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Saving to Pay Federal Taxes

Image: Creative Commons

Last week, I helped you with the basics in getting your accounting ready to file taxes on April 15th this year.  (The rest is up to you to discuss with your accountant.)  By the way, read my tips on finding a good accountant here.

Today, I want to talk about saving to pay your federal taxes.  If you have to pay income taxes at the state level and/or sales tax, the strategies are the same.  But, because each state differs in their requirements (filing dates, etc), this post will solely address IRS taxes.  It’s a little too late to save for your 2011 taxes, so let’s move forward to create positive habits for 2012.

(I want to give the disclaimer again that I am not a tax accountant… please advise your accountant to find out the latest and greatest according to the IRS and to get proper tax advisement on your particular situation.)

If you are a corporation…

If your business is set up as a corporation, you will pay taxes as an employee of the corporation and as a shareholder (owner) in the corporation. This ‘double-taxation’ is the reason that many tax accountants advise small business owners against setting up a corporate structure.  (There are benefits, depending on your situation, so ask him/her what is best for you.)

Your tax saving will, therefore be double-duty.

As a business, you will have to save taxes for the following:

    • your corporate tax (generally 15-35% on your year-end net profit or loss)
    • your employees’ social security, FUTA, and medicare (and any amounts you’ve withheld on their behalf)

As an employee, you will have taxes withheld by the corporation (your company).  The company ‘holds’ your taxes and pays them quarterly to the IRS.  At the end of the year, when you file the 1040, you determine whether you had enough held, too much (resulting in a refund), or not enough (resulting in a payment).

The biggest challenge is for the business to save the cash to make these payments quarterly.  It’s easy to be paid for a client, think you are flush, and spend it.  In reality, you’ll want to save incrementally.  For corporate taxes, a tax accountant will help you calculate what your tax payments are expected to be quarterly.  Here’s an example:

  • Based on prior years, you will be required to pay $3000 quarterly for corporate taxes.
  • Break this down into monthly payments and set it aside in a ‘don’t touch this’ saving account.  $1000 monthly is the amount you’d save here.
  • If you have ~4 clients each month, you can break this down further so that you save $250 from each client.

You’ll also want to ensure that you are not touching the money withheld for employment taxes (social security, FUTA, medicare, and taxes withheld on behalf of the employee.)  Again, hold it in a separate account so that you can pay this quarterly.  Or elect to e-file so that you can send payments more frequently.

If you are a sole proprietorship, partnership, LLC, LLP, or S-Corp…

You will pay taxes as the owner of your business only.  In other words, you will make a draw against equity in order to pay yourself (a salary, per say.)  This is something we cover in our workshops, and it’s a little tricky, so I won’t get into too much detail here.  Suffice to say, the net income or loss that your business makes is your own personal income or loss.  This is what you pay taxes on.

This income or loss is stated on your annual 1040 (and supplementary schedules).  And, because you are paying these taxes at the PERSONAL level and not the BUSINESS level, this is something you need to budget for in your own personal budget.  (WHAT?  You don’t have one?  Read Dave Ramsey’s book, Totally Money Makeover.)  If you have employees, you’ll hold their taxes the same as above.

So… here’s where you can get into a fine mess…

  • Your business performs phenomenally in 2012!  Your net profit (after you pay all expenses, etc) is $100,000 for the year. YAHOOO!!!!  As an owner of your business, this is yours. (Chances are that you’ve drawn this incrementally.)
  • BUT – you didn’t really save for taxes, or pay quarterly.
  • You take this to your accountant and your accountant tells you that on April 15th you owe $25,000 in taxes.  YES – it’s time to cry.  You just bought yourself a car.  ONLY – it’s not a car – it’s a big fat tax payment.

How do you get around this?  You save and you pay quarterly. With the help of your tax accountant, you will calculate your estimated quarterly taxes.  In the example above, you would save $6,250 quarterly (and you will send this check to the IRS along with a little form called the 1040-ES).  AGAIN – this is something that you need to budget for on your personal budget – it’s a personal payment – not a business payment.  BUT, you can think ahead and you know that each time you make a draw on your business, you need to set aside 20-35% for taxes.

Does this help?  Do you feel better prepared to save for your taxes?

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February 6, 2012 - 8:39 am

IBTH - I really liked this post! Very good, straightforward advice. I spend most of my time dealing with people who are not proactive about saving for their tax debt. If people listen to you, they can save themselves a lot of heartache.

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