How do I avoid tax surprises?

Q: Dear Ruchi, last year I had an incredibly high tax bill that I was not prepared for. I was SO shocked and still quite frankly don’t fully understand how taxes work for a business owner like me. I don’t want to be in the same position this year and need some guidance on how to avoid this in the future. 

A: Would you believe that this is such a common occurrence amongst small business owners? As usual, you are not alone here! Dealing with taxes is one of the most high-stress items my clients come to me with. But trust me, there are ways to make this more manageable and put you in a place of comfort and preparedness. Plus, you'll be happy to hear it’s much easier than you think if you commit to a process. Let’s take a look together… 

First, I believe that the best way you can prepare for taxes is by saving and planning throughout the year. I typically advise my clients to do this by setting up a separate tax savings bank account that is linked to their primary operating account. Whenever revenue comes in, move a portion of your revenue into this account.  Ideally you would do this as you receive deposits, though at a minimum, you can do this monthly.  You will see how quickly the money starts to build!

Now in order to know how much to transfer to your tax savings, you want to understand what your tax rate is.  Note that typically you will be taxed on the net income (revenue less expenses) of your business, less other taxable deductions you may be eligible for.  I always say to my clients, “it’s an art, not a science”, so you’ll want to monitor as you go and adjust the percent of savings periodically as there are major changes in your income levels or tax regulations.

Finally, the best and most thorough way to align on all of the above would be to sit down with your CPA to help you understand your tax rate based on your projected net income. From there, you can determine how much to save and also how much to pay in quarterly estimated taxes in order to avoid tax penalties and interest, and most importantly so you don’t have any major tax “surprises” in the future.

You’ve got this, now go open that new account and start saving!

Here’s to your prosperity!

-Ruchi