Updated: Aug 7, 2018
When you first start a side-project, it might just be for a bit of pocket money. You do need to include that additional income in your tax return (there is a little exception which I’ll tell you about in a second), but you might have been used to, at first anyway, only having a small tax bill of a few hundred pounds each year.
You’ll know that if that’s the case, you need to pay your tax bill by 31 January of the following year by the very latest. That’s how it works for most people who have a self-assessment tax bill of up to £1,000.
For bills over £1,000
What you might not know or be prepared for is that once your tax bill exceeds £1,000, you’ll have to start doing something called “payments on account”. Some of my clients find this to be a bit of a shock and it can mean an expensive January if you’re not prepared for it. This is how it works.
Once your tax bill exceeds £1000, rather than being able to pay your tax bill by the end of the following year, HMRC will want you to make two instalments (payments on account) in the six and 12 months before your tax bill is due (which assume that your tax bill will be the same next year as it was this year), so that when you submit your actual tax return, you can just settle the difference with HMRC.
Here’s an example.
Let’s say you do your 17/18 tax return and your tax bill is £1,500 and this is the first time it’s been over £1,000. You’ll need to pay £1,500 on 31 January 19 to settle that bill. You’ll also need to pay 50% of that again on 31 January 19 as your first payment on account ahead of your 18/19 tax bill, and another 50% on 31 July 19 as your second payment on account. That means you’ll pay £2250 in total (£1,500 + £750) on 31 Jan 19 and a further £750 on 31 Jul 19 which means 2019 might be an expensive year for you.
Let’s say when you submit your actual 18/19 tax return, your bill is £2000, you’ll have already made payments on account totalling £1,500 so you’ll just settle up the £500 difference on 31 Jan 20, and of course make your first payment on account of £1,000 for 19/20 which will be 50% of the £2000 tax bill for 18/19. If I’m starting to lose you, this graphic might help you to understand what could be due and by when.
Payments on account allow you to spread your tax bill
What I’m trying to say, is that once you’re on payments on account, you spread your tax bill out over the year, but in the first year payments on account apply to you, you might find yourself facing a more expensive January than you were prepared for.
Although frustrating, HMRC are just trying to help you to budget more effectively for your tax bill by spreading your payments. And you can see that once you’ve gone through the first year of payments on account, things settle out nicely again (look at how much you’d pay in 2020 in the example above compared for 2019 for example).
How to be prepared for your tax bill
One way to be prepared is to calculate your tax return as early as you can in the year. I’m writing this post in July and there’s no reason why you can’t prepare and file your 17/18 tax return now, HMRC’s systems are open and I’ll share another post shortly about what to do if you can’t afford your tax bill as it’s good to know what to do, just in case.
And that exception?
Now, that exception I mentioned. If your side-project or startup really is just a bit of pocket money and the value of your sales is less than £1,000 in total (to be completely clear, that figure must be your sales, not your profit), you won't be taxed on it. It’s called the trading income tax free allowance and you can read more about it on HMRC’s website.
What if I need more help?
If you’re even slightly unsure whether this applies to you though, please speak to your bookkeeper or accountant or call HMRC, it’s important to get it right and if you need any more guidance on payments on account, there’s lots of information on HMRC’s website to help you. I'm of course, always happy to help, if you'd like to speak to me, please get in touch.