How to Avoid Surprise Tax Bills
With the tax return due date quickly approaching (moved to May 17), many people are filing their taxes now. As a small business owner, your taxes are a little more complicated. When filing their taxes, it is not unusual for small business owners to discover that they owe more than they thought they would. This month, I’ll explain how business taxes work and give you two strategies to help you pay the amount of taxes you owe.
In general, a business of any size is only taxed on its “net income.” This means you get to subtract your expenses from your revenue. You are then taxed only on the profit your business makes. If you had more expenses than revenue, you have a loss and you are not taxed on losses. In fact, in many cases, you get to subtract the loss from any other non-business income you have.
For S Corporations and multi-member LLCs, you report your business income and expenses on a separate business tax form. Then, you take the amount of net income you had and report it on your personal Form 1040.
And that is where you can get into trouble. Unlike a paycheck from a regular job, this business income has had no withholding. There have been no taxes already paid on that large amount. So when business owners prepare their taxes, they are faced with a large tax bill they were not expecting.
What do you do?
Two Strategies for Avoiding Unexpected Tax Bills
When it comes to your personal income taxes, there are only two ways to pay them:
Have them withheld from your paycheck, or
Send payment directly to the IRS.
So the best way to avoid a large tax bill is to send in more money during the year. If you are set up on payroll through your business, then you can simply increase the amount withheld from your paycheck. Yes, you will feel the effects of a smaller check, but the taxes are paid without you having to do anything else.
If you aren’t on payroll, then you must send money to the IRS on your own. These are called “estimated tax payments.” Since you won’t know exactly how much you owe until you file your tax return, these payments are your best guess during the year as to what that amount will be.
As a third option, you can always do both withholding and estimated tax payments, and many business owners do.
How much should I send?
Sending money to the IRS always begs the question of just how much you should send. Obviously, no one wants to overpay on taxes. But underpaying feels worse since you have to come up with the money all at once. So how much should you send in? Well, the answer is up to you.
How Tax Refunds Work
Once you complete your Form 1040 for the previous year, you will know exactly how much tax you owe. If you have paid in more than that amount, the government will send the overpayment back to you. This is a tax refund. If you have paid in less than that amount, you will have to send in the additional amount when you file your 1040.
The ultimate goal for your taxes is to owe $0. In a perfect world, you will have paid in exactly the amount you owe and no more. However, nothing is ever perfect in this world, particularly with taxes! So here are some pros and cons of getting a refund versus not getting a refund (i.e.owing tax.)
Refunds
Pros - You get money back! You don’t have to come up with more cash. You can rest easy knowing that you won’t be digging into savings to pay more tax.
Cons - Unfortunately, when you get a refund, the government does not pay you interest on that money. The government has had use of your money all year while you did not.
Not Getting a Refund (i.e. having to pay)
Pros - You had use of your own money all throughout the year. You can invest it, pay down debt, pay monthly bills, etc.
Cons - If the amount is large, you will have to come up with the cash all at once. If you don’t have the cash, you will have to set up a payment plan with the IRS to pay the amount owed while also paying in taxes for the current year.
Understanding how much you should pay for taxes from your business earnings can be confusing. Having well-maintained, accurate books are a big part of clearing up that confusion! Let me help you by maintaining your books and talking you through where you need to make adjustments for the most benefit to you and your business.