Small Business Taxes for Beginners: How Much to Set Aside

July 29, 2011 by Jan Roberg
Filed under: Small Business 
Dollar in Piggy Bank

Photo by taxbrackets.org

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.

 

About the photo:  it comes from a website called TaxBrackets.org.  If you’d like to learn more about income tax brackets–which they’ve got some really good information, or if you’d just like to check out their images of money, click on this link:  http://www.taxbrackets.org/

Comments

21 Comments on Small Business Taxes for Beginners: How Much to Set Aside

  1. Matt South on Fri, 20th Jan 2012 7:16 pm
  2. I wish I had looked up this advice last year. I could have saved myself a lot of tax headache. Thanks for the info!

  3. Admin Roberg on Sat, 21st Jan 2012 3:07 am
  4. Hi Matt, Glad I could help. Thanks for the comment.

  5. Meghan D. on Sat, 24th Mar 2012 6:19 pm
  6. What about if you are doing something like Thirty-One or another stay at home business. They pay you a percentage of the sales. Is 10% enough or should I set aside more? I had trouble when I worked as a waitress because they couldn’t tax all my tips. I am using this to supplement my husbands income.

  7. Admin Roberg on Mon, 26th Mar 2012 2:18 am
  8. Hi Meghan,
    I find that most stay at home businesses tend to have a really low profit margin–so setting aside 10% is probably going to be fine. If it seems like you’re really make much more money than you had anticipated, you might want to bump that up, but I’m thinking 10% is a good start.

  9. Emily M. on Thu, 3rd May 2012 11:22 am
  10. I just wanted to say this article was extremely helpful. All the others I found were either too vague, with little explanation, or do detailed with tax laws mixed in (a little too much for someone starting out). Thank you :)

  11. Admin Roberg on Fri, 4th May 2012 2:44 am
  12. Thanks Emily.

  13. John on Mon, 16th Jul 2012 6:33 pm
  14. I own a Single Member Limited Liability Company in NJ. If I set aside 10% of the profit that I think I am getting, what would I do with that 10% comes tax time? do I use that to pay the taxes owed? do I take that 10% as Owner’s Draw, then use it to pay taxes? single the IRS considers this a flow through as in everything flows through me.

    Thank you.

    John,
    Roosevelt, NJ

  15. Admin Roberg on Mon, 16th Jul 2012 10:19 pm
  16. Hello John,
    You get a gold star for the day! Yes, you take the 10% as owners draw and use that to pay your taxes. (And I love your line–the IRS considers this a flow through as in everyting flows through me!)
    Don’t suppose you’d like a job with a small but lively tax company in Missouri? I love it when people “get it”. This is one of the toughest concepts to teach. Thanks.

  17. Jerry on Wed, 25th Jul 2012 8:40 pm
  18. When I first started out I wasn’t putting nearly enough in savings as I should have. I was hoping that my expenses would somehow equal huge deductions. Boy was I wrong. Every small business owner should definitely read your article! I wish you had a facebook button here so I could share it with my friends.. Thx Jerry

  19. Admin Roberg on Thu, 26th Jul 2012 8:39 am
  20. Thanks Jerry, and thanks for the advice. I’m going to have to figure out how to do that.

  21. Christina on Mon, 18th Feb 2013 9:39 am
  22. Im starting out new and Part of my home is going to be used as well. How much of my revenue should I sit aside Im already in the hole and have no monies comming in til this fall maybe. What taxes do I have to pay federal, state, ss? what % for each? Im a dog breeder and I sell pups So i was wondering do I take taxes on each pup sold and whats the % on each…

  23. Jan Roberg on Tue, 26th Feb 2013 9:22 pm
  24. Hi Christina,
    So many questions! What you really need to do is sit down with a professional. I’m actually teaching a class on all that next month, but I’m in St. Louis.

    Bottom line, you won’t have income tax on your business while you’ve got a loss. You’ll want to check with your local area about sales tax on the puppies. It will be different all over the country.

  25. Talitha Markle on Wed, 3rd Apr 2013 11:48 pm
  26. I am a Slumber Parties Consultant and I was curious if I need to put aside 10percent for each the federal, state and ss or just ten percent all together? I make around we will say 800-900 a month it is a very small business, but I am also wondering up top you said if you range in the 25% bracket you will need to set back 40%? how does that work? I will probably be in the 10% bracket so do I need to set aside 25% for all or for each the federal state and ss? The reason I ask this is my girls I work under don’t pay in quarterly and they get money back every year, that confuses me maybe it is because they have other jobs that make up for the losses, and should I just claim what I pocket? or everything? I receive 40% of all sales. please help thanks a bunch!

  27. Jan Roberg on Wed, 24th Jul 2013 9:43 pm
  28. Hi Talitha,
    It’s hard to say home much exactly you’re going to need to pay. That’s why I came up with the general 10% of your revenues to get you started.
    Computing the actual tax on your business income involves your actual tax rate, which you say is 10% and the self employment tax rate, which is 15.3%–so you’d by paying about 25% towards your federal.

    Now, your state tax would be in addition to your federal tax. For example, here in Missouri, the state tax is 6%, so that would be in addition to the 25% federal tax.

    You mentioned that your friends who also do the Slumber Parties sales don’t pay quarterly taxes and always get big refunds. The refunds probably have nothing to do with their Slumber Parties business; more likely they’re getting refunds based on what they withheld during their other jobs, or maybe they’re qualifying for an Earned Income Tax credit.

    I’m guessing that you’re probably going to be fine not making estimated tax payments yet. But just to be safe, I’d still set 10% of your revenues aside to cover taxes just in case you do need to pay. If you don’t wind up owing at tax time–you’ll at least have put some money into savings–and that’s a good thing!

  29. Johnny S on Tue, 20th May 2014 11:21 pm
  30. I’m wanting to start my glass business, but I hesitate only over this tax issue. My question is once I file for my DBA, if business is really slow during the first year do I pay taxes. And how long is a DBA good for.

  31. james on Thu, 22nd May 2014 1:03 pm
  32. I’m wanting to start my own glass business, for which I have a few questions about taxes. Just starting out, until I get steady work coming in, can I get in trouble by the its if I don’t file for a DBA at first. I’d like to see if the business will be profitable enough to pay taxes first, then can I file a DBA and EIN?

  33. james on Thu, 22nd May 2014 1:12 pm
  34. Also one more question. What is the legal way for a small business owner to pay them self from the business. Would I pay myself a salary out of my own company? Any advice you can offer will greatly be appreciated.

  35. Jan Roberg on Sun, 25th May 2014 8:32 am
  36. Hi James,
    You’ve got two really good questions. First, let’s talk about the DBA and EIN. You don’t have to do either yet. You’re starting a glass business, so for the most part, I’m guessing that you’re selling to private buyers, not businesses so the EIN is not that important yet. (If you’re selling to businesses and selling over $600 worth of product–then get an EIN number, it’s free, it’s easy, so just do it.)

    And you don’t need a DBA, just have your customers pay you directly. My husband is an artist, when he sells a painting, the people just write the check to him directly–no business name.

    This makes you a “sole proprietor”. You’ll do your taxes on a schedule C, which is a page on your 1040 tax return.

    You still need to keep good records–report your income and expenses, but its’ the easiest of the small business entities.

    When you reach that point where you can pay yourself out of the business–just write yourself a check. No FICA, no withholding, just write a check. You pay the FICA with your regular taxes. Crazy right? Let me show you with an example:

    James Glass Business:
    Income $10,000
    Expenses: $6,000

    Net profit $4,000

    This will all be on your 1040 Schedule C.

    On the Schedule SE it will compute your FICA which is basically 15.3% or $612. (That’s the simplified formula, it’s not exact but pretty close.)

    If you’re in the 25% tax bracket, you’ll also pay $1000 in regular tax on that money. So, when you’re doing your tax return, you’ll be paying $1,612 tax on the $4,000 of income.

    Now if you had a corporation, you’d pay yourself a paycheck and do the withholding just like a regular employer. But you don’t need to do that. You may choose to at some point, but you don’t have to. You can prevent yourself from having a huge tax bill at the end of the year by making quarterly estimated tax payments. (But you’re really not going to be doing that until you’re making a profit.)

    If you’re maintaining a separate bank account for the business (which is what I recommend) you will write the check to James _____________. If you’re using Quickbooks or some type of bookkeeping software, you will label the payment to yourself as “owner’s draw”. It’s not a business expense, it’s part of the owner’s equity (if you’re into accounting.) If you’re not into accounting, it at least notifies your tax person that you took money for yourself and that it counts towards your taxable income.

    I hope that helps.

  37. Jan Roberg on Sun, 25th May 2014 10:24 am
  38. One more thing Johnny, you file for your DBA with the state. Different states will have different rules about how long a DBA lasts. You can find that information at your state’s Secretary of State website.

  39. Yoxuam on Thu, 12th Jun 2014 8:22 am
  40. Greetings,

    We started a Record label in July 2010, and basically every single person involve volunteers or donates their talent, then we give out the music and live performances for free. No we just decided to registered as a DBA, also got an EIN.

    The idea is the same we all volunteer and donate our talents, will also give our music free as digital downloads, but now people will be able to support us by buying a physical copy of the album or buy misc. merchandise when available or just simply donate money.

    Our idea is in the case any type of income/profit comes in then we divided a percentage among the participants after production cost is covered.
    so our breakdown is example:

    1- cover cd printing cost
    2- cd printing investor gets a cut
    3- DBA gets funds into account 30%
    4- remaining is 35% producers 20% management 15%

    but now that I read your article and a few comments I guessing 100% goes into the dba

    then take care of the cost of production , cut a owners draw for the investor , etc…

    we are considering our production members as service provider’s so is it better to give them a 1099 so they pay their taxes not us.

  41. Jan Roberg on Sun, 6th Jul 2014 8:52 am
  42. Hi Yoxuam,
    So it sounds to me like you’ve got yourself a partnership. And yes, you can 1099 the production members and owner’s draw the investors.

    The individuals will be responsible for paying the taxes, but you’ll need to file partnership returns and issue K1s so people will know how much to report.

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