What is payment on account and how does it work?

If you’re self-employed or have income that isn’t taxed at source, you’ve likely come across the term “payment on account” on your Self Assessment tax return. While this critical part of the UK tax system can feel confusing initially, if you take the time to understand how it works, you’ll likely find that it’s fairly straightforward. And it’s pretty helpful, too. 

Here, we’ll explore what payment on account means, explain when it applies, and help you navigate it in practice.

What is payment on account?

So, what does it mean when a payment is on account?

Payments on account are advance tax payments that self-employed individuals and some other taxpayers in the UK make towards their upcoming tax bill. It’s a means of spreading your tax burden across the year, rather than facing one large payment when your Self Assessment is due.

When you submit your Self Assessment tax return, HMRC doesn’t just calculate what you owe for that tax year, they also estimate what you’re likely to owe the following year. If your tax bill (excluding any tax already deducted at source) is over £1,000, you’ll typically need to make two payments on account towards next year’s liability.

These payments are each worth 50% of the previous year’s tax bill, and they’re due on 31st January and 31st July. So if your tax bill for 2023–24 was £4,000, you’d make two payments on account of £2,000 each during 2024–25 — one by 31st January 2025 and another by 31st July 2025.

The system is designed to help both you and HMRC. For taxpayers, it means avoiding the shock of a massive tax bill all at once, and for HMRC, it provides a steadier flow of revenue throughout the year. It’s particularly relevant for self-employed people, landlords, and anyone else whose income isn’t subject to PAYE deductions.

While it might feel like you’re paying tax twice, you’re actually just paying it in advance. Any payments on account are credited against your final tax bill when you complete your next Self Assessment.

Looking for more info? The gov.uk website provides an overview on payments on account. 

When did payment on account start?

Payment on account has been part of the UK tax system since the introduction of Self Assessment. This process came into being during the 1995–1996 tax year and was fully operational by 1997. 

Payment on account helped HMRC to move away from the previous system where it was responsible for calculating tax liabilities — a system that was often plagued by delays and errors. The new approach placed the responsibility on taxpayers to calculate their own tax, with payments on account providing a mechanism to pay tax slowly throughout the year rather than one huge lump sum. The system has remained largely unchanged since.

What is the threshold for payments on an account?

The threshold for payments on account is £1,000.

You’re required to make payments on account to HMRC unless you fall under one of the following two categories: 

• Your last Self Assessment tax bill was less than £1,000
• 80% or more of your tax was deducted at source through PAYE

If your Self Assessment tax bill (after any tax already deducted at source) comes to less than £1,000, you don’t need to make any payments on account. You simply pay your tax bill in full by the 31st January deadline, and that’s it until the following year. However, once your tax bill exceeds £1,000, the payments on account system kicks in automatically.

The second exemption is equally important. Even if your tax bill is over £1,000, you won’t need to make payments on account if 80% or more of your tax was already deducted at source through PAYE or other deductions (such as tax deducted from savings interest by your bank). If the vast majority of your tax liability has already been collected through other means, HMRC feels that there’s little point in requiring advance payments.

This typically applies to people who earn employment income alongside their self-employment income, where most of their total tax liability has already been collected through their employment.

How does payment on account work?

OK, let’s take a look at what payment on account means in practice.

Payments on account are calculated based on your estimated earnings (usually the amount you earned the previous year). Each payment is usually half of the tax you owed the previous year. So if your tax bill for 2023–24 was £4,000, you’d make two payments on account of £2,000 each during 2024–25.

You make these payments twice a year:

• 31st January: Your first payment on account (alongside any balancing payment for the previous year)
• 31st July: Your second payment on account

When you complete your actual tax return, HMRC compares what you’ve paid on account with what you actually owe. If you earn more than you estimated, you may have tax to pay on top of your payments on account. This is known as a “balancing payment”. If you earn less than estimated, you may be able to claim a tax refund. You must make your balancing payment by midnight on 31 January the following year.

This can come as an unpleasant surprise and is one reason why it’s a good idea to do your tax return as early as possible — it gives you time to put money aside! Many newly self-employed people are caught off-guard because they effectively have to pay 150% of their tax bill in that first January payment. The process does become easier to manage after that, however.

The system assumes your income will be similar to the previous year, but of course business income often fluctuates. That’s where the balancing payment system ensures you pay the right amount in the end, with any overpayments refunded automatically.

Is payment on account compulsory?

Yes, payment on account is compulsory for most Self Assessment taxpayers. The only exception is if you fall under the two exempt circumstances described above (your last Self Assessment tax bill was less than £1,000 or 80% or more of your tax was deducted at source).

For everyone else, payment on account is compulsory. Once you submit your Self Assessment tax return, you are automatically enrolled into the payment on account system if you meet the criteria.

That said, there is some flexibility in the system. If you expect your income to be significantly lower in the current year compared to the previous year, you can apply to reduce your payments on account. But bear in mind that there are some risks involved.

Is it a good idea to reduce payments on account?

Whether it’s a good idea to reduce your payments on account depends on your specific circumstances, but it’s generally a decision that requires careful consideration. Be sure to weigh the pros and cons.

• The pros: If you have genuine reasons to believe your income will be significantly lower than the previous year, reducing payments can help with your cash flow. This might apply if you’re transitioning from self-employment to employment, taking a career break, or your business’s profitability has genuinely declined. 

If you know the tax you owe is going to be lower than last year, you can ask HMRC to reduce your payments on account either online through your HMRC account or by sending form SA303 to your tax office.

• The cons: The main danger is getting the calculation wrong. If you reduce your payments on account and your tax bill is higher than expected, you’ll be charged interest on the difference. This interest can be substantial and will apply from the original payment dates, potentially wiping out any cash flow benefits you gained. You’ll also need to find the extra money for a larger balancing payment.

Rather than reducing payments on account, it’s often better to make the full payments and claim a refund if you’ve overpaid. If your profits are indeed down, then HMRC will refund you the difference when you submit your tax return. This protects you from paying interest.

The key is being realistic about your income projections. If you’re absolutely certain your earnings will be lower, it might be worth considering. However, if there’s any doubt, it’s usually safer to stick with the standard payments on account and let HMRC refund any overpayment later. If in doubt, chat to your accountant or a tax consultant, they’ll be able to advise you. 

Quickfire summary: What does payments on account mean?

Payments on account are advance tax payments made by self-employed individuals and other Self Assessment taxpayers towards their upcoming tax bill. Rather than paying all your tax in one go, the system spreads the cost across the year through two equal instalments, each worth 50% of your previous year’s tax bill.

This system only applies if your Self Assessment tax bill exceeds £1,000 or if less than 80% of your tax was deducted at source through PAYE.

In practice, you’re essentially paying next year’s estimated tax bill based on this year’s actual figures. When you complete your next tax return, any difference between what you’ve paid on account and what you actually owe is settled through either a balancing payment or a refund.

Payments on account are designed to help you manage your cash flow by avoiding one large annual tax bill. Take the time to understand the system and set money aside, and you’ll feel more financially secure and better prepared. 

Also read:

• How to register as self-employed in the UK
• What expenses can I claim as self-employed in the UK?
• What to know about your business tax account (HMRC)