Why do the self-employed have to make payments on account?

‘Payments on account’ are advance payments made to HMRC towards your tax bill (including Class 4 National Insurance if you’re self-employed). They are essential but not always fair and often confusing, say tax experts.

You have to make two payments on account every year unless:

• your last Self Assessment tax bill was less than £1,000
• you paid more than 80% of the previous year’s tax you owed, for example through your tax code or because your bank had already deducted interest on your savings

Each payment is half your previous year’s tax bill. Payments are usually due by midnight on 31 January and 31 July.

Prepare for shocks

“This can be a major shock if you haven’t budgeted for this additional tax payment or you weren’t expecting it,” says Debie Warburton, Managing Director of accountants GW & Co.

Warbuton says payments on account bring the self-employed “someway in line with employees who pay their taxes via PAYE.”

“The only problem with payments on account is they are based on this year’s tax liability, if you earn less money next year then you will have paid too much tax,” she says. “You can apply to reduce your payments on account, but if you reduce them by more than the tax amount actually due then interest will be charged on the underpayment,” says Warburton.

But as reported by The Freelance Informer, many sole traders this year are not aware of how much they owe HMRC until the very last minute.

UK economy is far behind others and it’s impacting the self-employed

Sky News reported this week that Labour’s Thangam Debbonaire has criticised Jeremy Hunt after the International Monetary Fund forecast that the UK economy will fare worse than any other country in the developed world – including Russia – this year. Debbonaire goes as far as saying the IMF’s estimations of the UK are a “dud economy”.

Seb Maley, CEO of self-employed insurer Qdos CEO, sympathises with the self-employed who have been grappling with the ever-rising costs of doing business with other challenges of running your own business.

“You can’t help but sympathise with the self-employed after a tough couple of years,” says Maley.

Maley says that right now, many small business owners are struggling to pay their tax bills while “the former Chancellor of all people is under pressure to resign over his own tax affairs.”

It is particularly gruelling if you have had an unexpectedly good year and you get a bill that you knew was going to be higher but are asked to pay 50% of that again for next year, not knowing if the trend will continue.

Samuel Mather-Holgate, Mather and Murray Financial

Self-assessment has always been a bugbear for the self-employed and payments on account is certainly one thing that confuses people, says Samuel Mather-Holgate, an IFA at Mather and Murray Financial.

“It is particularly gruelling if you have had an unexpectedly good year and you get a bill that you knew was going to be higher but are asked to pay 50% of that again for next year, not knowing if the trend will continue,” says Mather-Holgate.

So, From HMRC’s view, the IFA says paying half upfront is “easier to manage from the taxpayer” because it is split into two payments so they are more likely to get their money but also PAYE pay in real time. Mather-Holgate says, “why should self-assessors benefit from paying 9 months after the tax year has ended?”

You can set your payments on account amount

However, Mather-Holgate, reminds the self-employed that there is some good news: “You can actually set what you pay HMRC on account. If you want to pay less, go into your Gateway ID and there is an option to reduce this down to £100. It will mean your end-of-year bill is that much more,” he says.

But others find the ‘payment in advance’ approach “particularly unfair to freelancers” because many work for larger companies and the payment culture in the UK is often very poor,” says Jill Poet, CEO of The Organisation for Responsible Businesses (ORB).

“Typically, a freelancer will have to wait 60 days or longer to get paid by clients and yet the HMRC wants payments in advance which can cause major cash flow issues for many freelancers,” says Poet.

Poet believes that it’s time government departments “valued the contribution of freelancers and micro businesses to the UK economy and the greater societal contribution they make.”

“They should treat these very small businesses fairly and with more respect for their unique circumstances and roles in our society,” says Poet.