How do you figure out how much money to set aside for small business taxes? There are a few options for calculating your tax obligations and saving the correct amount of money.
The best method depends on how long you've been in operation, how stable your revenue is, and whether you're willing to get your hands dirty and crunch some numbers on a regular basis.
If you're just starting out, you'll want to use the safe harbor method. This involves estimating your tax liability for the year and setting that money aside in a separate account.
You can find calculators online to help with this or work with an accountant to make sure you're doing it right.
Step 1: Determine Your Tax Obligations
The first step is to determine your tax obligations. This includes not only federal taxes but also state income tax and local tax. You can use a variety of resources to figure this out, including the IRS website and your state's Department of Revenue website.
These taxes include your self-employment tax, income tax, sales tax, franchise tax, property tax, and excise tax.
Examples of self-employment taxes are Social Security and Medicare taxes that apply to business owners.
The rate is 15.3% of your net income from the business. You can deduct half of this amount from your income taxes.
Your income taxes are what you pay on your business profits. The rates vary depending on your income and filing status. You can use the IRS tax tables to figure out how much you owe.
Sales taxes are imposed by states and local governments on the sale of goods and services. The rate varies depending on the jurisdiction. You'll need to check with your state and local governments to find out the rates and pay taxes.
A franchise tax is a tax that some states impose on businesses. The rate and base vary by state. You can find out more from your state's Department of Revenue.
Property taxes are imposed by local governments on the value of the property, such as buildings and equipment.
The rates vary depending on the jurisdiction. You'll need to check with your state and local governments to find out the rates to pay taxes.
Excise taxes are imposed by the federal government on certain types of goods and services. The rate and base vary by type of good or service. You can find out more from the IRS website.
Step 2: Figure Out Your Net Income
The next step is to figure out your net income. This is your revenue from the business minus your business expenses. You can use accounting software to track this or do it manually.
If you're just starting out, you may want to estimate your net income. You can do this by looking at your revenue and expenses for the month and extrapolating that out for the year.
Step 3: Stick to the 30% Rule When It Comes to Taxes
The 30% rule is a general guideline that states that you should set aside 30% of your income for taxes. This includes federal, state, and local taxes.
You can use this rule to help you figure out how much money to save each month. Or, if you're using the safe harbor method, you can use it to determine how much money to save each year.
Excess payments are not calculated in the same way for every organization.
If you'd want to get more specific or see whether you can save less than 30%, talk to your accountant about how much of your business income should be set aside to pay taxes.
Step 4: Save in a Separate Account
Once you know how much money to set aside for taxes, you'll need to put it in a separate account. This will make it easier to track and ensure that you're not spending the money on other things.
You can use your business checking or savings account for this or open a special account specifically for taxes.
Step 5: Choose a Saving Method
You may have money set aside for taxes as often as you like, however, the ideal savings technique for your business depends on a variety of factors, including the type of business you run and how long it's been operational.
The Per-Payment Method
If you haven't been in business for long or if this is your first year filing an income tax return for your firm, the pre-payment option makes sense.
This is especially true when you operate in a high-risk market, such as healthcare.
Because your business may be growing quickly, it's difficult to predict its total income (and therefore taxes owed) for the current year.
Because the records would be too old, you don't have access to them, and your company's monthly earnings are most likely changing or growing.
Seasonality can make it difficult to predict income for a first-year, especially if your business is affected by it.
Put 30% of each payment received from a client or customer into a business savings account every time.
This is simple to do if your incoming funds are low-frequency but high-value. For example, if clients pay you for project work only a few times per month, you won't have to worry about setting aside money for taxes too often.
However, if you sell a large number of products through eCommerce, it is impossible to take 30% off after every purchase. In this situation, calculate your earnings for one week or one month and then take the 30% cut.
Consider using the sum total of one or more payments to cover the current quarter's estimated taxes if you receive low-frequency/high-value payments and have a robust financial cushion in your bank.
You'll get the joy of crossing that tax payment off your to-do list in one fell swoop, and it will spare you from having to save 30% from each paycheque that comes in.
The per-payment method is only recommended if you're confident that your estimated taxes for the year won't change. If they do, you'll need to account for that by making larger or additional payments.
The Safe Harbor Method
The safe harbor method is a rule that allows business owners to pay a fixed percentage of their taxable income instead of estimated taxes. This can be helpful if you have difficulty predicting your company's annual income.
You must average your income over the past three years and then pay 90% of that amount. The final 10% is paid in the following year.
This method makes it easier to budget for taxes and prevents you from incurring penalties for underpayment.
Unlike the per-payment option, estimated taxes can be paid using the safe harbor method even if your company's income fluctuates from year to year.
However, you must have filed income tax returns for the past three years in order to use this method. If you haven't, you'll need to taxes using another method.
The Average Method
If your business is seasonal or has irregular income, the average method may be a good option.
This technique smooths out fluctuations in earnings by averaging your income over the past three years.
To use this method, add up your taxable income for the past three years and divide by three. This will give you an average annual income.
This method is helpful if you can't use the safe harbor or pre-payment methods because you haven't been in business long enough or your income varies too much.
Like the safe harbor method, taxes using the average method can be paid using any frequency, even if your company's income fluctuates from year to year.
Be sure to file tax returns for the past three years before using this method.
The Monthly Method
If your business has regular income, you can use the monthly method to calculate taxes. This approach is simple and accurate if your earnings are consistent from month to month.
To use this method, multiply your taxable income for the current year by 12. Then, multiply that number by 90% (0.9). The final 10% is paid in the following year.
This method is only recommended if your company's income doesn't fluctuate much from month to month. If it does, you should use another method to calculate taxes.
The Quartly Method
If you receive low-frequency/high-value payments, you can use the quarterly tax payments method to calculate estimated quarterly taxes.
This approach is simple and accurate if your earnings are consistent from quarter to quarter.
Read More: Business Tax Calculator
The Yearly Method
If your business has regular business income, you can use the monthly method to calculate taxes.
This approach is simple and accurate if your earnings are consistent from month to month.
To use this method, multiply your business income tax for the current year by 12.
Then, multiply that number by 90% (0.9). The final 10% is paid in the following year. This method can also be used to calculate your tax deductions.
What Happens if You Underestimate Your Taxes Owed?
If you underestimate your taxes owed, you may be subject to penalties for underpayment. To avoid this, be sure to choose a method of calculation that is simple and accurate.
What Happens if You Pay Too Much Taxes?
If you pay too much taxes, you will receive a refund from the IRS. This money can be used to cover future tax bills or other expenses.
How Do I Start an Income Tax Savings Account?
You can open an income tax savings account by setting up a separate account at your bank or credit union. Be sure to label the account so that you know it is for estimated taxes.
You can also use this account to set aside money for other self-employment taxes, such as Social Security and Medicare taxes.
When Do I Pay Small Business Taxes?
You will need to pay small business taxes when you file your annual tax return. Be sure to set aside money each month so that you have enough to cover your tax bill when it is due.
How Much Should I Set Aside for Small Business Taxes...
Figuring out your income tax obligations and how much to save can be complicated. But, with a little work, you can get it done. By following the steps in this article, you'll be well on your way to knowing exactly what you need to do.