The single most common cause of tax distress among the self-employed is not the rate of tax. It is the January bill in the second year of trading, when the balancing payment for last year and the first instalment towards this year fall due on the same day — roughly 150% of a normal year's tax, payable at once, to someone who budgeted for 100%.
How the system works
Payments on account are advance instalments towards the current year's income tax and Class 4 National Insurance. There are two, and each is half of the tax you owed last year:
- 31 January — the first instalment for the current tax year, paid alongside any balancing payment for the year just filed;
- 31 July — the second instalment.
After the return is filed, the actual liability is compared with what has been paid. If the year was better than the last, a balancing payment falls due the following 31 January; if it was worse, the excess is refunded or set against the next instalment.
Two exemptions remove the obligation entirely. You make no payments on account if the tax you owed last year was less than £1,000, or if you paid more than 80% of last year's tax outside self assessment — through PAYE, or because tax was deducted at source. The second is why an employee with a modest amount of untaxed income rarely meets them, and why someone leaving employment to go self-employed meets them immediately in year two.
The second-year problem, with numbers
Take a trader whose first year of self-employment produces a tax and Class 4 liability of £12,000, due on the 31 January after that year ends. On that same date, the first payment on account for the following year — half of £12,000 — is also due. The cheque is £18,000. On 31 July, another £6,000.
Nothing has gone wrong; the system is simply catching up. But a trader who has set aside 12 months of tax and is asked for 18 will borrow, or will not pay. It is entirely avoidable with one instruction given in the first year of trading: put aside a proportion of every payment received, in a separate account, from the first invoice — and increase it in year one to fund the overlap.
Reducing them — carefully
Where you expect this year to be worse than last, the instalments can be reduced: through the online account, or on form SA303, stating the expected liability. It is a legitimate and frequently sensible step — a trader who has lost their largest customer should not be funding tax on profits they will not make.
The trap is optimism. If the reduced payments turn out to be too low, interest runs from the original due dates on the shortfall, at the base rate plus 4%. Reducing to nil because the year "feels quieter" is an expensive way of being wrong. The disciplined approach is to base the reduction on an actual forecast — management accounts to date, plus a realistic view of the rest of the year — and to review it before the July instalment rather than only in January.
The mirror-image mistake is failing to reduce when profits have genuinely collapsed, which funds HMRC with money the business needs and recovers it many months later.
What is not included
Payments on account cover income tax and Class 4 National Insurance. They do not cover capital gains tax, which is payable in full with the balancing payment — or, for UK residential property, within 60 days of completion. Student loan repayments are likewise excluded and settled through the balancing payment. The high income child benefit charge is the one people get the wrong way round: it is a charge to income tax and is not on the list of amounts deducted in working out payments on account, so it does form part of the liability the instalments are based on.
The practical consequence is a January collision, but be precise about what collides. The balancing payment for the year just filed and the capital gains tax on the disposal both fall due on the same date, alongside the first instalment for the following year. What the gain does not do is inflate that instalment: capital gains tax is stripped out of the payment-on-account calculation, so the instalments continue to follow income tax and Class 4 National Insurance only. A big gain makes the January cheque large; it does not make next year's instalments large.
Making January survivable
Three habits, in order of effect. File early. Filing in the summer does not accelerate payment — the money is still due on 31 January — but it tells you the number seven months in advance, which is the entire difference between planning and reacting. Set money aside per invoice, at a percentage that reflects your actual marginal rate rather than a guess. And where the money genuinely will not be there, arrange Time to Pay before the deadline: HMRC's self-serve arrangement covers liabilities up to a threshold without a conversation, and late payment penalties are avoided where an arrangement is agreed in time.
Acumon handles self assessment and the payment planning around it as part of private client tax work — including reduction claims where they are justified and Time to Pay where they are not enough. If you are in your first year of self-employment, the number to establish now is what next January actually looks like.