Will you face a tax bill worth more than you earn next year?

The nation’s 4.76 million self-employed workers could find themselves with multiple tax bills that amount to more than they earn in total next year as falling income and a pile up of HMRC debt threaten to create a double-whammy cash crisis.

The complicated set of circumstances and rules could mean that someone whose self-employed income suddenly falls dramatically from one tax year to the next – as many have as a result of the pandemic – may end up scrambling to cover a tax bill for more than they make in that year.  

That’s partly because the self-employed have been allowed to defer paying the tax they owe in a bid to soften the economic impact of Covid on freelance workers. This year, those with tax bills for 2019-20 have the option to defer or spread their payment, with the final settlement due by January 2022.

But solo workers could also run into significant problems because the current tax system demands that the self-employed pay their tax for the coming year in advance or “on account”. The calculations for those up-front bills are based on previous earnings and so won’t take plummeting ‘real time’ income levels into account at a time when there is precious little extra cash around to cover such an overpayment.  

In other words, many self-employed people may have to settle tax bills which bear no relation to 2020’s real earnings, number crunching by mutual insurer Royal London has revealed.

Wait… what?

Unlike PAYE employees, the self-employed are expected to pay tax in advance. In normal circumstances, self-employed workers who file annual self-assessment forms must also make two “payments on account” for the approaching tax year – one in January and one in July.  

The payment on account that should have been due in July 2020 was based on income earned in the 2018-19 tax year, for example, and the one that would have normally been due by January 2021 is based on income earned in 2019-20.  

This system of charging in advance based on the previous year’s earnings means a change in income takes a long time to be reflected in a freelancer’s tax bill.  

If someone who previously earned £50,000 saw a drop in income to £15,000 during the pandemic, their total tax bill next year would probably be £16,682  to cover 2019-20 as well as their 2020-21 payments on account, despite their annual earnings having dropped to less than this amount.

Millions of self-employed people suffered a loss of income during the pandemic. More than 2.7 million people have so far claimed support from the self-employment support scheme (SEISS). Although the average drop in freelancer income was more than 30 per cent in the first half of this year, according to not-for-profit organisation the Association of Independent Professionals and the Self-Employed (IPSE), some self-employed people have reported that their regular income has been completely wiped out by the pandemic.  

It is possible to ask HMRC to reduce payments on account and this year to set up a series of monthly tax bill instalments on the deferred amount instead of having to paying a large lump sum. But the onus is on the self-employed to sort this out themselves. The system is incredibly complicated and the self-employed may need extra help to understand their options.  Most don’t.

Self-employed people who may not know that they can ask for their payments on account to be reduced, or that they can spread out their payments, should contact HMRC to discuss a “real-world” tax bill for 2021 based on predicted earnings rather than using those based on the 2019-20 tax year in a bid to make sure they are not over-paying tax.  

Most of this is done online and falls under “time to pay” arrangements. Those who think they have overpaid can claim a refund but this can take weeks to process.

Anyone who misses the 31 January self-assessment deadline also faces late payment penalties and interest charges. In addition, those self-employed who choose to spread out their tax payments in 2021 will be charged interest by the revenue.

HMRC is also being urged to launch a targeted information campaign for the self-employed which draws their attention to the need to ensure tax is calculated on genuine predicted earnings.

Mona Patel, a spokesperson for Royal London, said: “Many self-employed people may be expected to pay more in tax than they have actually earned in the past year because of the payment on account system. This lack of ‘real world’ tax bills means it’s perfectly feasible that those who have suffered the steepest drops in income could find themselves in this situation.  

“While the revenue has announced a system that enables people to pay in more manageable instalments, this still doesn’t go far enough for those who could end up overpaying tax unnecessarily because their bill is based on last year’s earnings. We urge HMRC to do the right thing and help the self-employed understand their options.”

In response, a HMRC spokesperson said: “HMRC stands ready to support any taxpayer in financial distress as a result of Covid-19 and we would urge anyone who may struggle to pay their outstanding tax liabilities to contact us as soon as possible.  

“Any business or self-employed individual can contact HMRC’s helpline for help and advice on 0800 024 1222.

“Since 1 October, self-assessment customers can set up an online payment plan to spread the cost of their tax bill, of up to £30,000, into monthly direct debit payments, to help ease any potential financial burden they may be experiencing due to the coronavirus pandemic.”

The revenue appears to have no plans to review the requirement for the self-employed to pay their tax bills up front.  

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