Almost every contractor who moves to drawing dividends, or who starts having tax to pay through self-assessment for the first time, gets the same shock. They expect a tax bill of, say, £6,000 — and HMRC asks for £9,000. The extra isn't a mistake, and it isn't a penalty. It's the payment on account system, and once you understand it, it's entirely predictable.
This guide explains what payments on account are, why your first bill is 50% bigger than the tax actually due, what counts towards them, when you can ask to reduce them, what to do if you can't pay in full, and how to budget so the system never catches you out. It ends with the reform that will replace the whole thing from April 2029.
What is a payment on account?
A payment on account (POA) is an advance payment toward your next year's self-assessment tax bill. HMRC's logic is that if you owed tax last year, you'll probably owe a similar amount this year — so rather than wait until the end of the year, they collect it in two instalments along the way.
Each payment on account is 50% of your previous year's "relevant amount". That is your income tax and Class 4 National Insurance for the year, less any tax already deducted at source — so if part of your income came through PAYE, the payments on account are calculated on what was left over, not on your headline liability. For a contractor on a £12,570 salary the PAYE deduction is nil, so in practice the two are the same. There are two payments:
- First payment on account — due 31 January (the same date as your balancing payment for the year just filed).
- Second payment on account — due 31 July.
You'll be asked for payments on account if that relevant amount is more than £1,000 for the year, unless at least 80% of your tax was already collected at source (for example through PAYE). Both tests work off the same figure, which is why they fit together: if most of your tax came through PAYE, the leftover is both small and a minor share of the total, and no payments on account arise.
For most contractors drawing dividends from their own company, neither test offers an escape. A £12,570 salary carries no PAYE, so effectively none of the tax is collected at source, and the dividend tax alone clears £1,000 comfortably. Note that dividend tax counts here — payments on account are not limited to self-employment income, and there is no Class 4 National Insurance on dividends, so for a typical contractor the liability driving the payments is income tax on dividends and nothing else.
Why your first bill is 150% of the tax due
The shock happens in your first year of having tax to pay, because two things land on 31 January at once: the balancing payment for the year you've just filed, plus the first payment on account for the year ahead. That's 100% + 50% = 150% of your annual liability, all due on the same day.
Here's a worked example. Say your 2025/26 liability is £6,000 — dividend tax on drawings above your salary, with no Class 4 National Insurance because dividends aren't trading income — and it's your first year in self-assessment:
| Date | What's due | Amount |
|---|---|---|
| 31 January 2027 | Balancing payment for 2025/26 | £6,000 |
| 31 January 2027 | First payment on account for 2026/27 (50%) | £3,000 |
| 31 January 2027 total | Both, same day | £9,000 |
| 31 July 2027 | Second payment on account for 2026/27 (50%) | £3,000 |
So against a £6,000 annual bill, you pay £9,000 in January and another £3,000 in July — £12,000 across the year. But £6,000 of that is genuinely paying ahead for 2026/27.
It evens out in year two
The reason this feels brutal in year one and manageable afterwards is that, from the second year on, you've already paid half the year's tax in advance. The system reaches a steady state:
How the cycle settles down
Year one (31 Jan): balancing payment (100%) + first POA (50%) = the painful 150% bill.
Following 31 July: second POA (50%). By now you've paid 100% of year one's equivalent toward year two.
Year two (31 Jan): only the balancing payment (any shortfall not covered by your two POAs) plus the next year's first POA. If your income is steady, the balancing payment is small.
If your earnings are roughly stable year to year, the two payments on account cover most of each year's liability, and the January balancing payment becomes modest. The 150% hit is genuinely a one-off — but it lands precisely when many people least expect it.
Think of payments on account as HMRC moving you from "pay in arrears" to "pay as you go." The first year you have to bridge the gap between the two systems, which is why you pay one-and-a-half years' worth in twelve months. After that, you're simply paying this year's tax during this year — which is arguably fairer, just unwelcome the first time.
What's included in a payment on account — and what isn't
Payments on account are based on your income tax and Class 4 National Insurance. Some things are deliberately excluded and are always paid in full as part of the balancing payment instead:
- Capital gains tax is not included in payments on account — a one-off gain doesn't inflate next year's advance payments.
- Student loan repayments through self-assessment are not included in the POA calculation.
- Class 2 National Insurance is collected with the balancing payment, not via payments on account. In practice it rarely arises now: mandatory Class 2 was abolished from 6 April 2024 for those with profits above the small profits threshold, who receive the National Insurance credit without paying, and voluntary Class 2 remains available for those below it.
This matters because a year with an unusual one-off — selling a property, say — won't lock you into permanently higher payments on account.
This one catches people out, and you may see it stated the other way round elsewhere. The High Income Child Benefit Charge is a charge to income tax, so it forms part of the liability that drives your payments on account — there is no carve-out for it in the way there is for capital gains tax.
The practical consequence: the first year your income crosses £60,000 and you pick up the charge, it increases not just that year's balancing payment but the two payments on account for the year after. If you have children and your drawings are heading into the £60,000–£80,000 band, budget for the charge appearing one-and-a-half times over in the first year, exactly as with any other new liability. Pension contributions reduce adjusted net income and therefore the charge itself — see our expenses guide for how that works.
Reducing your payments on account
Payments on account are only an estimate, based on the assumption that this year will look like last year. If you know your income is going to fall — you're taking a career break, reducing dividends, or moving back to a PAYE role — you can apply to reduce your payments on account rather than pay money you'll have to reclaim. This is done online or on form SA303, and you can reduce them to nil if you expect no liability at all.
Worth weighing before you do: an overpayment isn't lost. HMRC refunds it once the return is filed and pays repayment interest on it in the meantime. So the cost of not reducing is a temporary cash-flow hit, while the cost of reducing too far is interest, a possible penalty, and the admin of putting it right.
If you reduce your payments on account below what your actual liability turns out to be, HMRC charges interest on the shortfall backdated to the original due dates — as if you'd underpaid all along. Since 6 April 2025 late payment interest has been Bank of England base rate plus 4 percentage points, up from base plus 2.5%, which puts it around 7.75% and it is reviewed quarterly. That is expensive money.
There is also a penalty in reserve. Where a claim to reduce is made fraudulently or negligently, HMRC can charge a penalty of up to the amount by which the payments were under-stated, on top of the interest. Reducing on a genuine, well-founded expectation is entirely legitimate; guessing downward because cash is tight is not. If you're unsure, pay the standard amount and take the refund with interest.
If you can't pay the January bill in full
The 150% year catches people with the money not quite there, so it's worth knowing how the charges actually work — because they are not the same on both halves of the bill.
The 5% late payment penalties apply to the unpaid balancing payment: 5% if it's still outstanding 30 days after the deadline, another 5% at six months, another at twelve — 15% in total on a bill left for a year. Payments on account attract interest but not those 5% surcharges.
So if you can only part-pay on 31 January, clear the balancing payment first and let the payment on account run late. Both accrue interest at the same rate, but only one of them adds a penalty on top. That single ordering decision can be worth hundreds of pounds, and most people do it the other way round or pay proportionally across both.
Two further options worth knowing:
- Time to Pay. If you can't pay at all, HMRC's self-serve arrangement lets you spread self-assessment debts online where you owe less than £30,000 and meet the criteria. Setting up a plan stops late payment penalties being charged — interest continues, but you avoid the 5% surcharges entirely. Do it before the deadline rather than after: the arrangement has to be in place for the penalty protection to apply.
- Collection through your tax code. If you owe less than £3,000 and have PAYE income, filing your return online by 30 December lets HMRC collect the balance through the following year's tax code instead of demanding it on 31 January. For a contractor taking a salary through their own payroll this is a genuine option, and it's the strongest argument for filing in the autumn rather than January.
One thing on the horizon: late payment penalties for income tax and VAT are due to increase from 1 April 2027, announced at Autumn Budget 2025, with the detail still to be published. Paying late is going to get more expensive rather than less.
How to budget so it never catches you out
The pain of payments on account is almost entirely a cash-flow problem, not a tax problem — the money is genuinely due, it just arrives in a lump. A few habits make it painless:
- Set aside tax as you earn. Move a fixed percentage of every dividend into a separate savings account the moment it lands. For 2026/27 the dividend rates are 10.75% up to the higher rate threshold and 35.75% above it, so a contractor drawing to £50,270 needs roughly 11% set aside and one drawing well beyond it needs to think in the mid-thirties on the excess. Our salary vs dividends guide sets out where the bands fall. Add a margin for the payments on account and you stay ahead of both.
- Earmark roughly 150% in your first year. If you know your first self-assessment year will trigger payments on account, budget for one-and-a-half times the expected bill by that first 31 January.
- Don't spend the 31 July gap. The July payment on account is easy to forget because there's no return to file alongside it. Diarise it.
- Consider HMRC's Budget Payment Plan. If you'd rather spread the cost, HMRC lets you make regular weekly or monthly payments toward a future bill by Direct Debit, so the lump sums are partly pre-funded.
- File early. Filing your return well before 31 January doesn't change the payment date, but it tells you exactly what you owe months in advance — turning a surprise into a planned expense. File online by 30 December and, if you owe under £3,000 and have PAYE income, you also open up collection through your tax code.
The system is changing from April 2029 — and there's a consultation open now
Everything above describes the regime as it works today, and it will keep working this way for several years yet. But the government has announced the biggest change to self-assessment payment timing since the system began, and if you are reading this as a contractor with a salary through your own payroll, you are squarely in scope.
Announced at Autumn Budget 2025 and now the subject of a consultation published on 23 June 2026, the proposal is that from April 2029, self-assessment taxpayers who also have a PAYE source of income will pay their forecast self-assessment liability in-year, through PAYE, each pay period — rather than in two lumps the following January and July. Around 2.1 million of the 12 million people in self-assessment are expected to fall within it. On the illustrative design, a monthly-paid taxpayer would pay their 2029/30 liability as twelve monthly instalments each equal to about 8.3% of their forecast liability, based on their 2028/29 return, with a balancing instalment due by 31 January 2031. Forecasts could be updated during the year, with payments adjusting accordingly.
Separately, the consultation explores replacing payments on account for those without PAYE income with monthly or quarterly in-year payments, bringing them forward so the tax is paid in the same tax year as the income that generated it. The ability to ask HMRC to reduce the amount would be retained.
Here is the part worth diarising. The change doesn't alter how much tax you pay, only when — but moving from one system to the other means a year in which payments on account fall due for an earlier year at the same time as tax is being collected in-year through PAYE. ICAEW has flagged exactly this overlap as the reason the measure raises a spike of revenue in 2029/30.
In other words, the same bridging problem this whole guide exists to explain is scheduled to happen a second time, to people who have long since got used to the current rhythm. If you are still contracting in 2029, budget for it the way you budgeted for your first year. We'll update this page as the design firms up — the consultation is a proposal, not law, and the detail may well move.
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