Tax
Payments on account: why HMRC wants tax you haven't earned yet
Payments on account are advance instalments towards next year's tax bill — and they're the reason so many first-year sole traders open their January tax calculation and feel physically unwell. The July instalment has just passed, which makes this the perfect moment to understand the system before the next cycle.
How it works
If your self assessment bill is over £1,000 (and less than 80% of your tax is collected at source), HMRC assumes next year will look like this year — and asks for it in advance: half on 31 January, half on 31 July. Each payment is 50% of last year's bill. When the actual year is settled, anything overpaid comes back; anything underpaid is due as a balancing payment.
The first-year shock
Here's the trap. Your first January bill includes the whole of last year's tax plus the first payment on account for the current year — roughly one and a half years of tax, payable at once. Nobody who hasn't been warned budgets for that. If you started trading recently, this paragraph might be the most valuable thing on this site: put aside more than you think you need this year, because January wants 150%.
When to reduce them
Payments on account are based on the past, so if this year's profits will genuinely be lower — you've lost a contract, gone part-time, had a rough patch — you can apply to reduce them. Done honestly, that's sensible cash management. Done optimistically, it backfires: reduce below what the year actually produces and HMRC charges interest on the difference. Our rule: reduce when you can evidence the fall, never to ease this month's cashflow.
Making it a non-event
The fix is boring and works: a separate tax pot, fed every time you're paid — 25–30% of profit for most sole traders — and a forecast of the January figure prepared in the autumn, not discovered in the new year. That's standard practice for our self assessment clients: by October you know your January number, and July stops being a surprise too. If January has ever hurt you, a short conversation now fixes the next one.
This is general information, not advice for your circumstances. If you'd like it applied to your situation, get in touch — the first chat is free.
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