July 31 tax deadline - a freelancer's need-to-know

For freelancers, the self-employed and others who pay their liabilities to HM Revenue & Customs through self-assessment, another tax deadline is imminent!

So if you have to make payments on account of your income tax and class 4 National Insurance, then the second of these payments is due by Tuesday July 31^st.

And you may also have class 2 National Insurance to pay by the end of July.

But what exactly are payments on account, and how are they worked out? Emily Coltman ACA, chief accountant to FreeAgent, a provider of online accounting software for freelancers and other small businesses, runs through the key things you need to know:

What are payments on account?

Briefly, they're payments towards your next year's income tax and class 4 National Insurance bill - which you have to make if your tax and NI bill is over £1,000, or less than 80% of your income tax is deducted at source, i.e. taken off before you get the money; like PAYE from your salary.

So you may have already made a payment on account on January 31^st 2012, and have another one to make on July 31^st 2012, towards the tax you're going to have to pay on your income for the tax year 2011/12 (the year ending 5th April 2012).

How they're worked out

Each payment should be half the previous year's tax bill.

So, if your tax bill for 2010/11 was £1,500, then each payment on account for 2011/12 would be £750 - and this would be the amount to pay by July 31^st 2012.

What if I pay too much on account?

HMRC will give you the difference back. They'll either do this by cheque or bank transfer, or by deducting the difference from your next tax bill.

If you know in advance that you're going to pay too much on account because you know your tax bill will be lower next year - perhaps because you're winding down your business and your income will drop, or you're passing retirement age and no longer have to pay class 4 National Insurance, then you can apply to HMRC to reduce your payments on account.

Be warned though, if you reduce your payments on account too far the taxman will charge you interest and penalties for underpaying your tax.

So if you’ve already done your tax return for 2011/12 then you might be able to apply to HM

Revenue to reduce your payments on account, and pay less at the end of July.

Here’s how that works: Let’s say you’ve paid £750 on account for 2011/12 on January 31^st 2012. You’ve completed your 2011/12 tax return and discover that your tax and Class 4 National Insurance liability for that year is actually only £1,200. So if you pay £750 on 31st July 2012, you’ll overpay. You would therefore apply to HM Revenue to reduce both payments on account to £600 - because the payments on account are always worked out as a pair.

HM Revenue would then treat the extra £150 you’ve paid in January as an overpayment, and you would need to pay the difference of £450 to HM Revenue by July 31^st.

What if my tax bill goes up and I haven’t already paid the full amount on account?

Taking the above example, you've paid £1,500 on account for 2011/12, including £750 that you paid by the end of July 2012.

But let's say when you come to do your tax return in a couple of months’ time, you find you're actually due to pay £1,700.

Don't worry; all you'd do is to pay the difference to HM Revenue by the following 31st January, so that would be a payment of £200 by January 31^st 2013. HM Revenue calls this a "balancing payment".

Then of course you'd have to make your payments on account for 2012/13 - half of £1,700 each, so £850 each on January 31^st 2013 and July 31^st 2013. So you'd pay a total of £1,050 on January 31^st 2013.

When they're really nasty

Payments on account are particularly unpleasant the first year you have to pay them.

This may either be your first year of trading, or the first time your tax bill has gone over £1,000 in a tax year.

But whichever it is, you'll be paying effectively one and a half year's worth of tax and National Insurance on January 31^st.

So let's say you began trading between April 6^th 2011 and April 5^th 2012; have a tax and National Insurance bill of £1,400 for that year, and didn't have any tax deducted at source.

That tax bill would be due for payment on January 31^st 2013.

BUT... on January 31^st 2013, because your tax bill is over £1,000 you'd also have to make your first payment on account for 2012/13. That's half the prior year's tax bill - £700.

So on January 31^st 2013, instead of £1,400, you'll be paying £2,100! Ouch!!

This is one reason why it's a good idea to do your tax return as early as possible so you have time to put money aside!

What’s even nastier

Lastly, all taxpayers facing the July 31^st tax deadline should remember that HMRC’s penalty regime was revamped last autumn, under which there are interest charges if you don’t pay what you owe. On top of an automatic £100 fixed penalty, further penalties, after three, six months and a year, are likely to hit those who shirk their obligations.

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