There’s a small business tax trap that many owners fall prey to. The IRS requires you to make quarterly estimated payments of your tax liability. Most of us small business owners either underpay the tax rate or not even pay at all. The worst part is that, unfortunately, a lot of CPAs aren’t paying attention to this either.
So how do we plan for taxes appropriately? We need to make sure we’re not falling into this tax trap, where we get stuck and end up paying a huge chunk of our revenue at the end of the year to pay for taxes we didn’t expect.
Remember, the number one cause of business failure in this country is a lack of cash. To combat this small business tax trap what you’ve got to do is make sure you have enough cash on hand to pay your taxes. After all, they’re your number one creditor every single year.
How Do We Plan for Small Business Taxes?
First and foremost it’s important to understand that the IRS quarters are not calendar quarters.
If you have to make quarterly estimates by January 15th, April 15th, June 15th and September 15th of every single year, and if you don’t pay at least ninety percent of this year’s tax balance, nor pay at least one hundred and ten percent of last year’s, you’re going to get hit with fines and penalties.
What you’ve got to do is stay up on your tax liability. If you are an S corp, an LLC, a partnership, a sole proprietor or a C Corp, this doesn’t apply to you the same way. However, most small businesses are pass-throughs, which is cause for concern.
Here at TGG, we accrue for business taxes; we accrue for those taxes as an accrued distribution on the balance sheet. So, rather than pay the business owner, we end up paying the IRS but we make sure to accrue for it so that we see this as a liability.
We know in advance that this negative number is going to hit us. Accruing helps us plan accordingly.
I made a mistake about fifteen years ago in one of my first businesses. All of a sudden March came along and I ended up owing the government hundreds of thousands of dollars. It turned out that year my business ended up being more profitable than I originally thought, putting me in a different tax bracket.
This completely threw off my business plan. I already decided that I was going to hire two new people, but at that point, I couldn’t afford to, nor could I expand the way I wanted to because we didn’t plan effectively for the tax trap.
This is exactly why I call it a trap because not many of us are aware of it. If we don’t keep up with those accruals and make sure that we have it on our balance sheet and in our financial statements, you can end up in the same situation I was in.
Plan effective meetings with your CPAs, pay those taxes quarterly, and accrue for them monthly to make sure you don’t get stuck in the tax cash trap.