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.

 

80 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!

  15. Holy tax confusion. I own and operate an LLC that prospers in the 2nd and 3rd quarters due to seasonal work. I pay all of my workers with a 1099 as I do not dictate how, when, hours, availability and such for seasonal cleaning services in a resort town. I have been creating Profit and Loss statements that shows my business with an annual expense in the 22,000.00 range. The 1st and 3rd quarters are almost zero income so I make the money stretch for the entire 12 month duration. My question is do I need to pay my personal estimated taxes quarterly or just set aside 30% of what will appear on my personal 1099? Also, how do I pay my quarterly business taxes? Is is based on the Overall Total after my Profit and Loss statements each quarter? If so how much do I need to pay quarterly on behalf of the business? Thus far my 1st quarter showed a profit of 113.00. My 2nd quarter shows a loss of -4638.00. My 3rd quarter will show a profit as I already have money building up in this quarter. My 4th quarter will show a loss due to no more income. The money is plentiful June, July, and August and then halts. I make it stretch for the duration of the 13 months, making sure to get the annual business expenses paid in this time frame. ( Portions of home office rent, portion of utilities, company vehicle payment, insurances, cell phones, internet, gas, supplies, advertising, attorney fees, travel expenses, auto maintenance) . Am I doing any of this right? When it is all said and done my personal 1099 will fall under 30,000.00 for the year as head of household with 2 EIC dependents. Any advice would be greatly appreciated! Jo from North Carolina

  16. Hi Jo,
    If you make all of your profit in one quarter, it makes sense for you to pay your quarterly taxes all in that quarter. That makes sense for a seasonal business. Also, it’s so much easier to pay the tax when you’ve got the money!

    I’m wondering about your personal 1099 though. You mean that you receive a 1099 from a company that hires you and then you issue 1099s to the contractors who work for you right? You’re not issuing yourself a 1099 – that wouldn’t be right. (I only ask because I had a client try to do that.)

    I wasn’t sure if your LLC was being reported on your personal return on a schedule C. Or, if you had an S corp or a partnership – which would provide you with k1 forms. Generally, unless you have elected to have your LLC taxed as a C corporation (which is pretty rare) your estimated taxes are all considered to be personal taxes. (Even though, you’re earning the money in your business – the income passes through to your personal return.)

    But bottom line, I think it’s a good idea to make an estimated tax payment in the third quarter.

  17. Hi jan
    My name is Tyler. I recently just started up an LLC electrical contracting service in PA. I’m curious as well as to how much money to set asidefor taxes for the business and taxes for my self. Currently I work in maintenance at a factory until late I am hopefully able to get this business up and running and turning a profit. 1st when I do a job I include labor and materials into my quote. So say a job cost 10000 dollars total. About 4000 of that would be materials. The other 6000 I used to pay for business expenses like gas or tools and also for labor. Right now I am working by myself but have a friend who also has his contractor license so I plan to pay him as a sub contractor and use a 1099. Where I get confused is do I need to pay taxes on the whole 10000 total or on the 6000 that would be costs for my business. Or would I have to subtract the expenses of the subcontractor first? So far I have been setting aside 30 percent of the total so to follow along with the example it would be about 3000 out of the 10000 dollar total. Am I on the right track. Should I set more aside? What actually needs to be calculated for taxes? When should i calculate my taxes? Thanks for the help!

  18. Hi Tyler,
    Congratulations! You’re asking the right questions, that’s half the battle!

    Okay so you bill $10,000 for the job and $4000 of that is materials. That leaves you with $6000 to pay for other stuff. So if you saves 30% of the 6,000 ($1,800) that would be pretty good. Granted, you’ve got some other expenses that we haven’t counted, like your sub-contractor and your office expense, but it seems to me it will balance out okay.

    Bottom line, when it’s time to actually file the tax return – you will want to deduct as many expenses from that $10,000 as possible. So you will deduct the materials, the mileage, the office expenses, tools, sub contractor, phone expense, etc. The net (that’s the word they use for income less expenses) is what you will be taxed on.

    I hope this helps.

  19. Hi jan question im opening a donut shop and dont know how this taxes work can u give me an idea its my first business not sure how much to put away for my taxes

  20. Hi Krystal,
    I love donuts! My best advice is to sit down with an accountant in your city and talk. It’s worth paying the consultation fee. You’ll want to know about sales tax, payroll taxes, unemployment tax, in addition to potential income taxes. Good luck!

  21. Hello, I just started a cleaning business and I use someones help to perform the job but I do it too, I pay her a porcentage of whaf I’m charging the client.. My question is how much should I start saving for taxes and what form should I use when filing taxes also how do I substract the porcentage that I am paying to this person that is helping me.. I’m married, my husband works and we file together. Thank you!

  22. Hi Andrea,
    I have a couple of suggestions for you. First, you will need to file a 1099MISC form for the person that works with you. I’m guessing that over the course of the year, you will pay her over $600. You’ll want to give her the 1099MISC form by January 31st, and you’ll also have to file it with the IRS. Here’s a link to see the 2016 form: https://www.irs.gov/pub/irs-pdf/f1099msc.pdf

    You will use a schedule C with your regular 1040 tax return. You will put the amount you pay your helper as an expense under contract labor. You probably also have expenses for supplies, and mileage and your home office. You might have some other expenses I don’t know about either, like advertising or phone service.

    Since you’re married, you have to remember that your income is over and above whatever your husband makes as far as your tax bracket. But, you only pay tax on your net profit (that’s your income minus your expenses) not the total amount you charge your clients.

    So, let’s say you charged your clients $10,000 for the year. You paid your worker $4,000 and you had $500 worth of other expenses. $10,000 – $4,500 equals $5,500 that you’d have to pay tax on. You would pay 15.3% for your self employment tax, plus whatever tax bracket your husband is already in. So if your husband’s income puts you in the 25% tax bracket, then you’ll want to save 40% of your profit. If your husband’s tax bracket is 15%, then you’ll want to save 30% for taxes.

    Sometimes its a little overwhelming trying to figure it all out at first. If you want a quick short cut, take the income, minus what you pay your worker and stick a third of it into savings for taxes. After you’ve gone through one round of taxes, you’ll have a much better feel for what you’ll owe next year. But at least you’ll have put some money away to pay the tax.

  23. I have a service based business with few expenses that I started in November last year. I don’t make very much(less than $1,500/mo), is it ok to not pay quarterly taxes? I haven’t done it and now I’m stressed about it.

  24. I am going to buy a Domino’s pizza from my father that I currently work for. His profit margin is is between $10,000 and $13,000 a month. When I buy the store from him I will be taking out a loan for $1,000,000 to pay him for it. I am hoping to make my current salary $7,000 a month after paying the loan which will be about $10,000 and other expenses of the business. My husband also makes $85,000 a year, We live in California, and have three children, and own our house, which tax bracket will we most likely be in/ how much should I be putting aside for taxes each month?

  25. Hi Roberta,
    I’m assuming that your LLC business return is a partnership, right? In that case, your business income is taxed on your personal tax return so you’ll want to pay your estimated taxes out of your personal checking account. That said, it’s perfectly acceptable to take out an owner’s drawer in the amount to cover your taxes.
    For example: let’s say your estimated tax payment should be $5,000. You’d have the LLC wrtie a check to you personally, and then you write the check to the IRS. That’s technically the way it should be done.

  26. Hi Toots,
    As long as you can pay your taxes come April it’s okay. There may be a small penalty for not making estimated tax payments, but it’s not real large in the grand scheme of things. You won’t go to jail or anything like that.

    That said, $1500 a month translates to $18,000 a year. You’re looking at $2700 in self employment taxes. It wouldn’t hurt to pay something in just to cover that at least. Third quarter payments are due September 15th and fourth quarter payments are due January 15th of 2017. You can easily make a payment online at https://www.irs.gov/payments Then you can quit stressing.

  27. I am starting an online social media based clothing boutique. I will take presales and ship the items to the consumers after they pay via PayPal. I have no business expenses, will keep very little inventory, and no employees. What part of my income will need to be set aside for taxes?

  28. Hi Julie,
    It sounds like a cool business model. Basically, I’d save 15.3% for you self employment tax, plus whatever your regular tax rate is. And that’s going to depend upon if you have another job, are you married, what your spouse makes, etc. I’d say to save at least 30% of your revenues for taxes.
    If you really have no expenses – although I’m seeing product costs, shipping, internet costs, Paypal fees, and possible home office expenses just to name a few – you’ll want to save 40%.
    You may be thinking – oh, but the customer is paying the shipping. Well yes, they are – but you’ll get a document that says you were paid for it. Example: let’s say you sold a dress for $100 and the shipping was $10 and maybe there was even sales tax for $5. You get $100 for the dress right? But Paypal shows a transaction of $115 that you’ll wind up reporting on your tax return. You’ll want to keep track of all that stuff.
    But when I say save 40% for taxes – I’m meaning 40% of the net – what your profit is. So you may get $100 for the dress, but then of course you had to pay for the dress – so you’d back out the cost of the dress too before putting aside that 40%.
    I hope that helps. I think I just made it more confusing for you instead of helping. Sorry.

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