When you switch from being a traditional employee to a limited company contract role, one of the main changes you must become accustomed to is that tax will no longer be deducted at source.
Therefore, you’ll need to set aside money to pay this in your tax return, which is where ‘payments on account’ come into play.
How do payments on account work?
Payments on account are advance tax payments made twice a year by people who receive income that isn’t taxed at source, i.e. contractors who withdraw dividends from their limited company.
These payments are calculated based on the previous year’s tax, with each payment on account equalling 50% of the tax due and going towards the following year’s tax bill.
This can catch new contractors out – so it’s important to be aware that your first encounter with self assessment may be an expensive one.
In future years, however, assuming your income levels remain fairly constant, you’ll be in the self assessment cycle, and have always paid some of your next tax bill in advance.
Do I have to make payments on account?
You have to make payments on account to HMRC if:
You will pay less than 80% of the tax you owe at source i.e. through PAYE (which is why most people in ordinary employment are unaffected).
Your tax bill is more than £1,000
So, if you became a limited company contractor in 2023/24 and your tax bill for that tax year was £5,000 (and due on 31st January 2025), you would have to pay two payments on account for the 2023/24 tax year:
£2,500 on 31st January 2025 (making the total tax payable before this deadline £7,500)
£2,500 on 31st July 2025
These payments are then offset against your 2024/25 tax bill. In the above example, you would have already paid £5,000 towards your 2024/25 tax bill, so it’s important that you’re aware so you can set this aside also.
If your income the following year is higher and, as a result, you owe more tax, you need to make a balancing payment for your 2024/25 tax bill after you have filed that tax return.
It works the same way if the tax payable is less; you would be due a rebate.
What if I don’t earn as much as I did last year?
It is possible to lower your payments on account, if you have reason to believe your earnings for the current year are likely to be less than the previous year.
You can complete a ‘reduce your payments on account’ form through your online Self-Assessment account or by completing form SA303.
Completing these forms is also applicable when a contractor is no longer self-employed, as the tax paid in advance will not be required since it will be deducted at source.
The employee will receive a rebate on the taxes paid through the ‘payment on account’ system.
What about if you’re an umbrella company contractor?
If you’re an umbrella company contractor, you are an ’employee’ for tax purposes, so self assessment and payments on account are not a concern if your only source of income is from your umbrella.
