Once upon a time, in a not-so-long-ago blog article, I explored the idea of The Entrepreneur’s Withholding.
In fact, I kind of kicked it like a rat and jumped up and down on it with thick-soled combat boots.
Fact: everybody that makes money at a greater than poverty level of income pays tax.
For simplicity’s sake, let’s just say that if you make more than the standard deduction for your tax filing status, you’re paying.
Furthermore, if you make more than $400 in self-employment income, you’re required to report it.
This ridiculously low ceiling on SE earnings is because your least-favorite Uncle wants his unfair share of Social Security and Medicare, aka SE tax.
When you were working your first burger-flipper job you got something called a paycheck.
You were paid a gross wage, out of which came federal and state income tax withholding and your half of FICA.
Your employer paid the other half of your FICA and unemployment insurance premiums on your behalf.
FICA, by the way, is the Federal Insurance Compensation Act, and in money terms that means Social Security and Medicare.
Then…you discovered you have a skill for either making something, or some group or collection of things, or providing a service that has value to people with money, and you struck out on your own.
Now, you have to pay the federal and state taxes plus ALL of the FICA, both parts.
Blech.
At least, you’re paying all of the FICA until you figure out how to get out of about half of it, legitimately.
Or more importantly, figure out that I’VE figured out how to. 😉
No matter what, though, you still have to pay taxes.
And now you don’t have your government-mandated nanny employer doing the tax collection for you.
You have to do it yourself. With or without help, no escape, it’s a side-effect of that phenomenon the younger generation calls “adulting.”
To recap a highlight of the original post on Entrepreneur’s Withholding, you have 4 deadlines every year you have to hit.
That’s it. They are:
April 15th – for January through March
June 15th – for April and May
September 15th – for June through August
January 15th of the following year – for September through December
That’s it.
Simple.
I even tell myself, and others that I believe have the frame of mind to enjoy the metaphor, that you can look at it as though the IRS is treating us like adults.
The reasons for doing so are simple, too. I have two biggies:
- Making Estimated Payments pays them as you go, instead of the soul-sucking feeling of having to come up with all of it at once in March or April.
- Making Estimated Payments avoids the underpayment penalty, which for the sake of simplicity occurs in cases where the taxpayer anticipates owing over $1,000 in tax.
Now, I’m going to share with you the new shiny reason for revisiting this topic.
Ready?
Get on a Monthly Tax Saving Schedule
Saving for estimated taxes on a monthly basis is the smart way to plan for each Estimated Tax payment deadline, and also to avoid any surprises come next tax season.
Here are some steps you can take to make it easier:
Determine your estimated quarterly tax payments.
If you have a pretty steady stream of income, and you’re confident it will be similar to your previous year, this gets kind of easy.
Divide your estimated quarterly taxes by 12: Once you know your estimated quarterly tax payments, divide that amount by 12 to get your monthly payment amount.
Set up a separate savings account: Create a separate savings account specifically for your estimated tax payments. This will help you keep your tax money separate from your other funds, making it easier to track.
Review and adjust as necessary: Review your relative profit and loss and tax liability throughout the year, and adjust your monthly savings amount if needed.
Now, calculating estimated taxes in an unstable or more turbulent business can be challenging because your income can vary from month to month.
Here are some steps you can take to estimate your monthly taxes in an unstable business:
Estimate your annual income: Look at your income from the previous year and consider any expected changes in your business.
Calculate your estimated quarterly taxes. You can use the IRS Form 1040-ES worksheets from their Publication 505 webpage, or another reputable online calculator, to calculate your estimated quarterly taxes based on your estimated annual income. This will give you a rough idea of how much you should set aside each quarter.
Divide your estimated quarterly taxes by 3: Divide the amount you calculated in step 2 by 3 to get your estimated monthly tax payment.
Monitor your income and adjust your estimated taxes: Monitor your business income each month and adjust your estimated tax payments accordingly. If your income is higher or lower than expected, you may need to adjust your monthly estimated tax payments to avoid overpayment or underpayment penalties.
Five Accounts
We highly recommend five bank accounts for the organized small businessperson.
They are:
- Operating Checking
- This is your main account, out of which your contractor and employee payments and other vendor expenses should originate.
- NOTE: for recurring expenses we also suggest a business credit card, particularly for SaaS and other monthly auto-debits. This gets your payments made without extra work on your part, and also your credit card rewards are a tax-free bonus!
- Operating Savings
- Funds in excess of 2 to 3 times your anticipated monthly expenses go here, so they’re earning more interest than you’ll get with the checking account. Some call this a Profit account.
- Tax Savings
- This is where your monthly tax deposits go. If you are a sole proprietor 30% of your monthly profit should go right here. When you go to make your Estimated Tax payments to the IRS and your state you will be able to provide savings account information as an option, and if you have a surplus after January 15th treat yourself to a “bonus.”
- If you elect the S Corporation option this requires calculation of your reasonable compensation withholding, and varies with your income, but 15% to 20% is a pretty safe margin in most cases if you don’t choose to calculate that more precisely.
- Personal Checking
- Move money from your business to this account before doing your personal spending. If you do your own books you’ll thank me later, and if you have a bookkeeper, he or she will thank you. It’s the right thing to do.
- Personal High-Yield Savings
- Google that phrase without the “personal” part, and look at what comes up. As of this writing in early 2023 I’m enjoying 4.75% savings interest, and it’s with an online bank account I opened two years ago with about one hour’s worth of work.
- This is where your “mad money” goes. Savings for a real estate investment, a special vacation, or just plain-old “rainy day” money. You work hard, and you deserve to have a buffer in the event of life’s ugly surprises.
In Closing…
If you’re still unsure about how to estimate your taxes in an unstable business, it’s always a good idea to consult with a tax professional. This is what we live for here at Owings LLC. Reach out to us in a reply to this posting, or by Facebook or LinkedIn direct messaging. We’re here to help!
By following these steps and monitoring your income throughout the year, you can estimate your monthly taxes in an unstable business, and actually look forward to next tax season.