If you’re not sure how much your small business should set aside for tax time, you’re not alone. This is one of the most frequently asked questions from small business owners.
If you need help with the financials of your Cincinnati-based business, let Orcutt and Co. help. We specialize in payroll services, bookkeeping, accounting, and tax prep.
In this article, we’ll explain how you can determine how much to set aside for tax time.
3 Steps to Save for Tax Time
When it comes to determining how much to set aside for tax time, there are three steps to consider:
Get Clear on What You Owe
There are several types of taxes you and your business will need to pay, including:
It’s important to note that this is not a comprehensive list. You’ll want to work with an accountant that can explain the taxes that your business will owe and when you should pay them. Just keep in mind that it is your responsibility to set aside the money to pay your taxes and to make sure that they get paid.
Use the 30% Rule
Tax obligations vary from one business to another, but a good rule of thumb is to save 30% to 40% of your business income for taxes. This should ensure that you have enough to cover your quarterly taxes. You can work with your accountant to determine if you need to save more or if you can get away with saving less.
Choose Your Savings Method
There are several methods you can use to set aside for tax time:
This method makes the most sense if you’re just getting started or if this is the first time you will be filing a tax return for your business. This is because when your business is new, it can be challenging to estimate your total income for the current year because you have no previous information to use as a guide and your income is likely unstable or growing.
Therefore, every time you receive a payment from a client/customer, put 30% of it into a savings account. This is easy if your income is low-frequency and high-value. On the other hand, if you sell a high volume of merchandise, it’s not practical to set aside 30% after each transaction- but you can add up your income for a week or a month and set aside 30% of that amount.
This is best if this is the first year that you have made a profit. This can also be helpful if your income has changed so drastically that previous years are not a good indicator of what you can expect to earn in the current year.
Start by calculating your average monthly income by adding up your income each month between the current month and the beginning of the fiscal year. Then, divide it by the number of months. Then, take that number and calculate 30% of it, and set aside that much each month for your taxes.
If you filed a tax return the previous year and you don’t expect a drastic change to your income, you can use this method. The primary benefit is that you only have to do the math once for the entire year.
Take the total income for the previous year and divide it by 4 and calculate 30% of that total. This will tell you how much you need to set aside and pay for your quarterly tax payments.
What if I Underpay/Overpay?
According to the IRS, as long as you pay 100% of the amount that you paid the previous year, you won’t be penalized for underpaying. This is known as the safe harbor rule. If you did underpay, you’ll know when you file your taxes.
On the other hand, if you overpaid, you’ll get the overpayment back as a tax refund. The best way to reduce your burden of future taxes is to put the return in your savings account.
Do You Need Tax Planning Assistance?
If you need assistance with tax planning for your Cincinnati-based business, let Orcutt & Co. help. We have the experience and expertise to help you determine what taxes you need to pay and the best way to set aside for those taxes.