One of the most common questions new business owners ask is, “How much should I save for taxes?”
Unfortunately, there is no single percentage that works for every business owner.
Your tax situation depends on your income, business structure, deductions, other sources of income, filing status, and several other factors. Still, setting aside money throughout the year is one of the best habits a business owner can develop.
Why Business Owners Need to Plan for Taxes
Employees often have federal and state taxes withheld from their paychecks. Business owners may not have that same automatic withholding.
If you are self-employed or receive income from a business, you may need to make estimated tax payments during the year.
This means that the money deposited into your business or personal bank account is not necessarily all money that you can spend.
Some of it may need to be reserved for taxes.
Start With a Percentage
A common starting point for a self-employed person is to set aside a percentage of business profit for taxes.
Some business owners choose to set aside around 25% to 30% as a starting point, while others may need to save more or less.
However, this should be treated as a planning guideline rather than a universal rule.
Your actual tax liability could be significantly different.
For example, two business owners could each have $100,000 of business profit but have different tax situations because of differences in deductions, filing status, other income, retirement contributions, and business structure.
Save Based on Profit, Not Just Revenue
One important distinction is the difference between revenue and profit.
Suppose your business brings in $150,000 during the year but has $50,000 in legitimate business expenses.
Your business profit would be $100,000 before considering other adjustments.
Tax planning generally focuses on taxable income and profit rather than simply looking at the total amount of money coming into the business.
This is one reason maintaining accurate accounting records is so important.
Consider Estimated Tax Payments
Saving money for taxes and making estimated tax payments are related, but they are not exactly the same thing.
You may set aside money in a separate account so that you have funds available when taxes are due.
You may also be required to make estimated tax payments during the year.
Estimated payments can help prevent a large tax bill from accumulating until the end of the year.
Create a Separate Tax Savings Account
One simple strategy is to keep tax savings separate from your everyday business operating funds.
For example, you could transfer a portion of your business income into a separate savings account on a regular schedule.
This makes it easier to see how much money is available for operating expenses and how much has been reserved for taxes.
It can also prevent the common problem of spending money that was actually needed for a future tax payment.
Review Your Numbers Throughout the Year
Your tax situation can change during the year.
Maybe your business has a particularly strong quarter. Maybe you purchase equipment, hire employees, change your business structure, or experience a significant increase in expenses.
These changes can affect your estimated tax situation.
Rather than choosing a percentage in January and never looking at it again, consider reviewing your numbers throughout the year.
Don’t Forget About State Taxes
North Carolina business owners also need to consider their state tax obligations.
Federal and North Carolina taxes may not always follow identical rules, so your tax planning should consider both.
If you operate in multiple states, additional state tax considerations may apply.
What Should You Do If You’re Unsure?
If you’re not sure how much to save, don’t guess indefinitely.
A tax professional can review your income, expenses, previous tax returns, and current financial information to help you develop a more appropriate estimate.
The goal isn’t simply to put aside as much money as possible. It is to set aside enough to meet your obligations while keeping the rest of your money available for operating and growing your business.
Tax Planning Is a Year-Round Process
Saving for taxes becomes much easier when it is part of your regular financial routine.
Keep accurate records, monitor your profit, make estimated payments when required, and review your tax situation when your circumstances change.
If you own a small business in Mount Airy or the surrounding Northwest North Carolina area and want help developing a tax planning strategy, Transactions, LLC can help you understand your options.