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.

 

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

  1. Hi Al,
    I assume that you’re getting paid as a 1099 contract laborer and not as a wage earner. Interns often are wage earners, but you’re at this site so I’m guessing that’s not the case for you.

    Okay so California has 9 income tax ranges and I have no idea where you income is. I’m just going to shoot from the hip here. Save 8% for California. I’m guessing you’re not in the top bracket and not in the lowest bracket.

    I’m guessing that you have few business expenses. As an intern – you’re using someone else’s office space, etc. So you should probably withhold about 30% of your income for your tax. But I’m totally just guessing here. I think you’d be helped best by going into an office and speaking with a person face to face.

  2. Greeting,

    I am a Therapist Intern starting out a private practice seeing clients where I receive money for services but not sure what to set aside for tax purposes. I reside in CA.

  3. Hi Amsey,
    So, are you starting a charity? Which would mean you set up a 501c3. Or, do you just mean that you want to donate all of your profits to charity? That’s different. That means you will have taxable income – but be donating to charity. Depending upon your situation, you may still have taxable income. So – you need to sit down with an accountant and explain exactly what you’re up to and run the numbers.

  4. Hello! I am in the process of getting a charity-like business up and running. I will earn no money from this. The idea is for a percentage of the money I receive to go to a 501c3 charity and the remaining percentage to go back to the vendor supplying the product or service.

  5. Hi Marie,
    Sorry, but my minimum charge of a tax return with self employment is $600. Not to blow you off but if I start answering questions about how much tax people would owe, I’d be out of business. I only answer general questions.

  6. Hi – I read all your responses and they are really helpful. First of all thanks of taking time to do this. I have a small business and have a net income of $20K. I did not do a good job of tracking all my expenses so I may be paying a bit more but that’s OK. What would be my rough income taxes for a net income of $20K. I do not know my tax bracket as for first two years its zero net after expenses but I am wondering about this year. Any help?

  7. I think my situation is similar to Paul’s. I own a boutique and this is my first year. My estimated profit after taking the total sales – expenses – inventory, etc is around $42,000-$45,000. I have been paying monthly taxes every month which are 7% of the total sales made that particular month. I’m getting super nervous about filing yearly taxes. My husband and I file ‘married filing jointly’ – I’m just nervous as to how much I’m going to be owing 🙁 I saw you mentioned a refund to Paul but how do we determine if we will owe more after paying 7% all year each month and how much vs a refund or not?

  8. Hi Jan,

    I’m considering starting my own LLC, but I want to make sure I’m understanding the business tax.

    Federal: 25% (This is the tax bracket we’re in)
    State: 3.07% (PA)
    Local: 1%
    SS & Medicare: 15.3%

    TOTAL: 44.37% (Confirming I need to set aside 44.37% of the net profits?)

    Thanks!

  9. Hi Paul,
    You’re in the 25% income tax bracket so your accountant is pretty good. I’m thinking you may have a bit of a refund this year, but if you had made more, that 35% ratio would be spot on.
    You’ll pay 15.3% on the entire net of $56,000 so that’s $8568. Then you pay your regular income tax on the $56,000 all over again. Assuming that you’re single with a standard deduction, you would subtract $10,350 for your exemption and standard deduction. That leaves you with $45,650 of taxable income. Because the brackets are progressive, you’ll pay 25% on $8000, 15% on $28,375 and 10% on $9,275. (2000 + 4256 + 973 = 7229)

    Combine your income tax together with the self employment tax and you’ve got $15,797. So yes, right now you’re looking at a refund. BUT – you are in the 25% tax bracket. Had you made more money, you’d be much closer (even though you’d pay in more, the percentage would even out.)

    I think your accountant was steering you right.

  10. Hi Sara,
    Want a job? You seem like you’d be good at accounting. I think you’re spot on. And, if you get to the point where you’re in a higher tax bracket – then just start setting aside more when you get there. (How do you know until you get there, right?)

    But you’re organized. You’ve got a plan. It makes sense. Good luck! I think you’ll have a very successful 2017!

  11. Hi, I am a sole proprietor. I make about $80,000 annually and my expenses are roughly $24,000 annually. An accountant told me that I should stash away 35% of my profit for federal taxes. So if my annual profit after expenses is $56,000, does that mean my federal tax owed is $19,600? This is how I’ve been doing it so far, and I’ve been making quarterly tax payments. I also stash away 5% of my annual net profit for state taxes. After reading your site, it sounds like I am paying WAY too much in federal taxes and may actually be getting a nice refund. Is this true? Or am I doing it correctly?

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