How do payments on account work for self-employed people?

Understanding the basic idea of payments on account

Payments on account are a way of paying your tax bill in instalments rather than in one single lump sum. They are most commonly associated with self-employed people because self-employment income can fluctuate, and because there is no employer taking tax from wages each time you’re paid. Instead of paying the entire amount of tax for a year all at once after the year has ended, payments on account spread the cost forward into the next tax year.

If you’re new to self-employment, payments on account can feel confusing and even a little unfair at first glance. A very common reaction is: “Why am I being asked to pay tax for next year before I’ve even earned it?” The key to understanding this is that payments on account aren’t an extra tax. They are advance instalments towards your next bill. If your next year’s tax turns out to be lower, you can reduce the payments or receive a refund or credit. If your next year’s tax is higher, you’ll pay the difference later.

Although the rules vary by country, the concept is generally the same: once your tax bill reaches a certain level, the tax authority assumes you will have a similar liability in the following year and asks you to pay in advance. This makes tax collection steadier and reduces the chance of people falling behind, but it also means you need to plan your cash flow carefully as a self-employed person.

Who typically has to make payments on account

Payments on account usually apply to self-employed people and others who receive untaxed income, such as landlords or people with significant investment income. The typical trigger is that your tax bill for the year (often excluding certain amounts already collected at source) is above a threshold. Once you cross that threshold, the system expects you to pay the next year’s tax in advance.

In practical terms, this tends to affect self-employed people once their business has moved beyond a small side-hustle level and starts generating consistent profits. When you first start out, your first year’s tax is normally paid after the year ends, because there is no prior-year liability on which to base advance payments. After that first year, payments on account often begin.

It’s also possible to be self-employed and not need to make payments on account. That might happen if your profits are low, if most of your tax is already collected at source through other income streams, or if the relevant threshold hasn’t been reached. So payments on account are common, but not universal.

Why tax authorities use this system

From the tax authority’s perspective, payments on account solve a practical problem: if self-employed people only paid after the year ended, there would be a longer delay between earning income and paying the related tax. That can increase the risk of non-payment, create large one-off bills that are hard for people to afford, and make government revenues more uneven.

By collecting tax in advance, the system smooths payments. For self-employed people, it also creates a rhythm of regular tax deadlines that can encourage better budgeting. The downside is that it shifts some of the burden onto the taxpayer earlier than they might expect, which is why it can be so startling in the first years of running a business.

Once you’ve been self-employed for a while and you budget for it properly, payments on account often feel less dramatic. They become part of your annual financial cycle. The key is recognising that your “real” tax outflow each year is not just what relates to last year’s profits, but also what you’re prepaying for the next year.

How the amounts are calculated

Payments on account are usually based on your previous year’s tax bill. The logic is simple: if last year you owed a certain amount, you’ll probably owe a similar amount this year. The tax authority then splits that estimated amount into instalments.

Most systems calculate payments on account as two equal instalments, each typically equal to half of the previous year’s relevant tax liability. “Relevant” matters here: depending on the rules, certain components of your bill might be excluded, especially if some tax has already been collected at source. But conceptually, think of it as the portion of your tax that wasn’t already paid automatically.

At the end of the next tax year, you submit your return and the actual tax owed is calculated. Then the payments on account you already made are credited against that actual amount. If your payments were too high, you may get money back or have a credit applied to future liabilities. If your payments were too low, you’ll pay the balance as an additional amount.

Because the calculation relies on last year’s result, it’s a blunt instrument. It works reasonably well when income is steady, but it can be awkward when profits rise or fall sharply. That’s why it’s so important to understand when and how you can adjust payments on account, which we’ll cover later.

How payments on account fit into your overall tax timeline

To make sense of payments on account, it helps to imagine your tax obligations running on two tracks at once: one track is “true up” for the year that has ended, and the other track is “prepay” for the year you are currently in (or about to be in, depending on the exact calendar).

In a typical setup, you file a return for the prior year and pay any remaining balance for that year. At the same time, you make the first instalment towards the next year. Then later in the year, you make the second instalment. Finally, when the next return is filed, the cycle repeats: you pay any balancing amount and start the next round of advance payments.

In other words, once you’re within the payments on account system, your tax deadlines are not simply “pay last year’s tax”. They are “pay last year’s balance plus start paying next year’s tax”. That combined effect is what often creates the shock of the first payments on account, because the bill can feel almost doubled compared with what you expected.

It’s worth emphasising: it’s not doubled forever. It’s a timing issue. You’re moving from paying in arrears to paying partially in advance. Once you’re established in the cycle, each year you will generally pay about one year’s worth of tax, just allocated across multiple deadlines and with a balancing adjustment at the end.

The “first time” shock and why it happens

Many self-employed people experience a difficult moment when payments on account begin. The reason is that your first year of self-employment often creates a tax bill that you pay later, after that year has ended. By the time the payment date arrives, you may have already used the cash, reinvested it, or simply not set aside enough.

Then, when payments on account kick in, you can be asked to pay not only the full balance for that year but also an advance instalment for the next year. If you were expecting to pay, say, £5,000 (or your local equivalent) for the year, you might suddenly be asked for £7,500 or £10,000 depending on how the system is structured. That feels like an enormous jump, and it can be stressful if you haven’t planned for it.

The practical takeaway is that the earlier you build a habit of putting tax money aside, the less painful this transition is. A separate savings account for tax, regular monthly transfers, and realistic profit projections can make the process manageable.

Worked example: steady profits

Let’s walk through a simplified example. Imagine that in Year 1 of your self-employment, you calculate a tax liability of 6,000. You file your return after the end of Year 1. When it comes time to pay, the system asks you to pay the 6,000 balance for Year 1. Because this is now your most recent tax bill, payments on account begin for Year 2.

The system estimates that your Year 2 tax will also be 6,000, and it asks you to pay it in two instalments of 3,000 each. Often the first instalment is due at the same time as the Year 1 balance. So at that payment date, you pay 6,000 (Year 1 balance) plus 3,000 (first instalment for Year 2), totaling 9,000. Later in Year 2, you pay the second instalment of 3,000.

At the end of Year 2, you file your return and your actual Year 2 tax is calculated. If it really is 6,000, then you’ve already paid it through the two instalments. There might be no extra amount due for Year 2 other than starting Year 3 payments on account. If Year 3 is expected to be similar, the cycle continues smoothly.

This example shows why payments on account are best thought of as shifting timing rather than increasing the total tax burden. In steady circumstances, the system becomes predictable and easier to manage year to year.

Worked example: profits increase

Now imagine the same person has a great Year 2 and their tax liability rises from 6,000 to 10,000. Their payments on account for Year 2 were still based on Year 1 and totaled 6,000 (two instalments of 3,000).

When Year 2 is finalised, the actual tax is 10,000. The 6,000 already paid is credited, leaving a balancing payment of 4,000. That balancing payment is typically due alongside the first instalment for Year 3.

Because Year 2’s final tax is now 10,000, payments on account for Year 3 will usually be based on that higher figure. So the first instalment for Year 3 might be 5,000. At that point, the payment due could be 4,000 (balancing for Year 2) plus 5,000 (first instalment for Year 3), totaling 9,000. Later you’d pay the second instalment of 5,000.

This is a common pattern during growth: the better your business does, the bigger the “lump” becomes at the balancing stage. It’s a sign your profits are rising, but it can be challenging if you haven’t built tax budgeting into your pricing and cash flow management.

Worked example: profits decrease

Now consider the opposite. Suppose your tax liability in Year 1 is 10,000, so your payments on account for Year 2 are two instalments of 5,000. But in Year 2 you have a quieter year and your actual tax liability drops to 6,000.

In that case, you will have overpaid through payments on account. When Year 2 is finalised, the 10,000 already paid is credited against the 6,000 actual amount, leaving an overpayment of 4,000. Depending on the rules, you may be able to receive a refund, or it might be carried forward as credit to future payments.

This is why it’s important not to panic when you hear “payments on account”. If business slows down, the system should catch up and ensure you aren’t permanently paying too much. The challenge is that you may have had cash tied up in tax payments earlier than necessary, which is why adjusting payments can sometimes be sensible when a decline is expected.

Reducing payments on account when you expect lower profits

Most tax systems that use payments on account provide a mechanism to reduce them if you reasonably expect your next year’s tax bill to be lower than the previous year. This can be a useful cash-flow tool. If your business has lost a major client, you’ve taken time off, you’re switching industries, or you simply know your profits will be down, reducing payments on account can prevent you from paying far more tax in advance than you need to.

However, reducing payments on account should be done carefully. If you reduce them too far and your tax bill ends up being higher than you estimated, you can be charged interest or penalties on the shortfall. Tax authorities generally expect you to make a reasonable estimate, not a hopeful guess.

A sensible approach is to build a simple forecast. Look at what you’ve earned so far in the current year, what contracted work you already have, and what your typical monthly revenue looks like. Adjust for known changes, such as a planned break, increased costs, or a new pricing structure. Then estimate profit for the year and translate that into an approximate tax liability. If the estimate suggests a lower tax bill, a reduction may be justified.

Even if you reduce payments on account, keep some buffer cash set aside. Forecasts can be wrong, and it’s much less stressful to have the money available if you need to top up later than to scramble at the deadline.

Increasing payments voluntarily to avoid a large balancing payment

If your business is doing well and you expect your tax bill to be higher than last year, you can often choose to pay extra during the year. This can reduce the size of the balancing payment when the year is finalised. Some people do this by making additional voluntary payments, while others simply set aside money in a tax savings account and then make a larger payment when the time comes.

The benefit of paying earlier is predictability. If you hate surprises, increasing payments can make your eventual bill more manageable. It can also reduce any interest that might be charged in systems where underpayment creates interest costs.

The downside is opportunity cost: money paid to the tax authority early is money you can’t use in your business for marketing, equipment, training, or simply maintaining a comfortable cash buffer. So it’s a balancing act. If you have ample cash reserves and a strong forecast, paying earlier might be worthwhile. If cash flow is tight, it may be better to hold funds aside until the deadline, as long as you are disciplined about not spending them.

What income is usually covered and what is not

Payments on account generally relate to income that isn’t taxed at source. For self-employed people, that means your business profits. In many systems, employment income is taxed through payroll withholding, so it doesn’t create the same need for advance payments because the tax is already being collected as you go.

If you have a mix of income—perhaps you have a part-time job and a side business—your situation can be more complex. The part-time job may have tax deducted automatically, while your self-employed profits may not. Depending on how the rules work, payments on account may apply only to the portion not already covered by withholding.

This is one reason it’s important to keep good records and understand your overall tax picture. The presence of other income streams can change whether payments on account apply, and how large they are.

Cash flow planning: the skill that makes everything easier

If there’s one skill that makes payments on account manageable, it’s cash flow planning. Self-employment income can be uneven, and tax deadlines don’t always align neatly with when you get paid by clients. The best way to reduce stress is to treat tax as a regular business expense and set money aside continuously.

A common method is to transfer a percentage of each payment you receive into a dedicated tax account. The percentage should be based on your expected profit margin and tax rate, with a buffer for safety. Some people set aside 20–30% of profit, others more. The “right” number depends on your circumstances, but the habit is more important than perfection.

Another method is monthly saving. At the end of each month, you calculate roughly what your profit was and transfer an amount based on that. This can be more accurate than doing it per invoice, especially if your business has variable expenses.

Whatever method you choose, the aim is the same: when the payment deadline arrives, the money is already waiting. Payments on account stop being a crisis and become a scheduled transfer.

Common pitfalls and how to avoid them

One of the biggest pitfalls is treating all the money that comes into your business bank account as spendable. In reality, part of it belongs to future tax. If you spend it, you’ll eventually have to replace it. The solution is separation: separate accounts, separate budgeting categories, and a mindset that distinguishes revenue from profit and profit from personal spending money.

Another pitfall is confusing revenue with profit. Tax is usually based on profit, not total sales. If you set aside a percentage of revenue without considering expenses, you might set aside too much or too little. Revenue-based saving can still work as a rough rule of thumb, but it’s better to track profit properly, especially as your business grows.

A third pitfall is ignoring the effect of growth. As we saw in the earlier example, rising profits can lead to a balancing payment on top of the next year’s instalment. If your business is scaling up, build that into your planning: the year of strong growth may have a heavier payment point. This isn’t a sign something is wrong; it’s the system catching up to your success.

Finally, some people reduce payments on account too aggressively. If you cut them dramatically without solid evidence, you risk interest or penalties. Use forecasts, not wishful thinking, and keep a buffer in case your estimates are off.

Record-keeping and why it matters for payments on account

Accurate records make forecasting easier and reduce the risk of unpleasant surprises. If you know your monthly profit trend, you can estimate your year-end position and decide whether reducing payments makes sense. Good records also help you avoid underestimating tax because you forgot about certain income streams or overestimated deductible expenses.

At a minimum, keep track of sales invoices, business expenses, bank transactions, and any receipts that support your expense claims. Many self-employed people find it helpful to use accounting software, but even a carefully maintained spreadsheet can work if it’s consistent and complete.

The goal is to be able to answer questions like: “What has my profit been so far this year?” and “If the next six months look similar to the last six months, what will my profit be?” Once you can answer those, you’re in a strong position to handle payments on account without stress.

How to think about payments on account psychologically

Beyond the numbers, there’s a mindset shift that helps. Think of payments on account as your business paying its running costs. Just as you budget for software subscriptions, equipment, or rent, you budget for tax. The fact that the payment is labelled “on account” can make it feel abstract, but it’s simply part of staying compliant and financially stable.

It can also help to remember that many employees effectively pay tax in advance too—through withholding that happens each time they get paid. Payments on account are the self-employed version of that: a mechanism that prevents tax from building up as a single intimidating bill.

If you plan well, payments on account can even be comforting. You’ll know you’re keeping up. You’ll reduce the fear of a huge unexpected demand. And you’ll make your financial life more predictable.

Practical tips to make payments on account less painful

Start by treating tax savings as non-negotiable. Automate transfers if you can. Automation removes willpower from the equation and helps you stay consistent even in busy months.

Next, build a calendar of tax deadlines and review it every month. Payments on account can arrive at times when you’re also paying other business costs. Seeing the deadline ahead of time gives you room to adjust spending and chase invoices.

Consider maintaining a buffer fund beyond your tax savings. Self-employment often involves late-paying clients, seasonal dips, or unexpected expenses. A buffer means you can pay tax even if cash comes in later than planned.

Finally, revisit your pricing. If you’re consistently struggling to set aside tax money, it may be a sign that your rates are too low or your expenses are too high. Tax itself isn’t the problem; it’s a reflection of profit. But if you don’t leave room in your business model for tax, you’ll always feel squeezed.

What to do if you can’t afford a payment on account

If you realise you can’t afford a payment on account, the most important thing is not to ignore it. Ignoring deadlines can lead to escalating interest and penalties, and it can make the problem feel bigger than it is.

Start by understanding the reason. Is it because you didn’t set aside money? Is it because clients paid late? Is it because the payment on account is based on a year that was unusually strong, while the current year is weaker? Your next steps depend on the cause.

If you genuinely expect your current year’s tax bill to be lower, you may be able to reduce the payments on account to a more realistic amount. If the problem is short-term cash flow, some tax authorities offer payment plans. The earlier you engage, the more options you’re likely to have.

It’s also worth checking whether any of your invoices can be collected faster. Polite reminders, clearer payment terms, deposits, or incentives for early payment can sometimes free up cash quickly. If you regularly face late payments, changing your invoicing practices can have a big impact on your ability to meet tax deadlines.

How payments on account interact with other taxes and contributions

Depending on where you live, your total liability might include more than just income tax. Some systems include social security contributions, health insurance contributions, or other mandatory charges tied to self-employed profit. In some places, these are rolled into the same advance-payment mechanism; in others, they are calculated separately with their own instalments.

The important point is that when you hear “payments on account,” you should think broadly about the total amount you may need to set aside. If you only save for one component and forget another, you can still be caught short.

This is another reason why good bookkeeping and professional advice can pay for themselves. Once you understand the full set of liabilities that apply to you, you can build a reliable savings percentage and stop feeling surprised by the totals.

A simple framework for staying in control

You don’t need a complex financial system to handle payments on account, but you do need consistency. A simple framework looks like this:

First, track profit regularly. Monthly is ideal, quarterly at a minimum. Second, set aside tax money every month based on that profit. Third, keep a dedicated tax account so the money is mentally and practically separated. Fourth, forecast the year ahead whenever your business changes—new client, lost client, big expense, or time off. Fifth, adjust your payments on account if the forecast shows a meaningful change, but do it cautiously and keep a buffer.

This framework turns payments on account from a stressful surprise into a predictable process. You’re no longer reacting to deadlines; you’re planning for them.

Key takeaways

Payments on account are advance instalments towards your next tax bill, usually calculated from your previous year’s liability. They can feel like an extra charge at first, but they are mainly a timing shift that moves you from paying entirely in arrears to paying partly in advance.

The amount is usually split into instalments, and when your next year’s tax is finalised, you either pay a balancing amount or receive a credit/refund if you overpaid. If you expect profits to drop, you can often reduce payments on account, but you should do so carefully to avoid interest or penalties.

The practical secret to making the system manageable is cash flow planning: set money aside regularly, forecast when your business changes, and treat tax as a routine business cost rather than an occasional emergency. With good habits and clear records, payments on account become just another part of running your business—important, predictable, and far less intimidating.