Payments on Account Explained: Avoid Unexpected Tax Bills

One of the biggest shocks for people completing their Self Assessment tax return is discovering they owe not just the tax for the year that's ended, but also advance payments towards next year's bill. These are called "payments on account", and they catch thousands of taxpayers off guard every January. Understanding how they work can help you plan ahead and avoid nasty surprises.

What Are Payments on Account?

Payments on account are advance payments towards your next year's tax bill. They're based on the assumption that your income (and therefore your tax liability) will be similar to the previous year.

Think of them as HMRC's way of collecting tax throughout the year, similar to how PAYE spreads income tax across 12 monthly payments for employees. For self-employed people and others who complete Self Assessment, these payments ensure tax is collected more evenly rather than in one large sum.

Who Pays Them?

You must make payments on account if your Self Assessment tax bill (after deducting any tax already paid at source) exceeds £1,000.

You typically need to make payments on account if you're:

• Self-employed or a sole trader
• A partner in a business partnership
• Earning significant income from property rental
• Receiving untaxed investment income
• A higher earner with unpaid tax exceeding £1,000

You don't pay them if:

• Your last Self Assessment tax bill was under £1,000
• More than 80% of your tax was already deducted at source (e.g., through PAYE)
• This is your first year of Self Assessment

How Much Do You Pay?

Each payment on account is 50% of your previous year's tax bill. You make two payments:

• First payment: Due on 31st January (alongside your balancing payment for the previous year)
• Second payment: Due on 31st July

Example Calculation:

Your 2023/24 Self Assessment tax bill was £8,000. On 31st January 2025, you need to pay:

• £8,000 - your 2023/24 balancing payment
• £4,000 - first payment on account for 2024/25
• Total: £12,000

Then on 31st July 2025, you pay:

• £4,000 - second payment on account for 2024/25

When you complete your 2024/25 tax return in January 2026, if your actual tax bill is exactly £8,000, you've already paid it all through your two payments on account. If your bill is higher or lower, you either pay a balancing payment or receive a refund.

The January Shock

This system catches many first-time filers completely off guard. They expect to pay the tax they owe for last year, but don't realise they also need to pay half of next year's bill at the same time.

Real-World Scenario:

Maria became self-employed in April 2023. In January 2025, she completes her first tax return. Her tax bill for 2023/24 is £6,000. She expects to pay £6,000, but actually needs to pay:

• £6,000 - balancing payment for 2023/24
• £3,000 - first payment on account for 2024/25
• Total: £9,000

Plus another £3,000 in July 2025. That's £12,000 in total within seven months, even though her actual tax bill for 2023/24 was only £6,000.

This is why understanding payments on account from the outset is crucial for cash flow planning.

What If Your Income Has Dropped?

The payment on account system assumes your income will be similar to last year. But what if your income has fallen significantly? You can apply to reduce your payments on account.

When to Reduce Payments on Account:

• Your business income has decreased substantially
• You've stopped trading or taken a career break
• You've had significant one-off income that won't recur (e.g., a large capital gain)
• You've become employed and will pay tax through PAYE
• You've retired

How to Reduce Payments on Account:

You can reduce your payments on account when you file your tax return. There's a section where you can state what you think your tax bill will be for the current year, and HMRC will adjust your payments on account accordingly.

Alternatively, you can contact HMRC at any time to request a reduction.

The Risks of Reducing Payments on Account

While reducing payments on account can help your cash flow, there's a significant risk: if you reduce them too much and your actual tax bill is higher than you estimated, you'll face interest charges on the underpaid amount.

HMRC charges interest from the date the payment was originally due. The interest rate is currently 7.75% per year (as of January 2026), which can add up quickly.

Example of Getting It Wrong:

James reduced his payments on account from £5,000 to £2,000 (total of £4,000 instead of £10,000) because he thought his income would drop. However, his income was actually better than expected, and his final tax bill was £12,000.

He underpaid by £8,000 (£12,000 actual bill minus £4,000 paid on account). HMRC charges interest on this £8,000 from the dates the payments were due (31st January and 31st July). By the time he files his return the following January, he's accrued several hundred pounds in interest charges.

When Is It Safe to Reduce?

Only reduce your payments on account if you're genuinely confident your income and tax bill will be lower. If you're uncertain, it's safer to make the full payments and claim a refund later if you've overpaid. HMRC pays interest on repayments too, though typically at a lower rate.

What If Your Income Has Increased?

If your income has increased significantly, you might want to increase your payments on account voluntarily. This spreads your tax bill more evenly and avoids a large balancing payment in January.

You can do this by contacting HMRC or by making voluntary payments against your Self Assessment account throughout the year.

Benefits of Paying Extra:

• Better cash flow management - spreading payments across the year
• Avoiding a large bill in January
• Reducing the risk of late payment penalties if something goes wrong
• Peace of mind that you're staying on top of your tax

Making Payments

You can pay your Self Assessment bill (including payments on account) through various methods:

• Online or telephone banking: Usually clears same or next day
• Debit or credit card online: Clears within 3 working days
• Direct Debit: Can be set up when filing online
• At your bank or building society: Using a paying-in slip
• By cheque through the post: Takes at least 3 working days

Important: Payment must reach HMRC by the deadline. Different payment methods take different times to clear, so don't leave it until the last minute.

What Happens If You Miss a Payment?

Missing payment on account deadlines triggers penalties and interest:

Interest Charges:

Interest starts accruing from the day after the payment deadline at the current rate of 7.75% per year. This applies to both late payments on account and late balancing payments.

Penalties:

Late payment penalties apply as follows:

• 30 days late: 5% of the tax outstanding at that date
• 6 months late: Additional 5% of the tax still outstanding
• 12 months late: Another 5% of the tax still outstanding

These penalties are in addition to the interest charges, so the costs can mount up quickly.

Time to Pay Arrangements

If you genuinely cannot afford to pay your tax bill by the deadline, contact HMRC immediately to arrange a Time to Pay agreement. This allows you to spread payments over up to 12 months.

Key points about Time to Pay:

• You must contact HMRC before the deadline (or as soon as possible after)
• You'll need to explain your circumstances
• You'll still be charged interest, but at a lower rate than penalty interest
• You must keep up with the agreed payment schedule
• You must file your tax return before you can set up a Time to Pay arrangement

For amounts up to £30,000, you can often set up a Time to Pay arrangement online through your HMRC account. For larger amounts, you'll need to call HMRC.

Planning for Payments on Account

Set Money Aside Throughout the Year

The best way to manage payments on account is to set money aside regularly. A good rule of thumb: if you're a higher-rate taxpayer, set aside 40% of your self-employed income. If you're a basic-rate taxpayer, set aside 20-25% (accounting for the personal allowance).

Open a Separate Tax Savings Account

Keep your tax money separate from your business operating account. Every time you receive payment from a client, immediately transfer your estimated tax portion to your tax savings account. This makes the money "unavailable" and prevents you from accidentally spending it.

Remember National Insurance Too

Don't forget that payments on account also include Class 4 National Insurance if you're self-employed. This is typically 6% on profits between £12,570 and £50,270, and 2% on profits above that.

Plan for the First Year Shock

If you're in your first year of self-employment, you won't have payments on account to make in your first January. But in your second January, you'll face both last year's bill and payments on account for this year. Plan ahead for this by saving more aggressively in year two.

Payments on Account for Different Situations

Fluctuating Income

If your income varies significantly year to year (common for contractors and freelancers), payments on account can be frustrating. You might be paying advance tax based on a good year, only to earn less the following year.

Strategy: Review your income regularly and reduce payments on account if you're confident income has dropped. Keep detailed records to justify your reduction if HMRC queries it.

Seasonal Businesses

If you run a seasonal business with income concentrated in certain months, the July payment deadline can be particularly challenging as it may fall in a quiet period.

Strategy: Set aside money during busy months specifically for the July payment. Consider voluntary payments during peak season to spread the burden.

New Side Hustle

If you start a side business while employed, your first year won't have payments on account. But in year two, you'll need to pay both years' tax simultaneously.

Strategy: In your first year of side income, save as if you have payments on account to make. This builds a buffer for year two.

Common Questions About Payments on Account

Do I pay payments on account on capital gains?

Yes, if you've had a capital gain, the tax on it is included in your payments on account calculation. However, if it was a one-off gain that won't recur, you should reduce your payments on account for the following year.

What if I've overpaid?

If your payments on account exceed your actual tax bill, HMRC will refund the overpayment. This is paid automatically after you submit your tax return, usually within a few weeks. HMRC may pay interest on the overpayment.

Can I make payments on account in instalments?

The official payment on account dates are fixed (31st January and 31st July). However, you can make voluntary payments against your Self Assessment account at any time throughout the year, which will be offset against your liability when it becomes due.

The Bottom Line

Payments on account are designed to spread your tax liability across the year, but they require careful planning. The key is understanding that once you have a Self Assessment tax bill over £1,000, you're not just paying for last year - you're paying for next year too.

Failing to plan for payments on account is one of the most common causes of tax-related cash flow problems for small businesses and self-employed individuals. Setting aside money regularly, keeping a separate tax savings account, and understanding when to reduce (or increase) payments on account are essential skills for managing your tax affairs.

Concerned about managing your payments on account? MCC Partners can help you plan your tax payments effectively and avoid cash flow problems. Our experienced team at our Gravesend office provides comprehensive tax planning services for self-employed individuals and small businesses throughout Kent. Contact us on 01474 619 990 or email This email address is being protected from spambots. You need JavaScript enabled to view it. for expert guidance.