9 MIN READ
The yearly tax bill is the #1 expense that catches most business owners off guard when it comes to Preparing for Taxes. 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?”
As the tax season approaches, you may find yourself scrambling to find the cash, raiding any accumulated profits, and even dipping into your owner’s compensation for the coming months, all in a rush to pay Uncle Sam for last year. This unexpected tax bill can be a significant letdown and a genuine motivation destroyer, leaving you wondering how to tackle Preparing for Taxes effectively. If this situation sounds familiar, rest assured, you’re not alone. However, it’s essential to recognize that it doesn’t have to remain your ongoing reality.
Navigating Pass-Through Entities and Tax Obligations
With Profit First, you can stop worrying about being unprepared for Uncle Sam and start Preparing for Taxes. 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?
Irrespective of your business structure, your business can proactively manage the income taxes it incurs. While sending a check directly to the IRS from your business checking account may not be an option, you can proactively set funds aside throughout the year. Then, when tax time arrives, you can take a distribution for yourself to settle your tax bill with the IRS. This tax account allows you to either pay the IRS for the taxes due with the tax return or reimburse yourself for any income taxes deducted throughout the year from your paycheck. In both scenarios, you are effectively preventing any unexpected tax bill surprises 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?
What if you don’t have access to your Tax Return? In such a scenario, if you prefer not to contact your accountant right away, there’s an alternative approach for tax preparation. You can opt to use the standard high-income tax bracket rate of 35%. While this method may not provide pinpoint accuracy, it serves as a prudent strategy to safeguard against unforeseen tax liabilities that may arise at year-end.
However, you might wonder, “If I estimate my income tax rate at 35%, why not set my Tax Target Amount (Tax TAP) at 35%? Why the suggestion of 15%?”
To determine your Tax TAP accurately, begin with your revenue and allocate the appropriate proportions to your Profit Account, Owner’s Compensation account, and Tax Account. The remaining balance typically represents your Operating Expenses, which usually fall within the range of 40% to 60%. Subtract this percentage from 100%. For example, if your total Operating Expense account stands at 55%, you’ll be left with 45%. This 45% is the portion subject to taxation since operating expenses are typically not taxed. Next, multiply your non-operating expense percentage (in this case, 45%) by your estimated tax rate (35%), resulting in 15.75%—this becomes your Tax TAP.
Accounting for Taxes
In Preparing for Taxes, the Profit First Instant Assessment employs a standard 15% Tax Target Amount Percentage (Tax TAP) for your allocation. However, it’s crucial to note that business taxes in the USA can be remarkably intricate, especially when dealing with pass-through entities that blend personal and business income taxes into one. If you have numerous individual deductions, you might have the potential to reduce your income tax liability.
While the aforementioned methods provide valuable starting points, it’s imperative to consult your tax accountant for their expert insight. They can offer guidance on what they anticipate your tax liability to be at the end of the year and advise on the appropriate amount to set aside throughout the year.
Adjusting your Target Allocation Percentage
To further refine your financial strategy, consider Adjusting your Target Allocation Percentage based on your accountant’s guidance. If your rate falls below the standard Tax TAP, you’ve essentially discovered extra funds. You can allocate these resources to expedite your progress in other financial accounts. However, if you find the need to increase your Tax TAP, you may need to reduce your TAP in another category. Be cautious when trimming your Operating Expenses, as this can elevate your tax liability, potentially requiring additional reserves for taxes.
Setting Aside Money For taxes
When it comes to Preparing for Taxes, one critical aspect is Setting Aside Money for taxes. As a business owner, this proactive approach is essential. Failing to allocate funds for taxes throughout the year can lead to overspending, leaving you short of the necessary funds to pay Uncle Sam when tax time arrives. By consistently earmarking funds throughout the year, you’re not only safeguarding your business’s financial future but also building a solid foundation for long-term financial security and stability.
Profit First Chiro Roadmap
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