Small Business Taxes for Beginners: How Much to Set Aside

 

self employment tax

When you start a new business, one of the hardest things to figure out is how much money you need to set aside to pay your taxes.

One question I hear all the time is: How much should I put away to pay my business taxes? If you’ve been in business for a few years, you probably have a good feel for how much you take in versus how much your expenses are and what your overall tax bracket is. After a while, you’ll be able to make estimated tax payments with fairly good accuracy. But if you’re just starting out and you don’t have a lot of experience, it’s really hard to guess. This post is for you.

Starting with the very first payment you receive, put away 10% of your revenue. Ideally, you will set up a special savings account at a bank to escrow your taxes, but you can use a piggy bank at home for all I care. Set aside 10% of your revenue.

But I thought my self-employment taxes were more than that? They are. Generally, self employment taxes are 15% of your income, and then you pay your regular tax rate on top of that. If you’re in the 25% tax bracket, the taxes on your business are 40%. This puts people into a panic—most people don’t pay 40% of their revenues, you have to back out your expenses first.

So shouldn’t I put away 40% of my profit? Yes, after you’ve got your business settled in and running smoothly. In the beginning, most start ups lose money, so your business taxes might be zero. You could even reduce your other taxes by reporting a business loss. Setting aside the 10% is your safety net. 10% is easy. 10% is a number you can live with. Most importantly, 10% might save your life.

You were right, I had a loss my first year. Can I spend the tax money that I had set aside? No. You’re going to add to it the next year so that you’ll have enough money to pay taxes then.
What if I have a loss for my second year of business? Keep setting aside 10%. There are basically three things that could happen:

Eventually your business will start making a profit and you’ll be glad that you set aside some money to pay your taxes.

Your business will never make money, so the IRS will decide to call your business a hobby and you’ll have to pay back the taxes you avoided by claiming business losses. We don’t want that to happen! But again, you’ll be glad you have that money set aside.

Your business doesn’t make any money and you’re smart enough to get out before the IRS declares you to have a hobby. Now you’ve got a nice little savings account started.

The 10% rule is a win/win situation for you no matter what.

I make really good income as a contract laborer and I don’t have any expenses. What if I expect to definitely make a profit my first year? A good example of this situation would be an independent IT contractor; a lot of these folks are profitable from day one. If you’ve got a similar situation, I’d hold back 25% at a minimum, 30% is better. If you’re married and you’re adding your income onto a spouse’s earnings, I’d put away 40% right from the start. If you anticipate over $100,000 of income your first year, you should sit down with a professional and do some strategy planning. Your self-employment taxes will actually go down after $106,800 but you could be in a higher overall tax bracket.

Face it, if you’re making over $100,000 a year, you can afford to pay the consulting fee to an accountant. By the way, you’ll write that off as a business deduction.

Okay, so I set aside 10% of my revenue for my business taxes the first year but it wasn’t enough. Now what do I do? First, be glad that at least you had the 10% set aside. Now you’ve got some figures to work with for next year. Based upon your tax return, you can now compute a percentage for you to set aside. Maybe it’s 20%, maybe 30%. Once again, you’ll set aside a percentage of your revenues. You’ll make estimated tax payments every quarter based on what you owed last year. Let’s say you had a balance due of $4,000 last year, then you’ll make quarterly estimated tax payments of $1,000 each this year. You’re still putting money in the bank for your taxes and you’ll pay the estimated taxes from your set-aside fund.

I see a lot of people with small businesses get into tax trouble. They scrape to get ahead and then when success finally comes, the tax bill is a big slap in the face. Success is sweet, but there’s a price. If you start from day one setting aside a portion of your revenue for taxes, you’ll be prepared.

 

64 thoughts on “Small Business Taxes for Beginners: How Much to Set Aside

  1. If I start a caregiver or personal care and start off small how would I do so what would be my first step and my first step with the taxes

  2. Hi Shannon,
    I’m assuming that you are the caregiver? In that case, at least with the people that I work with, they don’t have many business expenses other than mileage and maybe uniforms. So you probably don’t have a lot expenses to deduct. That means you’ll at least need to save up 15.3% of your income for your self employment taxes. The rest is going to depend upon your regular tax rate. If you’re single and this is your only income, you might not need to save up much more than that, maybe another 10%. If you’re married and your husband has a job, then your income will be on top of his so your tax bracket will be higher. Take a look at your most recent tax return. See what your “marginal tax bracket” is. I would save up that much plus the 15.3%. So if you’re in the 25% tax bracket, that means saving up 40% for taxes!

  3. Hi I’m an operating partner on a LLC.
    My partner will be paying all the business expenses and I’ll be getting 50% of the “net profits”
    every quarter,since I’m not gonna pay taxes on my share of the net profits every quarter, how much money should I put aside to pay my taxes once tax season comes?
    I think I have to use a 1065 form or a K-1 . I’m not sure.
    One more question, me as an operating partner with no business expenses. are there any deductions that I can claim? donations? charities? gas used to get to work?
    THANK YOU.

  4. Hi Jose,
    As an operating partner, you’ll be subject to self-employment tax, so whatever your tax bracket is, you’ll want to set that much money aside – plus an extra 15.3% for your self-employment tax. Ideally, all expenses that you have for the partnership are being paid through the partnership. So if you’re getting money, then you’re making a profit. But seriously, if you have any expenses for the partnership–it’s much better to have the partnership reimburse you (for things like mileage) than to get a tax deduction for them.
    So, the donations that are available to you as an operating partner are going to be the same that were available to you before (since you want all of your expenses channeled through the partnership.)

  5. Hi I just started a residential window cleaning business. My wife works and so do I aside from this. Curious as to how much a should put aside. Some have said 25% others 30% appreciate any advice given.

  6. *update. I checked something that says I fall in the 15% tax bracket. So would this mean that I should stuck closer to putting away 30%

  7. Hi,
    My husband and I just started up a mobile power washing business. We are both new to this process. This is how I have it set up. From each job that we get paid from. I am setting aside %10 for taxes, %20 for gas/supplies and 20% for help. Should we be setting aside more money for taxes?

  8. Hi Pablo,
    Part of your issue is going to be your expenses. You’ll want to write off your mileage, your equipment, your cleaning supplies, uniforms, and your home office, advertising, and any other business expenses of course. So it’s kind of hard to figure until you have a good handle on your “net” income. (Net is your revenue minus your expenses.)

    Also, your self employment income is taxed at 15.3% (for the self-employment tax) plus whatever your regular tax rate is. Since you and your wife both work other jobs in addition to this you could be in a fairly high tax bracket.

    That said, I’m thinking that if you sock away 30% for your taxes, you’re probably in good shape. And – worst case scenario – you might save too much money! Or darn! You have too much money! You could put it towards retirement, or savings, or new equipment, or whatever! This is not a bad problem to have.

  9. Hi Pablo,
    Yes, 30% is pretty much what you’d pay for your federal. Plus – you may also have state taxes too. But remember, you will have expenses to write off as well, so saving 30% on your revenue should cover both your federal and state income taxes after expenses. (And maybe even still leave you a little extra.)

  10. Hi Brittney,
    It sounds like you’re thinking things through. That’s smart. Remember that you’re going to be taxed on your net. So, let’s say you make $5,000 this first year in power washing. You spend 20% on gas and another 20% on help. That’s $2,000. (5,000 times .4 = 2,000) So, your “net” would be $3,000. The self employment tax on that $3,000 would be 15.3% so that’s $459. So you’ve withheld $500 so that’s good.
    My only problem is that you’re probably in a higher tax bracket than just zero, so you probably should be withholding more.

    What’s cool about your situation though is that you’ve got a formula for your profit. Okay, maybe your formula turns out to be wrong – you can always tweak it as you get more experience. But it’s probably a pretty good guideline.

    You know the self employment tax rate is 15.3%. You can check what your regular tax rate is based upon last year, maybe its’ 15% or 25% or maybe it was zero. Look at your last year return to give you a clue. Let’s use 15% just for kicks. So the tax on your power washing business will be 15.3% plus 15%. So, to figure what you should withhold let’s use your formula. (Sorry if I’m geeking out too much.)

    Revenue – 40% expenses for help and gas x 30.3% = taxes

    So let’s say you take in $20,000 on your business. You can expect that you’ll spend 40% on gas and labor so that’s $8,000. That means you should have a profit of $12,000 right? So, you’ll want to have put aside $3,636 (12,000 times .303)

    Now, if you’ve got kids, and you’re in the EIC bracket, you may not need the extra withholding. If you’re in a higher tax bracket, you’ll need to withhold even more. It all depends upon with other income you have besides this business.

    Good luck with your new business. I hope it’s a big success! (And boy, could I have used your help yesterday!

  11. So I just started a cheerlending business, I have employee’s & myself. Do I treat myself as an employee & pay my quarterly taxes on the income I make or should I pay just the employees quarterly taxes without mine included?

  12. Hi Donna,
    Great question. If your business return goes on a schedule C – which is part of your 1040 return, then you don’t pay yourself a wage, so you would only pay the payroll taxes on the employees’ wages.

    If your business is a corporation (whether it’s a C corporation or an S corporation) then you would pay yourself a payroll and you’d need to pay the quarterly payroll taxes on that.

    An LLC – is not a corporation – it’s a limited liability company. If you don’t make any special elections with the IRS, then you are putting that income on your Schedule C. (Or, if it’s a partnership, a partnership return. Partnerships also do not pay payroll taxes for the owners.)

    Confused yet? Sorry, there’s a whole lot there.

    Now one thing – if you are making a profit (which I hope you are) you might want to make estimated tax payments to cover your income taxes. Those are separate from payroll taxes. It’s easier to pay quarterly than to pay a huge chunk in April. (Of course, if you owe a lot of taxes, it means your business made money and that means success!)

  13. Hi Jan! We made this business 2 month ago LCC wedding photo & video, my husband 70% (no other job, me neither) and his cousin 30%(with another job), how much do you think they need to set aside of the total income?

    They already have many contracts, but no one is getting paid yet, cause they don´t know how to check payment or gain with an accountant.

    My husband paid for all the expenses with money we bring from our country….. how can he can repay without affecting the accounts for the counter? , do you think they need a professional? 😛

    Thank you for your time!

  14. Hi Priscila,
    I strongly recommend hiring a professional. First – you come from another country. US taxes are confusing enough to people born here much less to someone moving here from someplace else. Second, your husband and his cousin technically have a partnership – that’s a different return from a regular 1040 so you really want help with that. Third, there are some rules that you just need to make sure you know. For example – sales tax. The rules for what to charge for sales tax are different in each state. And, sometimes, they’re even different for each city! And since you’re a professional photographer, here in Missouri, there’s special rules just for photographers!
    I know that it’s sometimes hard to come up with the money to pay an expert when your business is new, but for you, I really think it will be money well spent. Good luck!

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