Payment on account surprises many freelancers, and it can be a painful cost you weren't expecting.
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Most well-prepared freelancers are aware they’ll need to pay income tax - and put 20-30% aside on each invoice.
However, something many don’t know about is “Payment on Account” - where you have to ALSO pay the next year’s tax in advance!
This can lead to your first year’s tax bill being 50% more than you expect.
If you’re a UK taxpayer who pays less than 80% of your income tax at source and your tax bill is over £1,000, you are likely to be told by HMRC to make ‘payments on account’.
Payments on account are payments towards your next year’s Income Tax.
When you’re self-employed, you’ll be paying your income tax annually via self-assessment.
After your first year of trading, you’ll be required to complete a tax return, and pay your tax bill to HMRC by January 31st.
However, if less than 80% of your earnings are not taxed at source (i.e. PAYE), you’ll likely also need to make payments on account - which is a process where you pay your estimated taxes for the following year in advance.
Payment on account is made every six months, and is actually intended to make paying tax a little easier for the self-employed, by spreading the cost over the year, rather than a single lump sum.
Once you’re established as a freelancer - this is as simple as paying your estimated tax twice a year, and HMRC will tell you how much you’ll need to pay, based upon your previous years turnover.
HOWEVER! In your first year of trading, you might end up needing to pay more than you expect. Let’s break it down!
It's the end of your first year of freelancing - it's time to complete your self-assessment.
You calculate you have a £1000 tax bill to pay, based upon your turnover for the first year.
This is due by January 31st.
HMRC will write to you to confirm your tax bill for 2024/2025 - £1000
They will also setup your "Payment on Account" for 2025/2026 - the FOLLOWING tax year.
You'll receive a bill for £1500 - which is £1000 for 2024/2025 and £500 (half) of 2025/2026.
Your 2024/2025 tax bill is due.
You'll have two payments due:
£1000 for 2024/2025
£500 for 2025/2026
It's tax return time again, you'll work out how much is due to pay, and submit your tax return.
Let's say this year is £2000 tax is due (you had a great year!)
You've already paid £500 towards this remember. But you actually made more than they estimated.
So HMRC, will send you a new tax bill for:
The new amount of tax due for 2025/2026 (i.e. an extra £1000)
And the updated estimate for 2026/2027 (which will be based upon this year, so another £2000)
Your next payment-on-account for 2025/2026 is due, the next £500 (or it might be adjusted basedupon your tax return).
Your balancing payments will be due for 2025/2026 (i.e. the extra £1000 you owe)
And your next year's payment on account will also be due (i.e. another £1000 as 50% of your estimated bill).
So as you can see, you’ll be making tax payments BEFORE you’ve even done the work.
For your first year of trading, this means you might end up paying 150% of the tax you expected to pay (i.e. the first year’s tax, AND half of the second year’s tax).
During your first year of freelancing, make sure you’re estimating your tax bill for your first year, but also put aside additional cash to pay your payment on account.
It’s only in this first year you’ll have that extra to pay - but if you’re not aware of it - it can be a nasty surprise, and there are of course fines if you don’t pay on time.
Payment on account is relatively simple, but can feel complicated.
Working with an accountant can help, as they can help you estimate your tax bill, give you guidance on how much you should be putting away, and help you keep on top of what payments you’ll need to make, and when.
If you don’t have an accountant, make sure you’re keeping good paperwork, and complete your tax return as soon as possible, so you can confirm what tax bill you’ll have to pay, including your payment on account.
There are some really helpful videos and guides from the ecosystem below.
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