Law Firm Partner Tax Reserving and Payments on Account

Why Reserving Is Different for a Partner

As a self-employed law firm partner you are taxed on your allocated profit share, not on the cash you draw (ITTOIA 2005 section 863). That single fact changes everything about how you handle tax. Under PAYE, tax is deducted at source, smoothly, every month, before you ever see the money. As a partner, no tax is deducted at source. It lands in two lumps a year through self-assessment, and it is calculated on the profit allocated to you, which can be more than you have actually drawn in cash. So holding back enough tax is a discipline you have to run yourself, not something that happens automatically.

This guide does three jobs that the broader pages touch but do not pull together. First, it explains payments on account mechanically and precisely, so the dates and the maths are never a surprise. Second, it builds a reserving rule of thumb band by band, so the percentage you hold back is defensible rather than a guess. Third, it walks the basis-period-reform transition-profit squeeze, a one-off charge still being collected through to 2027/28 that sits on top of the normal annual bill. It closes with the cruel reality specific to law firms: you can owe tax on profit that is still tied up in work in progress and unpaid debtors.

Payments on Account: The Mechanics, Precisely

This is the core mechanical section. Under TMA 1970 section 59A you make two payments on account towards your income tax (and Class 4 National Insurance) for a year. The first is due on or before 31 January in the tax year, and the second on or before the following 31 July. Each is an amount equal to 50% of the relevant amount, broadly your prior year's self-assessment liability. A balancing payment (or a repayment, if you have overpaid) on the next 31 January settles the difference once your return is filed and the actual liability is known.

There are two exclusions, and it is worth stating them exactly as HMRC does. You make the two payments on account unless either the amount of tax you owed last year was less than £1,000, or last year you paid more than 80% of the tax you owed outside of self-assessment (for example through PAYE). For most full-time partners taxed on a substantial profit share, neither exclusion applies, so payments on account are simply how the system works for you.

Two further points. Class 4 National Insurance is included in the liability that the payments on account are based on, so it is collected through them, not separately. And Class 2 National Insurance is no longer a charge from 6 April 2024, so there is no Class 2 element to fund. When you reserve, you are reserving for income tax and Class 4 together. For the wider filing picture and deadlines, see our solicitor self-assessment tax guide.

Why the First 31 January Feels Like 150% of a Year's Tax

The pile-up that catches partners out happens when payments on account first kick in, typically for a newly promoted partner or one whose profit share has risen sharply. On that 31 January, the demand can carry two things at once: the balancing payment for the year just ended, plus the first 50% payment on account for the next year. Together, the cash demand can approach 150% of a single year's liability in one go, with a further 50% payment on account due the following 31 July.

It is essential to see this for what it is: the system catching up to your real-time income in arrears, not a penalty and not extra tax. Once you are in the rhythm, the payments on account each January and July broadly match your liability, and the balancing payments are small adjustments. The shock is a one-off transition into the system. It is most acute on promotion to equity partner, which is where it first hits; see our guide to the fixed-share to equity partner promotion and its first-year cash flow.

Can You Reduce a Payment on Account, and When Should You?

You can make a claim to reduce your payments on account if you genuinely expect your liability to be lower than last year's, for instance because your profit share is falling. This is a legitimate cash-flow tool. But the risk is real and worth stating plainly: if you reduce the payments too far and the actual liability turns out higher, HMRC charges interest on the shortfall back to the original due dates.

So reduce on evidence, not on optimism. If the firm's management accounts genuinely show a lower share coming through, a measured reduction is sensible. Reducing aggressively in the hope that things will be quieter turns a pure timing question into a real interest cost. When in doubt, fund the full payment and take any refund on the balancing date.

The reverse case is worth a word too. If your profit share is rising, your payments on account (set at 50% of last year's lower liability) will undershoot the year's actual liability, so a larger balancing payment falls due on the next 31 January, and the payments on account for the following year step up with it. This is the same 150% effect appearing again whenever income climbs, not just on first entry to the system. The discipline is the same in both directions: reserve against the allocation you actually expect, not against the payments on account HMRC happens to have set from an out-of-date prior year. The payments on account are a collection mechanism keyed to the past; your reserve should be keyed to the present.

How Much of Each Profit Allocation to Hold Back: The Rule of Thumb

The reserving heuristic is most useful when you can see the per-pound logic behind it, so it is defensible rather than arbitrary. Build it from the 2025/26 rates. The marginal cost of an extra pound of profit is the income tax rate plus the Class 4 National Insurance rate on that slice:

• Basic-rate slice (up to £50,270): 20% income tax plus 6% Class 4 equals roughly 26%.
• Higher-rate slice (£50,270 to £125,140): 40% income tax plus 2% Class 4 equals roughly 42%.
• Additional-rate slice (above £125,140): 45% income tax plus 2% Class 4 equals roughly 47%.
• The taper zone (£100,000 to £125,140): the personal-allowance taper removes £1 of allowance for every £2 of income, producing an effective income tax cost of about 60%, plus 2% Class 4, so roughly 62% on that slice. This is the most expensive band, and it is easy to overlook.

Translate that into a practical blended reserve. A partner whose share sits mostly in the higher band, with some in the taper zone, often lands a working reserve in the 35% to 45% range overall, higher the more of the share that falls in the upper bands or the taper zone. Two disciplines make it work. Reserve against the allocation, not the cash you have managed to draw. And sweep the reserve into a separate, named account monthly, so it is never confused with spendable money. The headline 30% to 45% range is also noted on our drawings versus profit page; the value here is the band-by-band build behind it.

A Reserving System That Actually Holds

The maths above is only useful if the reserve is real money in a separate account. A few operational habits make the difference:

• Estimate the allocation early from the firm's management accounts, and revise the estimate through the year as the picture firms up.
• Move the reserve monthly, a percentage of each drawing or allocation, rather than scrambling to find a lump in January.
• Hold the next payment on account visibly, ideally labelled, so it is never accidentally spent.
• Treat 31 January and 31 July as immovable. They do not move, and the reserve is what meets them.

This is the operational counterpart to the band-by-band maths: the percentage tells you how much, the system makes sure it is there when the dates arrive.

A practical refinement many partners find useful is to run two reserves rather than one. The first is the ordinary annual reserve, swept monthly against the current year's allocation. The second is a separate transition reserve, set aside specifically for the basis-period transition slice that is still landing each year through to 2027/28 (covered in the next section). Keeping the two visibly apart stops the transition charge eating into the money earmarked for the normal annual bill, which is exactly the surprise that catches partners out in January. The same logic applies to any one-off, such as a year in which you elect to accelerate part of the transition profit: budget it as its own line rather than hoping the general reserve will stretch.

The Basis-Period Transition-Profit Squeeze (Still Being Collected to 2027/28)

This is the time-sensitive section that distinguishes this page. Basis period reform (Finance Act 2022) moved unincorporated businesses, including partnerships and LLPs, to a tax-year basis (profits taxed for the actual tax year, 6 April to 5 April) from 2024/25, with 2023/24 the transition year. Firms with a year-end other than 31 March or 5 April generated a one-off block of transition profit: the catch-up from the old basis date to 5 April 2024, less any unused overlap relief. For the full mechanics of the reform itself, see basis period reform for law firms; this page applies it to your reserving.

That transition profit is spread, not charged all at once. The default rule (Finance Act 2022 Schedule 1 paragraph 72) is that 20% of the transition profit is treated as arising in each of the four tax years beginning 2023/24 (so 2023/24, 2024/25, 2025/26 and 2026/27), with the balance treated as arising in the fifth year, 2027/28. So a partner in a firm with a December or other non-March year-end is still paying a spread transition slice through to 2027/28, on top of their normal annual liability, and that slice feeds into the payments-on-account calculation.

The transition profit has a distinctive tax treatment worth understanding. It is taxed as a standalone amount: it is relieved in net income and then a separate amount of tax is calculated on it and added back (Schedule 1 paragraph 75). The effect is that the transition profit does not, of itself, sit in your net income for things like the personal-allowance taper, the high income child benefit charge or student loans. But there is an important caveat: the personal-allowance taper can still bite if your total income, your standard profits plus the transition slice together, exceeds £100,000. And transition profits are within Class 4 National Insurance, so the slice carries Class 4 as well as income tax.

The practical instruction is to reserve for the transition slice separately, so it is not a fresh surprise each January through to 2027/28, and to consider the acceleration election (below) where a low-income year makes clearing more of it cheap.

When Accelerating the Transition Charge Makes Sense

The acceleration election is the lever (Finance Act 2022 Schedule 1 paragraph 73). You can elect for an additional specified amount of the transition profit to be treated as arising in an earlier year than the default spread would put it. The reason to consider it is rate arbitrage: if you expect a lower-income year, perhaps a reduced profit share, or a year before a band or rate change, bringing more of the transition profit into that year can let it be taxed while you still have spare basic-rate or higher-rate band, potentially at a lower overall cost than leaving it to fall in a higher-income later year.

Frame this as a model-it lever, not a default. The election fixes the amount you bring forward (it is not something you reverse for that amount), and it interacts with the £100,000 personal-allowance taper, so check the total-income position first. In a year where your total income is already near or above £100,000, accelerating more transition profit into it can be counterproductive. The decision is genuinely partner-specific and worth running the numbers on.

The Lock-Up Reality: Taxed on Profit Tied Up in WIP and Debtors

The cruellest cash-flow point is specific to law firms. You are taxed on the allocated profit share even where the firm's cash is locked up in unbilled work in progress (WIP) and unpaid debtors. Law firms recognise WIP as revenue under FRS 102 as the firm obtains the right to consideration for its performance, not when a bill is paid. So profit can be recognised, and taxed on you, while the cash is still sitting in WIP days and debtor days rather than in the bank.

The consequence is that a firm that looks profitable on paper, but carries heavy lock-up, can leave a partner owing tax on profit that has not yet turned into drawable cash. This is precisely why you reserve against the allocation, not against the cash you managed to draw, and why drawings policy and billing discipline are part of the tax-reserving picture rather than separate from it. Reducing lock-up is the core working-capital lever for a firm; for the wider picture, see our guide to law firm cash flow management. For why the tax sits on the allocation rather than the drawings, see partner profit allocation in UK law firms and our guide to partner capital accounts and their tax treatment.

Worked Sketches

The following are illustrative only, anonymised, and not advice.

The 150% January. A partner whose payments on account have just begun faces, on one 31 January, the balancing payment for the year just ended plus a first payment on account (50% of the same liability) for the next year, then a further 50% on 31 July. This is the system catching up to income in arrears, not a penalty; a reserve built monthly absorbs it.

The band-by-band reserve. A partner's allocation spans the bands. On the slice in the basic-rate band the marginal cost is about 26% (20% plus 6% Class 4); on the higher-rate slice about 42% (40% plus 2%); on any slice in the £100,000 to £125,140 taper zone roughly 62% (effective 60% income tax plus 2% Class 4). Blending these for a typical upper-band partner lands a working reserve in the 35% to 45% range. Reserve against the allocation, sweep it monthly, and treat the taper zone as the expensive band it is.

The transition slice still landing in 2026/27. A partner in a firm with a non-March year-end carries transition profit spread at 20% a year. The 2026/27 tax year still includes a 20% transition slice (the fourth of the five), with the final balance in 2027/28, on top of the normal annual bill, all feeding the payment-on-account calculation. Budget the transition slice separately each January through 2027/28; it is one-off in total but spread across the years.

Accelerating into a low year. A partner expecting a lower profit share in a particular year elects to bring more transition profit into that year (Schedule 1 paragraph 73), so it is taxed while spare basic or higher-rate band is available, potentially below the rate it would suffer if left to a higher-income later year. The acceleration election is a model-it lever, not a default; check the £100,000 taper interaction first.

Taxed on locked-up profit. A firm is profitable on paper, but heavy WIP and debtor lock-up means the cash is not in the bank. A partner is still taxed on the full allocated share (WIP recognised under FRS 102), so tax falls due on profit not yet turned into drawable cash. This is the strongest argument for reserving against the allocation, not the cash you managed to draw.

Getting the Reserve and the Transition Right: Speak to a Specialist

The interaction of payments on account, the transition charge running through to 2027/28, the acceleration election and the firm's lock-up is firm-specific and partner-specific. The reserving percentage that holds for one partner under-reserves for another whose share sits more heavily in the taper zone, and the acceleration decision turns on a forecast of future years that only the numbers can settle.

Every partner's position is different, and the figures depend on your profit share, your firm's accounting date and your overlap relief. If you want a reserving and transition-profit plan that survives both the January demand and the spread through 2027/28, speak to a legal-sector-specialist accountant who can model it against your own allocation and your firm's year-end.