How much should a business set aside for taxes (2024)

Ah, the age-old conundrum that keeps many business owners up at night: “How much should I set aside for taxes?” As we step into 2024, the landscape of business and taxation continues to evolve, making this question even more pressing. Every entrepreneur, from the bustling coffee shop owner on the corner to the tech startup guru in Silicon Valley, grapples with this dilemma. It’s like setting the table for a feast, but not quite knowing how many guests will show up. Set aside too little, and you’re scrambling at the last minute; set aside too much, and you’ve missed out on potential investments.

How much should a small business set aside for taxes?

Determining how much a small business should set aside for taxes can be complex. Learn about key factors to consider and strategies for effective tax planning.

Dive in with us as we unravel this fiscal mystery, ensuring that when tax season rolls around, you’re not just prepared—you’re ahead of the game.

Key Considerations for Tax Savings

1. Business Structure: The type of business entity you’ve chosen—be it an LLC, S-Corp, or sole proprietorship—plays a pivotal role in determining your tax obligations.
2. Deductions and Credits: Familiarize yourself with the available tax deductions and credits specific to your industry. From home office deductions to R&D credits, these can significantly reduce your taxable income.
3. Estimated Tax Payments: If you’re self-employed or run a business, you might need to make estimated tax payments throughout the year. Missing these can result in penalties.
4. State and Local Taxes: Beyond federal taxes, be aware of state and local tax obligations. These can vary widely and have a notable impact on your overall tax bill.
5. Retirement Contributions: Contributing to retirement accounts like a SEP IRA or Solo 401(k) can offer tax advantages, reducing your taxable income now and securing your future.
6. Stay Updated: Tax laws and regulations are ever-evolving. Regularly consulting with a tax professional or using updated tax software ensures you’re capitalizing on every opportunity.

Remember, while taxes are a certainty, overpaying isn’t. Strategic planning and awareness of these key considerations can position your business for optimal financial health.

What are the different types of taxes?

1.  Federal Taxes:

• Income Tax: Every business, except for partnerships, needs to file an annual income tax return. However, partnerships submit an information return. The type of form you choose hinges on your business structure. You must pay federal income tax as you earn or get income throughout the year, making it a pay-as-you-go system. If you don’t cover your tax through withholding or if it’s insufficient, you may need to make estimated tax payments.

Forms: Check out Business Structures to pick the right forms for your business type.

• Estimated Taxes: You typically need to make regular estimated tax payments throughout the year on income, which includes self-employment tax.

Forms: For deeper insights, look into Estimated Taxes.

• Self-Employment Tax: Mainly for self-employed individuals, this tax contributes to social security coverage. This coverage offers retirement, disability, survivor benefits, and Medicare.

Forms: Use Schedule SE (Form 1040 or 1040-SR). Dive into Self-Employment Tax for more specifics.

• Employment Taxes: If you employ others, you must handle certain employment taxes, such as social security, Medicare, federal income tax withholding, and federal unemployment (FUTA) tax.

Forms: Dive deeper with Employment Taxes for Small Businesses.

• Excise Tax: If you deal with specific products, businesses, equipment, facilities, or services, you might owe excise tax. This category encompasses environmental taxes, fuel taxes, and taxes on various sales or uses.

Forms: Use Form 720, Form 2290, Form 730, or Form 11-C. For a full breakdown, check out Excise Taxes.

2. Sales Tax: This tax applies to the sale of products and services. Often, businesses must collect and send this tax to their state.

3. Franchise Tax: Some states charge businesses a franchise tax for the right to incorporate or operate within their borders.

4. Property Tax: Businesses might need to cover property taxes on real estate and personal assets.

State’s Role in Taxation:

Every state sets its own tax rules. While the federal government charges income, employment, and excise taxes, states might add taxes like sales, franchises, and property. Businesses should understand both federal and state tax duties.

Always keep up with the latest IRS rules and forms to stay compliant and dodge potential fines.

Benefits of Tax Tools:

Modern tax tools can simplify taxation. These digital resources, ranging from simple calculators to platforms like mesha, guarantee precision, speed, and current compliance with shifting tax regulations. They present a budget-friendly option compared to old-school tax services, letting users promptly gauge liabilities, test scenarios, and decide wisely.

Stick To The 30% Rule When It Comes To Taxes

One of the golden rules often touted by financial experts is the “30% Rule” when it comes to setting aside funds for taxes. By earmarking 30% of your income for federal taxes, you create a safety net, ensuring you’re adequately prepared when tax season rolls around.

However, it’s crucial to strike a balance between federal and state tax obligations. State tax rates can vary significantly, and in some cases, they might warrant setting aside an additional percentage of your income. As Benjamin Franklin famously said, “In this world, nothing can be said to be certain, except death and taxes.” By adhering to the 30% rule, you’re not just preparing for the inevitable but also ensuring a smoother financial journey.

A 2019 survey by the National Small Business Association found that 21% of small business owners spend over 120 hours annually on federal taxes alone. By sticking to the 30% rule and planning ahead, you can reduce the stress and time spent on tax-related activities.

Choose a Tax-Saving Method

Taxes can be daunting, especially when you’re trying to figure out the best way to save for them. But, with a little guidance and understanding of the IRS guidelines, you can choose a method that aligns with your business’s financial rhythm. Here’s a breakdown:

1. Per-Payment Approach:

When to Consider It:

This method is a lifesaver for businesses with fluctuating incomes. If you’re in the early stages or if your revenue sees frequent ups and downs, the per-payment approach can be your best bet.

How It Works:

Every time you receive a payment, be it from a client or a sale, immediately set aside a specific percentage (often recommended as 30%) for taxes. This ensures you’re consistently saving and not caught off-guard during tax season.

2. Monthly Method: For Businesses on the Rise

When to Dive In:

If your business is experiencing steady growth, with increasing but somewhat predictable monthly revenues, this method is tailored for you.

How It Works:

Instead of setting aside money with every payment, evaluate your total earnings at the end of each month. Based on your monthly income, set aside a portion for taxes. The IRS encourages businesses to make estimated tax payments to avoid a hefty year-end tax bill, and this method aligns well with that guidance.

3. Yearly Method: For the Steady Sailors

When It’s Ideal:

Established businesses with stable annual incomes can benefit the most from this method. If your revenue doesn’t see dramatic shifts and you have a clear picture of your yearly earnings, this is your go-to.

How It Works:

At the beginning of the year, based on your previous year’s income and any anticipated changes, determine an estimated tax amount. Divide this by 12, and set aside this calculated monthly amount. The IRS provides Form 1040-ES for estimated tax calculations, ensuring you’re in line with their expectations.

No matter which method you lean towards, the key is consistency and awareness of the IRS guidelines. Regularly setting money aside for taxes, coupled with a clear understanding of your business’s financial landscape, will ensure you’re not just compliant but also financially savvy.

How to Handle Tax Miscalculations

The IRS has clear guidelines to help taxpayers navigate the complexities of tax payments. One significant provision is the “safe harbor rule.” If you consistently pay quarterly estimated amounts that match 100% of your previous year’s tax, you’re shielded from underpayment penalties, even if this year’s tax turns out higher. However, for those with incomes surpassing $150,000, the stipulation is a bit different: you need to pay 110% of the previous year’s tax or 90% of this year’s tax to leverage the safe harbor’s protection.

As you prepare your annual tax return, you’ll assess your income, account for business deductions, and pinpoint your overall tax obligation. This exercise will highlight if your quarterly estimated tax payments hit the mark. If there’s a shortfall, the IRS equips you with Form 2210 (Underpayment of Estimated Tax by Individuals, Estates, and Trusts) to compute any penalties. This tool demystifies the underpayment scope and its repercussions, ensuring you remain informed and in line with regulations.

Tax miscalculations, while not uncommon, carry consequences. Underestimating taxes can lead to penalties determined by the IRS’s interest rate on underpayments. Regular underpayments might also increase your audit risk. 

Paid too much?

This means the IRS owes you. Instead of taking the refund and spending it or placing it in your regular bank account, you can use it smartly to ease your tax worries for the next year. How? When you’re filling out your business tax form, Form 1040, there’s an option to let the IRS keep some or all of your refund. By doing this, they’ll use it for your taxes next year. It’s like giving yourself a head start!

This is super handy if you think you might owe more taxes next year. Plus, it saves you the steps of taking the refund from the IRS, depositing it, and then setting it aside yourself. But here’s a thing to consider: if your refund is a big amount, you could potentially use that money in other ways, like investing it to earn some interest or putting it back into growing your business. If you just let the IRS keep it, it won’t grow.

Managing Tax Funds

• Establish Separate Tax Accounts:

Create a dedicated bank account exclusively for your tax funds. This separation ensures clarity between business expenses and tax obligations, reducing the risk of spending reserved tax money inadvertently.

• Leverage Automatic Transfers:

Set up automatic transfers to your tax account after each income payment. This proactive approach ensures consistent savings for tax obligations and minimizes the chances of underpayment.

• Identify Potential Tax Deductions:

Actively seek out and document business-related expenses that qualify as tax deductions. Regularly reviewing and updating this list can significantly reduce your taxable income, leading to potential savings.

• Collaborate with Tax Experts:

Engage with tax professionals or consultants. Their expertise can provide insights into tax-saving strategies, ensure compliance with ever-evolving tax laws, and offer guidance on maximizing deductions and credits.

Final thoughts

IRS guidelines constantly change and each financial year presents new challenges. But by implementing the right strategies, such as reserving funds, exploring tax-saving techniques, and seeking expert counsel, you can make this task more manageable.

Taxes don’t just represent what you owe; they mirror your business’s financial well-being and foresight. By staying alert, proactive, and making educated choices, you not only maintain compliance but also position your business for lasting financial prosperity.

Use the insights from this article as your guide. Whether you’re an experienced business owner or a newcomer, you can always fine-tune your strategy, maximize your savings, and pave the way for a hassle-free tax season.

• Facebook
• Twitter
• LinkedIn
• Pinterest
• Mail