Small Business Taxes for Beginners: How Much to Set Aside

Posted on: 07/29/11 132 Comments

 

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.

 

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

  1. Hi Jessica,
    Good questions.

    1. The 30% would be before your state taxes. You’d also set aside your state tax amount. State taxes are more normal though because you don’t have the added self employment tax, so just withhold your regular state tax rate.

    2. Yes, you file your business income with your regular return on a Schedule C. You make quarterly estimated tax payments, but you’re not filing a quarterly individual tax return. (You might be filing a quarterly sales tax return, I know many of my photographers in Missouri do that.) Quarterly income tax payments though aren’t tax “returns” they’re just tax payments. They’re based on an estimate of your quarterly earnings. Some people keep their books up to date and make a pretty accurate payment on their year’s earnings. Most people base their quarterly payments on what they had earned the year before.

    3. LLC versus S corporation? Here’s a post about that: http://robergtaxsolutions.com/2015/09/should-your-llc-be-an-s-corporation/
    But you might also want to look at this: http://robergtaxsolutions.com/2015/11/s-corporation-computing-the-tax-savings/

    It’s a pretty long answer, that’s why I’m doing links.

    For what it’s worth–you’re asking the right questions.

  2. Hi Merlene,
    This is a good example of when you should sit down with a professional and run some numbers. What kind of expenses should you have? What about the home office deduction? What about food and toy expenses? Are you married? Does your spouse have income? What is your current tax bracket? I could make a shoot from the hip guess, but I don’t think that would be fair to you. $40K a year is a sit down and plan kind of number. With no write offs, you’re looking at $6000 of self employment tax, and that’s before you add your regular taxes. So you want to do some planning with a professional.

  3. I am starting up a Day Care and should make approximately $885.00 a week so roughly $40,000 a year. Do you know about what I should save out weekly for taxes? This is all new to me and don’t want to under save.

  4. I think I am safe to assume setting aside 30% on the off chance I make money is a good idea. But I have some questions I am a photographer so my income is made up of a session fee and an ordering product income for lack of better words. So I am assuming I am taking 30% of each of these to set aside. I am an LLC in hawaii with GET . So is the 30% from the amounts before state taxes is added on or is it from the total amount? And I read in two different places that I file with my regular return and add a schedule C, but I also read that I pay quarterly? Which is it? My second question is what is the big difference between s corp and llc if they both are paid with personal income taxes?

  5. Hi Ashley,
    Basically, if you are reporting a business on your federal return, you report it on your state return also. At $500, you can still get away with calling it a hobby, but if you’re serious about making it a business, then go ahead and do it. Remember, lots of real businesses actually have negative income at first. Personally, I like the idea of setting up your dba now. Make it a brand! Go big! (Here in Missouri, a dba only costs $7. I think that’s a pretty worthwhile business expense.)

  6. Hi Zoe,
    I’m going to give you the standard accountant answer: It depends. How is the business set up? How big is his percentage? How did he and his partner set things up?
    I have some clients who have tiny percentages in their companies but they get paid as partners and they pay self employment tax.
    You say your husband gets a paycheck-that tells me the plumbing business is either an S corp or a C corporation. If it’s an S corp, he’d be getting something called a K1 and paying tax on his portion of the profit. So I’m thinking he’s got a percentage of a C corp. Those profits would be paid as dividends. But maybe the profits are being paid as bonus income to him.
    I honestly don’t know.
    You have a good case of you should sit down with an accountant and look at paperwork and discuss it.

  7. Hi I have a few questions about filing as a DBA with a photography business, depending on state do you have to make a certain amount before you file with your state? I’m new to this kind of thing and I’m not sure how to go about it without missing something important, say someone makes maybe $500 in one year for their business just starting out depending on state would they have to file that you would it not be worth filing with just $500 profit? Thank you I want to have everything in order before I decide to start up a business.

  8. Hello

    My question please my husband has a small percentage in a plumbing business, he has been working and been a partner for 32 years. My question is, is my husband entitle to a check quartely from the profits. His friends say he should be seeing a quarterly check beside his salary. My husband has nothing to do with the office or paper work of the business, he is the one that, bust his butt working while his partner sits,on his butt. Thank you

  9. Hi Quincy,
    I would have the other girls, ahem, Princesses, be independent contractors. You’re basically in the entertainment field that that’s pretty much an industry standard. If you wind up using a certain person a lot, to the point where she has no other job,- then you might consider moving her to employee status, but for now I’m thinking independent contractors.
    Dot your i’s, cross your t’s, have them fill out W9 forms. Issue 1099MISC to anyone that you pay over $600 to. Keep it all legal.
    I would put away at least 15% of each party towards taxes. I’m thinking that you’ve got a number of expenses to write off like costumes, mileage, prizes, etc so that will cut into your profits. 15% should cover your employment taxes though.
    For what it’s worth, I snuck a peak at your website, what an awesome idea! Good luck. I hope you have lots of success!

  10. Hello,
    I’m starting a Princess Party mobile business. I have 3 packages, I entertain, give prizes and sing and so on. I will be doing a lot of the work my self but will be hiring other girls to branch out. Are they Independant Contractors or employees? How much from each party should I put aside? Thank you for your site, I LOVE it!

  11. Hi Francine,
    I recommend sitting down in person with an enrolled agent or CPA in Massachusetts. I haven’t lived in Massachusetts for over 25 years and I’m not familiar with registering as a sole proprietor. (We don’t do that here in Missouri.)
    Bottom line, if you have income, you need to report that income on your federal taxes- even if your business isn’t registered yet. But if you don’t have income yet, then there’s no problem.
    But it sounds to me like you do have income, but your business application is still pending. A local EA or CPA can help you through that issue. I’m sorry, but I’m not qualified to help you with that state issue. I’d rather tell you I don’t know than to give you bad advice.

  12. Hello,

    I am in the process of becoming a provider for my state (MA). Part of the enrollment process is that I needed to apply for EIN, DBA, NPI, and DUN # which I have all. I am register as a Sole Proprietor since 2013. The application still pending but right now I am at the last leg of the application. I am scared that I will be penalty for never filing income with my business but I don’t have a business until the state approve it.

    Upon approval, I do not know who to budget or how to pay myself or anything. Any feedback will be good. Thank you.

  13. Hi Jeff,

    I’m going to make the assumption that your accountant has been doing your books correctly and when it says you made $20,000 in profit, that you really did have $20,000 in profit. So you’re only getting taxed on the profit, $20,000. So that would be correct.

    Let me give you an example. Let’s say you took $10,000 from your Roth IRA to start the business. That’s start up capital, not income. Then you had $20,000 worth of profit. Now you should have $30,000. You can take that whole $30,000 – but the $20,000 of profit would be taxable.

    You could just take the $10,000 that you put into the company and leave the $20,000 profit there for whatever. You would still pay tax on the $20,000 profit. That’s how S Corporations work. You pay tax on your profit, whether you take it out of the company or not. (But if you leave it in the company, you don’t pay tax on it again, it just increases your equity.)

    Does that make sense?

    So here’s the thing you want to double check. Did the start up money get recorded properly? That Roth IRA money? Did it get attributed to Owners contribution? Or did it accidentally get listed as revenue? If it got listed as revenue, then you don’t have a $20,000 profit.

    Remember, you only get taxed on the profit, not the equity.

    Also, before you close out your books for the year. Don’t forget to reimburse yourselves for any expenses that you paid out of pocket. When you own a small business, it’s easy to forget and pay business expenses out of your personal account. On a Schedule C, it’s easy to just add those expenses in. With an S Corp, you need to make sure you run it through the business So reimburse yourselves for those expenses from the business. For example: mileage costs, cell phone usage. Things like that. Read this post: http://robergtaxsolutions.com/tag/sub-s-corporation/

    And finally, congratulations on owning a profitable restaurant!

  14. My wife and I started a cafe as a LLC, our tax accountant changed us to an S corp for tax purposes, so I could be on the payroll. I make a nominal salary, my wife does not take a salary.
    My question is, we took money from our personal Roth IRA to start the business. We have been able to set some money aside in the business. Our quick books say we have 20k in profit. We want to pay ourself back, and figured that it would not be taxable, and that we should take it before the end of the year, but we were informed that it is taxable. Can’t we take back the amount that we loaned the company? I have already paid taxex on that money once.

  15. Hi Mallory,
    I’m thinking that for you, 30% is not going to be overkill. I also think that it may be worth your while to spend the money to sit down with someone and run some numbers.
    I would do the LLC. I think that makes sense. I would also look into setting up the LLC as a S corp–here’s some information on that: http://robergtaxsolutions.com/2015/09/should-your-llc-be-an-s-corporation/

    Oh, and here’s one more post that you might find helpful: http://robergtaxsolutions.com/2011/08/five-things-you-can-do-to-reduce-your-self-employment-taxes/ You want to make sure you claim every deduction you’re entitled too. Good luck on the new business!

  16. Example we billed an approximate $8000 for last month. After say $1000 expenses, 30% aside would be enough to cover fed and FICA?

  17. My husband has just started a mobile equipment business. He was employed full time for the first half of the year and I have a full time job also. We have been operating as a sole prop under his SSN. We have a small amount of expenses, office supplies, insurance, vehicle, fuel and tool supplies for his vehicle, etc. We have one small loan for the truck that he purchased. I have opened a separate business account and we have been making regular deposits from customer billings. So would setting aside 30% be overkill or not enough. We wont have that much in expenses, so I want to make sure we are not really short for taxes. Also, should we be operating as an LLC for liability purposes? Im worried about accidents given the nature of the business?

  18. Thank you!.. The information has been very helpful.. We are going to do whatever we need to do to become a S Corp..I have one final question!.. If I hire sales people do they have to be direct hires or can they be sub contractors.. I know when I need the help with cleaning, they will be direct hires on payroll…thanks again

  20. Hi,

    Recently I partnered with a company for a work from home call center . I will hire independent contractors. I was wondering while running a business and filing taxes do you still get to claim dependents?

  21. Hi Shirlee,
    You’ve got a bunch of issues here. First, you are an LLC and you have a partner. An LLC is considered to be a “disregarded entity” by the IRS. Because you have a partner, you are automatically considered to be a partnership and have to file a form 1065 partnership return. You may elect to be taxed as an S corp or a C corp, but until you make an election, you have a partnership.
    Partnership income “passes through” to your personal tax return. So, let’s say the business made $30,000. You’re an equal partner so $15,000 would be taxable to you–and it would be self employment tax as well.
    Also, you will pay tax to Massachusetts and any other state that you and your partner earn revenue in.
    So, bottom line is you will be taxed just as much as a sole proprietor for your business taxes. You’re just splitting the income with your partnerh. So YES–do put away money for the taxes. And NO–the tax is not pai by the company, it is paid by you. That’s a very common mistake. Your business income gets taxed on your personal tax return. You pay your income tax from your personal, not your business funds.

  23. I started a carpet cleaning company which my business partner and I share the work.. We do not have employees yet .. The business is out of Massachusetts but we have clients in other states.. I’m not sure how this will affect our taxes.. We don’t sell products, only services.. Would the same rule apply to us as far as putting aside at least 10%?.. We are an LLC.. We have not taken any money out of the company for us, only for our supplies..

  24. Hi RD,
    I always prefer using an EIN over an SSN–mostly for the identity theft protection. You will check the box for single member LLC but use the EIN number on the W9.
    Many consultants don’t have a lot of expenses to write off, so setting aside 40% isn’t overkill. Hey, if you don’t have to pay that much in tax, then you’ve started a nice little nest egg.
    Depending upon how much income you’ll be generating, in the future you’ll want to look at other options like making estimated tax payments, or maybe becoming an S Corp. But it sounds like you’re doing all the right things for now. Congratulations.

  25. Hi Jan,

    I am now starting out as a consultant. It’s only me, but I set-up a company name as an LLC and an EIN. However, I did not set anything else up yet and I may have landed my first contract. This is great, but I’m at a bit of a loss. For the W9 am I using my SS or the EIN? For taxes, is putting aside 40% overkill?
    Thx,
    RD

  26. Dear Lo,
    I can’t possibly tell you what to expect for a refund. Sorry. What I can tell you is that I strongly recommend that you hire a professional. Now remember, I’m a professional so what do you expect me to say? But seriously, for a first year LLC, it makes a lot of sense to sit down with a human that knows this stuff and can guide you. If your husband is good at taxes, then he can take over from there. But for a first year business–it makes a whole bunch of sense to start it off right.

  27. I started a food based business in may. I set it up as a sole proprietor llc and I did not make a profit this year. In fact I have spent about $5000 in start up costs. How does it work with write offs and how much can you expect back when writing a certain amount off. Also my husband wants to do the taxes himself my filing a 1040 c along with our personal taxes. I would rather have a professional account handle it to make sure we get the most written off. Is that a valid concern? Thanks for any help!

  28. Hi Tracy,
    You probably don’t need to make an estimated tax payment for December. You’ve both had withholding anyway. Now that he does have income coming in, you’ll want to start making estimated tax payments for 2015 though. (I’m thinking positive about good income.)

  29. Hello Jan,

    My husband is an Independent Contractor. He registered his business in August, but has not received any income until recently. Will we need to pay taxes for the month of December? I have a full time job and he had a fulltime job through May 2014. We typically file together.

  30. 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.

  31. 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.

  32. 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.

  33. 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.

  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. 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?

  36. 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.

  37. 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!

  38. 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!

  39. 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.

  40. 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…

  42. 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

  43. 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.

  44. 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

  46. 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 🙂

  47. 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.

  48. 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.

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