Week 8 – Be prepared for Uncle Sam
9 MIN READ
The yearly tax bill is the #1 expense that most business owners are caught off guard and are unprepared to pay. When tax day rolls around every year, you hear from your accountant that you owe taxes, and the immediate reaction is, “how is that possible? I never seem to make any money; how can I possibly owe the government money?”
You start scrambling to find the cash by raiding any accumulated profits and then moving on to your owner’s compensation for the coming months just so that you can pay Uncle Sam for last year! This unexpected tax bill is a huge letdown and a genuine motivation destroyer.
Does this sound familiar? Well, don’t worry, you aren’t alone. But that doesn’t mean that this has to continue to be your reality.
With Profit First, you don’t have to worry about not being prepared for Uncle Sam anymore.
Chances are that as a small business in the USA, you set up your business as a pass-through entity. Simply put, any income your business earns is “passed through” onto your personal tax return. The business’s tax return shows no tax due, but your personal tax return shows a tax owing for the income your business generated, not just what the business paid you.
While this allows you, as a business owner, to be charged tax only once, it also means that as a business owner, the taxes you owe on your business income are getting paid from your personal bank account.
“With Profit First you don’t have to worry about not being prepared for Uncle Sam anymore.”
But why isn’t your business paying the income taxes?
No matter what entity you have, your business can pay the income taxes it incurs. You might not be able to send a check directly to the IRS from your business checking account, but you can set the money aside throughout the year and then take a distribution to yourself at tax time and pay the IRS.
The tax account allows you to pay either the IRS for the taxes due with the tax return or to pay yourself back for any income taxes deducted throughout the year from your paycheck. In either case, you are ensuring that there is no surprise tax bill at the end of the year.
Determining your Tax Allocation
The Profit First Chiro Initial Assessment determines your Tax TAP, which is the percentage of your revenue transferred to your tax account to cover all tax liabilities. Essentially, you will put a certain percentage of your income into a special account to save for your taxes. This assessment will help you figure out how much money you should save each month to ensure you have enough to cover your taxes.
Your Tax Allocation Percentage is the percentage of your revenue that you will save for taxes. You can calculate it by adding up your tax liability and dividing it by your revenue. You should do this for the past three years to get a good sense of your ongoing tax liability. Remember, use both your personal and business tax returns.
What if i don’t have access to my Tax Return?
If you do not have immediate access to your tax returns and don’t feel like calling your accountant just yet, another option would be to use the standard high-income tax bracket tax rate of 35%. While this method is not going to be exact, that’s fine because it’s always better to over-save than get a call from your accountant at the end of the year when you owe money you don’t have.
But, wait, if I am estimating my income tax rate to be 35%, then why am I not setting my Tax TAP at 35%? Why are you suggesting I use 15%?
To determine your Tax TAP, start with your revenue and allocate the correct portions to your Profit Account, Owners Compensation account, and Tax Account. The remaining amount is your Operating Expenses, which will likely be between 40% and 60%.
Next, we will subtract that percentage from 100%. So, if your total Operating Expense account is at 55%, you will be left with 45%. That 45% is the amount you will be taxed on since you are usually not taxed on operating expenses. Now multiply your non-operating expense percentage, which in this case is 45%, by your estimated tax rate, 35%, and you end up with 15.75%—resulting in your Tax TAP.
Accounting for Taxes
Your Profit First Instant Assessment uses the standard 15% Tax TAP as your allocation. But, business taxes in the USA are incredibly complicated, especially when you have pass-through entities that combine personal and business income taxes into one. You could potentially reduce your income tax liability if you have many individual deductions.
While the methods above are getting starting points, it is imperative to seek advice from your tax accountant as to what they believe your tax liability will be at the end of the year and how much you should set aside during the year.
Adjusting your Target Allocation Percentage
You can adjust your Tax TAP based on your accountant’s advice. If your rate is lower than the standard Tax TAP, well, you just found some extra money! Use that to reach your goals in your other accounts faster.
If you need to raise your Tax TAP, you will need to lower your TAP in another area. Be careful when reducing your Operating Expenses, though, because this will cause your tax liability, so you might have to set even more money aside for taxes.
Setting Aside Money For taxes
As a business owner, it is essential to set aside the money for taxes throughout the year because otherwise, it is easy to overspend and not have the funds to pay Uncle Sam at the end of the year. By setting the money aside throughout the year, you are protecting the future of your business, an essential piece to reaching financial security and stability.
Profit First Chiro Roadmap
Is one of your goals to have a financial system that simple, easy, and allows you to make the best decisions to increase your practice's profitability?
With the Profit First Chiro Roadmap, you'll learn the five key numbers that every chiropractor needs to know to make informed decisions about their practice. You'll also get a personalized roadmap that shows you exactly how to achieve profitability.
Stop struggling and start making a profit with the Profit First Chiro Roadmap. Get started today and see the results for yourself!