October 29th, 2012 / Insight posted in

Why is my tax bill inexplicably big?

RT writes: I am a sole trader and have paid every tax bill I have been sent but have now been told I have not paid enough – more than £20,000 is due on January 31. How has this happened? Am I liable for interest? And why does the total tax I have to pay in January and July this year suggest an income significantly higher than I have ever earned?

The tax system for the self-employed is intended to be simple, but in some cases creates large payments on account, which can be a nasty surprise, writes Jon Sutcliffe, partner at Kingston Smith LLP.

Your high tax bill is likely to be down to two main factors – a high profit in the year; and the way payments on account work. However, you may be able to reduce your bill.

Payments on account are by default based on your previous year’s tax liability. This means you paid half in January 2008 and half in July 2008, but the bill was based on your 2006-7 liability. If your 2007-8 tax liability is higher, then a third payment is due on January 31, 2009. Provided the tax is paid on these dates, you should not be charged interest. If your profits are rising, then you will have this third payment.

Increased profits have a further impact as the payments on account for 2008-9 are also based on the previous year. The 2008-9 payments are due on January 31, 2009 and July 31, 2009. So, the January 2009 payment on account is a combination of last year’s tax and this year’s tax, and where profits have risen sharply can result in nearly a year’s tax being due when traders can often least afford it.

If you think your profits will be lower this year, it is possible to reduce the 2008-9 payments on account. If you make a claim to reduce your payments on account, make sure you consider your tax liability on income from all sources (such as rental income, for example) and not just your trading income.