Why does HMRC ask for payments on account?

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HMRC asks for “payments on account” to stop you from falling behind on your taxes and to bring the self-employed tax system closer to the way regular employees pay tax. Instead of waiting up to 20 months to collect tax on the money you’ve earned, HMRC uses payments on account to collect your tax in advance, spreading the cost into two manageable instalments. This prevents you from facing one massive tax bill and gives the government a steady flow of tax revenue throughout the year.

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If you are self-employed in the UK, understanding payments on account is vital for your financial survival. Here is a simple breakdown of what they are, how they work, and what you need to look out for.

What Exactly Are Payments on Account?

Payments on account are simply advance payments towards your next year’s tax bill.

Because HMRC doesn’t have a crystal ball to know exactly how much profit you will make in the current year, they have to guess. Their guess is based on a very simple assumption: you will probably owe the same amount of tax this year as you did last year.

How Do They Work?

Instead of making you pay your entire estimated tax bill in one go, HMRC splits it into two equal halves. Each half is exactly 50% of your previous year’s tax bill.

Here is the schedule you have to follow:

• 31st January: You pay the first half of your estimated bill for the current year.
• 31st July: You pay the second half.

When you finally submit your actual tax return for that year, HMRC will compare what you actually owe against what you have already paid in advance.

• If you earned more than expected and owe a little extra, you make a “balancing payment” to clear the debt.
• If you earned less than expected, HMRC will give you a refund.

Who Has to Pay Them?

Not everyone who fills out a Self Assessment tax return has to make payments on account. HMRC will only ask you to pay them if both of the following rules apply to you:

1. Your tax bill was more than £1,000.
2. Less than 80% of your tax was paid “at source.” (For example, if you have a regular day job alongside your side hustle, and most of your tax is already taken out of your paycheck through PAYE, you might not have to make payments on account).

Beware of the “First Year Shock”

The payment on account system works smoothly once you are in the cycle, but the very first time it hits you, it can be a massive shock to your cash flow. Accountants often call this the “150% payment.”

Let’s say it is your first year doing a Self Assessment, and your total tax bill is £2,000. When the 31st of January deadline arrives, you don’t just pay that £2,000. HMRC will also ask for your first payment on account for the next year (which is 50% of your bill, so £1,000).

Suddenly, your £2,000 bill becomes a £3,000 payment. If you haven’t saved up for it, this can be incredibly stressful. Always put extra money aside during your first year of self-employment to cover this hurdle.

What If You Are Earning Less Money This Year?

Because payments on account are just an estimate based on last year’s earnings, they can sometimes be too high. Business naturally goes up and down.

If you know for a fact that your profits are going to be lower this year—maybe you lost a big client, took time off, or had to buy a lot of expensive equipment—you do not have to pay the full amount HMRC is asking for.

You can log into your HMRC online account and select the option to reduce your payments on account.

A quick warning: Only do this if you are absolutely sure your profits have dropped. If you reduce your payments too much and it turns out you did owe the higher amount, HMRC will charge you interest on the money you underpaid.

The Bottom Line

Payments on account might feel like you are being double-taxed, but you aren’t paying any extra money overall. You are simply paying your tax bill upfront instead of at the end of the year. By setting aside a percentage of your income every time you get paid by a client, you will always be ready for January and July.

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