Accountants Tax Guidance – Self employed Payments on Account
As accountants, the team at Digivolve can help set you up as a sole trader.
Alternatively we can seamlessly migrate you from an existing accountants.
We use software such as Xero and Quickbooks along with Receipt Bank to help make this as easy as possible.
Making tax digital is coming into force soon for sole traders from April 2023, at that point all records will need to be digitally processed.
Don’t forget to Contact us today to help you get this set up ahead of time.
Who do payments on account apply to?
Generally speaking payments on account apply to any person that pays personal tax.
This maybe someone self employed, or someone receiving dividends and salary from a limited company.
Payments on account also do exist from Limited Companies if your taxable profits are above £1.5m
So What is a payment on account for self assessment?In simple terms when your tax liability goes above £1,000 for the year, HMRC ask you to pay 50% of your liability then on account towards the next year.
A Common misconception people have is that’s unfair HMRC asking for my tax in advance.
It’s worth pointing out to begin with, that if your employed you start paying tax as soon as you start earning, so already HMRC allowing you to pay your tax later is a cashflow bonus.
Lets look at a time line to help explain:
6 April 2020 Joe starts as a sole trader after leaving his previous job. – This is the first day of the 2020/21 tax year.
Joe continues self employment up to 5 April 2021 earning a profit of £26,000.
As this point Joe has earned a profit for 12 months and not paid a single penny in tax. Still unfair right?
Joe speaks to Digivolve as his accountants in May 2021 and we work out his tax liability as £4,185 for the 2020/21 tax year.
Now for the payment on account part we take 50% of the 2020/21 tax liability which is £2,092.50 for the 2021/22 tax year and add it onto the £4,185 liability for 2020/21.
This makes the total due on £6,277.50, however you don’t actually pay your personal tax until some 10 months later. So the tax year 2020/21 that ends on 5 April 2021 has a tax payment deadline of 31 January 2022.
So what HMRC are doing is actually still fair, They are in a way asking you to pay 18 months worth of tax after you have been working for 22 (12+10) months so therefore still making you better off than being employed.
But what if my income for the next year goes down?
No problem as your accountants we can help you calculate your income from 6 April 2021 to 31 January 2022 when the tax is due and if its lower, we can reduce the payment on account down so you pay 50% of the new lower liability.
The concern here is that if we calculate this incorrect, HMRC can demand interest on the payment on account they should have got in the first place.
So what happens next year?So for the 2021/22 tax year, first of all in July 2022 you make your second payment on account in this case £2,092.50.
Then when we work out your 2021/22 tax liability we deducted the payments made on account to create a balancing payment due 31 January 2023, the process then all starts again.
This concept is definitely one of the hardest to understand for clients, and it’s one that catches people out, for example they save their tax liability and put that to one side.
When we tell them there bill is 50% higher than expected it can be a hard amount to find.
Our processes are aimed to help you understand these liabilities and help you know where you are to avoid surprises.
HMRC’s NI rates can be read – Here
To find out more about – Xero
To find our more about – Quickbooks
For a one on one conversation to help you understand this please Contact us