Prepping for Your First Tax Season

~This is not tax advice~

Something I consistently see among newer business owners is the shock once they file taxes after their first year in business.

“My LLC only generated $20,000 all year, how is my tax bill pushing $4,000?”

It’s a big chunk of change, and it hurts to have it feel like it’s being taken away.

In reality, they aren’t paying that much more in taxes than they did as an employee percentage-wise.  Take a look at your last year of pay-stubs while working as an employee. 

If you can find one from December, look at the difference between your “Total Pay” and your “Net Pay.”  There’s a big difference in those two numbers!
While some of those missing dollars may have gone to a retirement account, most of it went to taxes.  

The biggest difference from working as an employee for someone else vs being a business owner is that instead of paying your taxes in smaller increments, now you are being asked to hand it over all at once.  It hurts in a whole different way to see that money come into your account, feel like it’s yours to keep, only to have it taken away.

Of course, paying taxes is never fun. But it that much more painful if you haven’t been saving a portion of your earnings throughout the year in preparation. Some have found themselves in a tough situation, having to scramble to pay Uncle Sam between 15%-20% of all their profit when they’re nothing left in the business bank account. 

How can it be handled in a better way?

From the very start, we recommend setting up a business checking account, and 2 business savings accounts. The checking account is used for all transactions as a funnel for everything your business does. At the end of each month, set aside roughly 20-30% of your net profit (revenue minus your business expenses) into one of the savings accounts. Label that account as the "Tax Savings Account." Don't get emotionally attached to the money in that account.

Think of it as already gone. It doesn't belong to you.

If your business has very few expenses (say, a service-based business where most of what comes in is profit), a percentage of revenue and a percentage of profit will look pretty similar. But if you're carrying real costs like inventory, contractors, equipment, then saving based on revenue alone can be much different than what you actually owe. Profit is the number that matters.

Hopefully with this approach, you’ll have saved a little extra compared to the amount due come tax time.  The leftover can be seen as your “tax refund”, and a small bonus is you’ll also have been gaining a tiny bit of interest from your savings account.

Once you've got the saving habit down, the next step is to consult your CPA. Your business may need to start sending that money to the IRS quarterly instead of all at once. An upside here is that the tax payments may feel slightly less painful too.

Ask us how to set up your business registration to be ready to open your business bank accounts today.