What is the payment on account system and how does it work?

At Towerstone Accountants we provide specialist personal tax services, for self employed, and individuals across the UK. This article has been written to explain What is the payment on account system and how does it work, in clear practical terms, so you understand how personal tax and Self Assessment rules apply in real situations. Our aim is to help you stay compliant, avoid costly mistakes, and make confident tax decisions.

The payment on account system is one of the most misunderstood parts of Self Assessment. I regularly speak to people who are shocked to receive a demand from HMRC that appears to ask for tax twice. In reality, it is not a penalty and it is not HMRC taking more than it is owed. It is a way of collecting tax in advance based on what you earned previously.

In this article, I will explain clearly what payments on account are, who they apply to, how the amounts are calculated, when they are due, and what happens if your income changes. Everything is based on current UK rules and on what I see in practice each year.

What Payments on Account Actually Are

Payments on account are advance payments towards your next tax bill.

Instead of waiting until after the tax year has ended, HMRC asks certain taxpayers to pay some of their tax early. These advance payments are based on your previous year’s Self Assessment bill.

The system applies mainly to people who are not taxed fully through PAYE such as:

• Self employed sole traders
• Landlords
• Company directors with significant dividend income
• Individuals with multiple income sources

If your tax is already settled through PAYE, payments on account usually do not apply.

Why HMRC Uses the Payment on Account System

HMRC introduced this system to smooth tax collection and reduce large one off bills.

From HMRC’s perspective, if you are earning income regularly, it makes sense to collect tax throughout the year rather than many months after the income was earned. From a taxpayer’s perspective, however, the system often feels confusing and front loaded.

The key thing to understand is that payments on account are not extra tax. They are simply early payments towards tax you are likely to owe anyway.

Who Has to Make Payments on Account

You will usually have to make payments on account if both of the following apply:

• Your Self Assessment tax bill for the year is more than £1,000
• Less than 80 percent of your tax is collected at source such as through PAYE

If either of these conditions is not met, payments on account normally do not apply.

This is why many people are caught out in their first year of self employment. The first tax bill often triggers payments on account for the following year.

How Payments on Account Are Calculated

Payments on account are based on your previous year’s tax bill excluding Capital Gains Tax and student loan repayments.

The total is split into two equal payments.

Each payment is normally 50 percent of your previous year’s Income Tax and Class 4 National Insurance liability.

For example, if your Self Assessment tax bill was £6,000, you would usually be asked to make:

• £3,000 as the first payment on account
• £3,000 as the second payment on account

These payments go towards your next tax year’s bill.

When Payments on Account Are Due

Payments on account are tied to the standard Self Assessment deadlines.

The first payment on account is due by 31 January alongside any balancing payment for the previous tax year.

The second payment on account is due by 31 July.

This is why January bills can feel particularly high. You may be paying:

• Any remaining tax for the year just ended
• The first payment towards the following year

From my experience, this is the point where people often think something has gone wrong. It has not. It is simply how the system works.

What Happens When the Next Tax Return Is Filed

Once your next Self Assessment return is submitted, HMRC calculates your actual tax liability for that year.

There are then three possible outcomes.

If your actual tax bill is exactly what was expected, the payments on account will cover it.

If your actual tax bill is higher, you will need to pay a balancing payment to make up the difference.

If your actual tax bill is lower, you will either receive a refund or the excess will be offset against future liabilities.

This adjustment happens automatically once the return is processed.

What If Your Income Goes Down

This is an important point and one that many people are not aware of.

If you know that your income is going to be lower in the following tax year, you can apply to reduce your payments on account.

This is done through your Self Assessment account.

However, it must be done carefully. If you reduce payments too much and your income does not fall as expected, HMRC can charge interest on the shortfall.

From my perspective, reducing payments on account makes sense when income has clearly dropped and there is good evidence to support it. Guessing is risky.

Payments on Account in the First Years of Self Employment

The first few years of Self Assessment are often the hardest.

In year one, you usually pay tax for the year just ended.

In year two, you often pay the balancing amount for year one plus payments on account for year two.

This can feel like a double hit even though it is not.

I spend a lot of time explaining this to new sole traders because cash flow planning is essential. Understanding payments on account early helps avoid panic later.

How an Accountant Helps With Payments on Account

Payments on account are simple in principle but stressful in practice.

An accountant helps by:

• Explaining why the bill looks high
• Checking that HMRC’s calculation is correct
• Advising whether payments can be reduced
• Helping plan cash flow around the deadlines
• Making sure nothing is missed or paid twice

From my experience, once people understand the system properly, it becomes far less intimidating.

Common Mistakes I See

There are a few mistakes that come up repeatedly.

Some people ignore the July payment because it feels optional. It is not.

Others reduce payments without a clear basis and then face interest charges later.

I also see people assume payments on account apply to everyone in Self Assessment. They do not.

Understanding your own position is crucial.

Key takeaways

The payment on account system is not a penalty and it is not HMRC taking extra tax. It is simply a method of paying tax in advance based on what you earned before.

Once you understand how it works, when payments are due, and how they are adjusted, it becomes much easier to manage. From my experience, the stress around payments on account almost always comes from misunderstanding rather than the system itself.

The key is planning ahead. If you know what is coming and why, payments on account become a cash flow issue to manage rather than a shock to fear.

You may also find our guidance on Why is my second payment on account higher than expected, and How do I work out how much tax I owe, helpful when reviewing related personal tax questions. For a broader overview of Self Assessment deadlines, reporting, and obligations, you can visit our self assessment guidance hub.