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.

 

54 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.)

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