Contractors, are you all set to make your second Payment on Account?

As a contractor, you are likely paying yourself a mixture of salary and dividends from your own limited company, writes Amanda Swales, a director of GoSimpleTax.

Due to changes in the way dividends are taxed, it is possible you are having to make payments on account for the very first time during 2018 or that this year’s payments on account are higher than in previous years.

The first payment on account towards your 2017/18 tax bill was due by January 31st – and it’s the one that people tend to remember. After all, at this stage in the year you’re thinking more about tax as you submit your Self-Assessment.

By summertime, however, tax can feel like a distant memory -- which is why a lot of people forget about their second payment on account due this month, in July. With the deadline for this tax debt fast-approaching, we look at the two big questions contractors are posing.

1. When do I need to make the payment and why?

All second payments on account are due by July 31st. It might seem unfair that you have to pay the taxman again when you’re trying to sort your summer holidays, but there’s a logic behind it!

Payments on account are essentially advance payments towards your next personal tax bill (2017/18 tax year at the moment) -- and these are calculated based on how much you paid the previous year (2016/17). HMRC splits this debt into two, equal, instalments six months apart from one another (January and July) -- creating a pair of lower bills rather than one big one.

For example, if during the 2016/17 tax year you were paid an £11,000 salary and £30,000 in dividends, the total tax due is £1,875 to be paid in full on January 31st 2018. In addition to this, you would be required to pay two payments on account of £937.50 – one being on January 31st 2018 and the second on July 31st 2018.

The only instances where you will not need to make any payments on account are if your last Self-Assessment bill was below £1,000 or if over 80% of your annual tax bill is deducted at source, such as from employment. For example, if your total tax bill for the year is £10,000 and you have already paid £8,200 via your salary then, while you will need to pay the outstanding £1,800 by January 31st, you will not be required to make any payments on account.

2. How do I ensure that I’m paying the right amount?

It’s important to get your calculations correct. Pay too little, and HMRC will charge you interest, and may even issue penalties if you continue to delay making up your debt. Pay too much, and you’ll eventually be awarded a HMRC refund -- but you might be forced to wait some time to receive it!

If you believe your 2017/18 income is lower than in 2016/17, then it may be that you can reduce the payments on account to reflect this. However, a warning -- if you do elect to pay a lower payment on account and this is too little, HMRC will charge interest on any shortfall.

First, factor in the ‘dividend drop’ – the tax-free rate has fallen from £5,000 to £2,000 for the 2018/19 year. That’ll impact your Basic, Higher or Additional Rate payments by a small margin. Assessing what you’ve got to make up, with the missing £3,000 of tax-free dividends, is a good starting point.

Final recommendation

But there are a lot of different tax debts to remember when you earn money outside of PAYE. So we maintain that the best way to stay on top of everything is by using digital tax software. That way, you can ensure you fork out no more than you owe to HMRC when making your payment on account at times you'll remember, and times you won't!