Payments on account: why your January tax bill is bigger than the tax you owe

Every accountant in the country takes the same phone call in the first fortnight of January. Someone has logged into their HMRC account, seen the amount due by the 31st, and rung up to report an error. They worked out roughly what they owed. The figure on screen is half as much again.

There is no error. What they are looking at is the tax on the year that has just been filed, plus the first instalment of the tax on the year they are currently living in. That second half is a payment on account, and it is the single most common reason a profitable sole trader has a bad January.

What a payment on account actually is

HMRC does not want to wait until 31 January 2028 to collect any of the tax on profits you are earning right now. So once you are in Self Assessment properly, it asks you to pay next year's tax in two instalments, in advance, based on what you owed last year.

You are asked for payments on account unless one of two things is true: your last Self Assessment bill was under £1,000, or more than 80% of the tax you owed was already collected at source, typically through a PAYE tax code. Miss both exemptions and the instalments start automatically.

Each instalment is half of last year's liability. One falls due on 31 January, alongside the balancing payment for the year just filed. The other falls due on 31 July. They cover income tax and, if you are self-employed, Class 4 National Insurance. They do not cover capital gains tax or student loan repayments, which is why those two land in full in the balancing payment and catch people out a second time.

Payments on account are not an extra tax. They are the same tax, collected roughly a year earlier than most people mentally budget for.

The maths, with real numbers

Take a sole trader whose 2025/26 profit after expenses is £48,000. This is illustrative, but the rates are the real ones for that year.

Income tax first. The personal allowance is £12,570, so £35,430 is taxable at the 20% basic rate: £7,086. Then Class 4 National Insurance at 6% on profits between £12,570 and £50,270, so 6% of the same £35,430: £2,125.80. Total liability for the year: £9,211.80.

If this is the first year the trade has produced a meaningful profit, no payments on account were made during the year. So on 31 January 2027 the bill is the full £9,211.80 for 2025/26, plus the first payment on account for 2026/27 at half of it, £4,605.90. That is £13,817.70 due in one go. A second £4,605.90 follows on 31 July 2027.

The person who diligently set aside £9,211.80 is £4,605.90 short, in the month when the Christmas trade has been paid for and January invoices have not yet landed. That is the whole problem in one sentence.

The flip side is that year two is gentler, because £9,211.80 has already gone out before the return is even filed. If 2026/27 profit holds at £48,000, the January 2028 balancing payment is nil and only the next instalment is due. The pain is a one-off timing shift, not a permanent extra cost — but it is a large one-off, and it arrives without a warning letter.

The year profits fall is the year to act

The system assumes next year looks like last year. When it does not, the instalments are wrong in a way that costs you real money.

Suppose that same trader has a quieter 2026/27 and profit drops to £30,000. The actual liability is £17,430 taxed at 20% plus 6%, so £4,531.80 — while the instalments demanded total £9,211.80. Pay them in full and HMRC is sitting on roughly £4,680 of your working capital until the return is filed and the repayment comes back.

You can ask for the payments to be reduced, either through your HMRC online account or on form SA303, and you can do it right up to the January deadline. The condition is that the reduction has to reflect a genuine expectation of lower profits, not a hope or a cash-flow preference.

Here is the trap. If you reduce the instalments and the year turns out better than you forecast, HMRC charges interest on the shortfall from the original due dates, as if the money had been late all along. That interest rate is base rate plus four percentage points, which since 9 January 2026 has meant 7.75%. On a £4,000 reduction that proved unjustified for the best part of a year, you are looking at roughly £300 of interest for guessing optimistically.

The sensible discipline is to reduce only against a real number — a set of management accounts, a lost contract, six months of actual figures — and to reduce by less than you think you can. Reading your management accounts in fifteen minutes once a quarter is what turns this from a guess into a decision.

Build it into how the business runs

The fix is boring and it works: treat tax as a cost of every sale rather than an event in January.

Open a second bank account and move a fixed percentage of everything that comes in, on the day it comes in. For a sole trader with profits in the basic-rate band, 26% of profit covers income tax and Class 4 National Insurance together, so a transfer of around 25-30% of takings after direct costs is a reasonable starting rule to refine once you have a full year of figures.

Then, in the first year payments on account start, add a half-year on top. If your set-aside is on track for £9,000, you need roughly £13,500 in the pot by 31 January. Put the date and the number in the diary the day the return is filed, not the week before it is due.

And if the money genuinely is not there, act before the deadline rather than after it. HMRC's Time to Pay arrangements are far easier to agree while a bill is current than once it has gone into collection. Interest still runs at 7.75%, but the 5% late-payment penalties that bite on an unpaid balancing payment at 30 days, six months and twelve months are avoided.

None of this is complicated. It is simply the difference between knowing the number in July and discovering it on 30 January — which is the same difference as profit and cash flow, and just as expensive to learn the hard way.

Common questions

Do payments on account apply if I run a limited company?

Not to the company. Corporation tax is paid separately, normally nine months and one day after the year end, and it has nothing to do with Self Assessment instalments. But payments on account can still catch you personally as a director. If you take dividends on top of a small salary, your personal tax bill is settled through Self Assessment, and once it exceeds £1,000 with less than 80% collected under PAYE, the instalment system starts on your own return. Directors who move from a salary-only year to a dividend-heavy one are among the most common people surprised by it.

Can I reduce my payments on account?

Yes, through your HMRC online account or on form SA303, and you can do it up to the payment deadline. The reduction must reflect a genuine expectation that this year's liability will be lower, based on something real such as management accounts or a contract you have lost. If the year turns out better than you claimed, HMRC charges interest on the underpaid amount from the original due date, currently at 7.75%. So reduce against evidence rather than optimism, and if in doubt reduce by less than the maximum. Overpaying is repaid; underpaying costs interest.

What happens if I miss the 31 July payment on account?

Interest runs from 1 August at the late payment rate, which has been 7.75% since 9 January 2026, and it is charged daily on the amount outstanding. The 5% late payment penalties that apply at 30 days, six months and twelve months attach to an unpaid balancing payment, not to payments on account, so a missed July instalment is an interest cost rather than a penalty. It still needs clearing, because the unpaid amount simply rolls into what you owe on 31 January, making an already large bill larger.

Do payments on account cover VAT, PAYE or capital gains tax?

No. VAT and PAYE run on their own schedules and are unaffected. Capital gains tax and student loan repayments are excluded from the instalment calculation, which means they fall due in full as part of the balancing payment on 31 January rather than being spread. If you sold a property or a shareholding during the year, budget for that tax separately and do not assume the payments on account you have already made have covered any of it. Residential property gains also have their own separate 60-day reporting and payment deadline.