see if there is scope to reduce the payments on account each year anyway for good cashflow.

I remember this double whammy, nobody told me and I hadn't got enough saved. I nearly had heart failure😱.

They let me pay the balance off monthly though.

The first year is brutal but then it evens out. It is tricky if your income is very variable though as you could end up wildly overpaying or needing a hefty balancing payment.

But the thing is- because the tax year is April to April, and your tax return isn’t due til the January following, you always earn the money before you pay the tax!
so tax year April 01 to April 02. January 03 you pay your taxes for all of that year 01-02, and half of the year April 02 to April 03. But it’s already January 03 by then, so unless you have a very bunched up earning period, you will already have earned 10 twelfths of your 02-03 income. By the time your second payment on account is due in July, you will be earning the income for 03-04! So if you always put away an appropriate percentage of your earnings AS THEY COME IN you will always be fine. Stick your percentage straight into a savings account, and think no more of it. Thus speaks a third generation self-employed person who grew up in a house where tax was always a terrible surprise…

It's not though. You never pay tax in advance of earning it.

The first payment on account on 31 January is half that year, and you've already earned it during April to September. The second POA is on 31 July and relates to the second half, October to March, so even with paying POAs, you're still paying 4 months in arrears and nothing in advance at all.

Thank you so much for all your insights. I think I get it.

We do have the money but it was ear-marked for going straight into ISAs, not paying the bloody taxman 😅

@Badbadbunny The overlap of the financial years and paying things in different months is frying my brain. I work on a year being April to April. But then HMRC are throw January and July at me and I can't cope. I can't figure out which tax year the POA is pertaining to, whether he's paying what he's already earned, or something in advance. I have no idea.
This is before you get to the fact I work in higher education where one meaning of 'year' is academic - October to October - but then we also have financial years which are August to August. Jesus Wept.

@buckingmad Don't get me bloody well started on the accountant situation. DP has an accounting firm who do work for his company but, apparently, they don't do the personal taxes of the company owners. I've told him he should just do an Ilana:

@MoneyMuppet id be moving accountants then! That’s very unusual for them to not provide the full service. 90% of our clients are business owners. We’d be losing a huge chunk of our income if we didn’t do the personal side of it.

@buckingmad Oh, believe me - you're preaching to the choir on that one. It'd take the accountants no time at all given that DP gets paid the same amount every single month. But he's adamant that they only do the business accounts 🙄

Never heard of that before. I've run my own accounting practice for 20 years and was employed as an accountant for 20 years before that. We've always offered to do personal tax returns for self employed clients and I'd say 99% of clients want us to do it for them, with just the occasional client wanting to do it themselves for various reasons.

I suspect it's more that your DH just doesn't want to pay for them to do his personal return. Either that, or he's using a cheap/unqualified firm to do the accounts who aren't regulated/insured to be HMRC agents for tax returns.

@MoneyMuppet i might have missed it in another post but do they offer any kind of tax advice? Ie whether it’s worth him incorporating and paying himself dividends? Company car benefit? Private pension contributions? Also how has he come to his tax figure? Accounting profit and taxable profit can be two very different figures!

Yes - say if you were starting from scratch, you lob them some up front, and at the end of the year they ask you for the difference. But at the same time, they ask you for another payment up front.

So in the first year it's a double whammy, you have to pay tax for that whole year plus some towards the next year as well.

It all evens out when you stop being self-employed or your earnings drop below the taxable threshold, and then they refund you.

Oh no, they're a big firm - regulated, legitimate, qualified etc.

I have no idea why DP doesn't get them to do his tax returns. I suspect it might be because the other shareholders don't and he doesn't want to risk using company cash for his personal accounting. But I've told DP he could just pay the accountants separately (i.e. not from the company account) to do his taxes. But he won't listen. I don't care, its his own weekends he's wasting trying to navigate the HMRC website.

I have no idea how he's reached that figure - that's just what HMRC spat out at him.
Yes, they've given more general tax advice.
The company's already incorporated.
They're not turning a profit yet so can't pay dividends to shareholders. DP's paid from the investment pot as a consultant.
DP doesn't drive so there's no need for a company car.
Not sure how private pension contributions would work - sorry if that's a bit thick.