Never has an article title been so off-putting, but if you are self-employed, you need to read this now to avoid a nasty shock regarding when you have to make tax payments.

Self-employed

If you are self-employed, you will pay income tax on your trading profits and other income.

You will also pay national insurance: class 2, based on a weekly charge of £2.20 (£2.30 for the tax year 2008/2009), and paid by direct debit or quarterly, and class 4, which is based on your profits.

You may also have to register for VAT, and so have VAT liabilities. And if you employ staff, you will also have to make tax payments in respect of them.

But before you get too depressed, here we are only concerned with income tax and class 4 national insurance, and specifically when you actually have to make the payments of these taxes. We leave the calculation of the actual figures for taxable profits and your tax liability for another time - and your accountant can advise you on this, but so many people get a huge shock at the time for making payments, that this deserves its own article.

Payments on account

The two important dates are 31 January and 31 July (i.e. just when you have no money after Christmas, and just when you want to go on holiday…).

Consider the tax year which will end on 5 April 2008. This is 2007/2008 in tax-speak.

The income tax and class 4 liability for 2007/2008 is paid in two payments on account on 31 January 2008 and 31 July 2008.

What you pay on each of these dates is usually half of what youhad to pay for the previous year in total. Then, if your total bill ends up bigger for this year, a top-up (”balancing“) payment is made on 31 January 2009.

There are some different rules if you have recently started trading, and, for example, you were previously an employee, so speak to your accountant about when this regime will apply to you (but don’t delay in doing this!).

Also, if you know that you will make less money in 2007/2008 than in 2006/2007, then it is possible to reduce these payments on account, but you need to be careful with this. At the very least, interest will be charged if you actually do better, and your accountant should advise whether making a reduced payment is appropriate in your particular case.

Example

So, if your total income tax and class 4 NIC bill for 2006/2007 was £6,000, you will pay £3,000 on each of 31 January 2008 and 31 July 2008, as payments on account for 2007/2008. If your final bill for 2007/2008 is calculated as £7,000, you will have to make a balancing payment of £1,000 by 31 January 2009.

Shock

This news might be shocking enough in itself, but consider the 31 January in particular. On 31 January 2009, for example, you will possibly have to pay a balancing payment for the tax year 2007/2008, and also your first payment on account for 2008/2009. While many people remember the balancing payment, it is the first payment for 2008/2009 which causes the shock!

Action

Don’t stick your head in the sand but act now. To avoid the shock of a sudden big tax bill, many self-employed people keep a separate bank account in which they continually save for their tax bill. To manage this, they often put a percentage of every amount they receive, when they are paid for a piece of work, straight into this account. The percentage needed depends on the level of profits likely, and so the rate at which tax will be paid, but ask your accountant to help you estimate this, if you think that this will help take away the pain of the tax bill. Your bank manager can advise on which accounts would be suitable for you for saving for this purpose.

As with all our information in The Business Lounge, this is not comprehensive tax advice, and may not apply to your specific circumstances; to discuss how these issues affect you, contact your accountant.