Today TaxMama hears from Matt in the Tax Quips Forum, who has the right idea. “I have started a side business doing yard work. I am trying to determine the best way to save to pay my taxes. I have a checking account that is just for the side business. I deposit all the money I am paid for yard work directly into this account. I also use only this account to pay for fuel, repairs, equipment, etc. (business expenses). I need to use some money from my business for personal expenses. I plan to write myself a check from the business checking account, and then deposit that into my personal checking. I also plan to take 25% of the check I write to myself and put it in a savings account that is just for my taxes. Should I being doing this, or do I have to set aside 25% of everything I deposit into the business checking account into a savings account for taxes?”
Good for you! You’re making an excellent start.
Let me briefly explain the overall concept of tax on your business income. The taxes will be on the overall profits from your business. It won’t just be on the money you draw out. Your taxes will be based on the difference between the income you receive and all the expenses – not just things you write checks to pay directly from your business.
For instance, you may be able to depreciate your vehicle, write off your auto insurance and other expenses for your vehicle that were paid from your personal account – perhaps even earlier in the year. OR you may use the mileage rate instead. Sometimes that comes out higher. (In 2011, it is 51 cents per mile for the first 6 months, and 55.5 for the last six months.)
What kinds of taxes must you set aside money for?
1) Self-Employment taxes. Normally, they are 15.3% of your profits – even when you don’t have income taxes. This year, they should be 2% less.
2) Federal (IRS) taxes. Those will be at 15% -25% based on your overall income -from your job and the side business. That’s your federal tax bracket.
3) State income taxes. That’s also based on your overall income.
So you see, that 25% you’re setting aside is probably too low – since you have income from a job to push up your tax bracket. You probably need to set aside about 31%-35% (unless you’re in a 15% tax bracket – in which case 21%-25%).
So, if you’re keeping track of your income and expenses – and tossing in the mileage deduction (instead of actual expenses) – you’ll get an idea of your net profit.
There’s a simple accounting system you might want to try out – it’s called Outright.com. It’s designed specifically for businesses like yours.
And yes, setting the money aside into a savings account is a good habit. You will need to make quarterly estimated tax payments. And if you set up an EFTPS account with IRS now (and a similar account with your state, if they have one), you will be able to send the money directly from your checking or savings account with no fees. You will have proof your payments – and be able to print out a summary for the year, when you need it.
This is just a start. Sadly, there is more to the administration end of running a business. Please, pick up a copy of Small Business Taxes Made Easy to learn other things you need to know – AND ways to cut your tax hit, as well.
More than you wanted to know?
And remember, you can find answers to all kinds of questions about saving up to pay your business taxes and other tax issues, free. Where? Where else? At www.TaxMama.com.[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the join TaxMama.com link – it’s free!]
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