Here are 7 Steps to Make Tax Time Easier
April 15th is Tax Day, and for some it is a day to celebrate their anticipated refund. However, for most people that are self-employed the thought of April 15th makes them cringe. My hope in writing this is to help ease the stress of the season.
Being self-employed comes with a lot of perks. However, tax-time is not one of them. Usually, we don’t start out our careers as self-employed, we work for an employer at another company. Regardless of its size, we received a W-4 form as part of our employee benefits package. We claimed whatever we claimed and then received a W-2 at the end of the year. If we were “lucky”, we paid so much in taxes we got a refund at the end of the year. Just in time to escape the cold and afford a vacation to some place warm!
When you received a W-2 it was easy to hop on Turbo Tax or go to H&R Block to report how much your employer withheld from your paycheck over the course of the year. Things are a little different now that you are your own boss. You are on your own. You can still use Turbo Tax or H&R Block but now you are responsible for paying self-employment taxes (FICA) and holding aside money to pay your state and federal income taxes. And the self-employment tax rate is double that of a person working for a company receiving a W-2. Here is why: The self-employment tax rate is 15.3%. It consists of two parts – Social Security is 12.4% and Medicare is 2.9%. Now, if you were a W-2’d employee then 50% of the FICA would be paid by your employer saving you 7.65%. You are allowed to deduct the 7.65% employer equivalent portion of your SE tax when calculating your adjusted gross income and there are certain other exemptions. But that’s a topic for another day, or your accountant!
All of these withholdings add up. It tends to sting a little after you hustled, marketed, and worked tirelessly that first year out on your own. You were courageous and vulnerable enough put yourself out there and now you are seeing your hard-earned money get taken away.
Please, don’t miss understand me. I am not an anti-tax person. Sure, there are plenty of inefficiencies in how certain money is spent, but overall, I truly understand the benefit of taxes. But there is no denying that there is shift in perception when you become self-employed. No longer are you making money for “the company” you are making money for yourself. Every dollar that flows in, is a direct result of the energy you put into your business. Equally, every dollar that flows out is directly leaving your account. It feels a lot different if you are a salaried employee whose take home pay is $70,000 than if you are a self-employed person earning $100,000 in profit, writing a check to the IRS for $30,000 and then only being able to keep $70,000 of that.
These are all realizations that self-employed people either face, fear, forget, or fumble with when they start their business. My hope is that you don’t find yourself in a position of owing more money to the IRS than you have saved in your account. Or having the IRS penalize you for not filing your estimated taxes. Or not having taken advantage of all the tax deductions available to you as a self-employed person. Or, or, or…
Although I can’t remove the requirement to pay taxes, I can try to remove some of the stress. My hope is that with this list I can help prevent you from dreading tax-time. You have to remember 8 out of 10 businesses fail. You are in the 20% of businesses that actually make a profit. Way to go!
7 Steps to Make Tax Time Easier
- Separate Accounts! I cannot emphasize this enough. Don’t mix personal and business income and expenses in the same account. It will get messy quickly.
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- If you are an LLC, this is easy because more than likely you will have already setup a business account.
- If you are running your business as a sole-proprietor, then you should open up a separate checking account exclusively to receive business income and pay business expenses.
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- I recommend having a business savings account in addition to the checking account. This savings account will be used exclusively for tax savings. Therefore, it allows you to transfer the money out of your checking account and hold it for tax time. Some people do this manually and others have the bank transfer it automatically on specific days of the week or month. This is the theory of “out-of-sight, out-of-mind”. If you don’t see it in your checking account, you will be less likely to spend it on something else.
- Save all your receipts for business expenses. Something I find easy to do is to scan them all when I receive them. If I buy something at the store, I will scan the receipt when I get home and save it to my computer in an organized folder called “business receipts 2019”. If I receive an email confirmation or receipt from a purchase I made online, I will save a PDF copy in the same location. That way I am not chasing down emails come tax time.
- Determine your profit and loss monthly. Some people may choose to do it more frequently. Determining how much profit or loss you have can help you determine how much of a salary or draw you can take from the business. Using a software program like Quicken, Excel or QuickBooks can make this process a lot easier. Profit and Loss statements can seem daunting to some, but as long as you are adding up all the income and subtracting all the expenses then you’ve created a P&L statement. If you feel more comfortable doing this with a notebook and a pen and paper, that’s great too! The key is to do it and do it consistently.
- Once you determine your profit and loss for the month you can start calculating what you’ll need to hold aside in that business savings account you opened for your taxes. You only pay taxes on the profit you have made not all the income generated. So, make sure you deduct all your expenses first. The general “rule” for how much to set aside is 27%-33%. This should be enough to cover the 15.3% needed for FICA and the rest will come close to covering your income taxes. Obviously, your tax bracket and the state you live in will determine the exact percentage to hold.
- You will need to file your estimated taxes quarterly. Most states will use the same calendar as the IRS. The dates can be easily found online or directly on the form you will submit with your payment. Once you start creating a Profit and Loss statement each month and holding the money aside, then paying your estimated taxes will become as easy as paying your cable bill. Although, with the price of cable maybe that’s not less stressful for you. Let’s say it’s as easy as paying your dog walker instead.When you have created a P&L statement each month it’s simple to add the three together to calculate how much profit the business has made that quarter. If you are using a software these calculations are done for you when you change the date of the report.
- Create your tax calendar. I recommend coming up with a schedule to remind you at the end of each month to print your Profit and Loss statement and at the end of each quarter to print your quarterly P&L statement and send in your quarterly estimated taxes to the IRS and your state. It’s best to have this calendar in writing or set it up electronically to give you reminders. That way you don’t forget. It’s very easy to get busy with work and forget. 3 months can pass quickly when you are busy building your business.
It’s not too late to start off 2019 right. Estimated taxes don’t need to be filed until April 15th. You still have enough time to gather the information needed to determine profit and loss. Once you determined your profit you will know how much to pay in estimated taxes.
You probably had an entire list of really great inspiring reasons why you started your own business. Don’t let a little paperwork a few times a year discourage you! You are doing it!
Do you wish you had more profits? You have already established a client base and have some money flowing in. Now is the time to revisit your business, could you be adding services? Are you getting enough business that you are considering finally starting an LLC? Do you need to update your website? What about lowering your office expenses by subletting your office when you are not using it? There are many opportunities for you to lower your expenses and increase your income, the key is to Lean Towards Joy™ while you are doing it.
