Planning your tax liability can be tricky when done right. To do it accurately, you need accurate records and a tax pro. And even then, it’s not precise.
One of the things that make projecting your taxes difficult is the fact that your tax liability is affected by multiple factors, like income from other sources, marital status, family size, medical expenses, homeownership, etc. And since the end of the year has not arrived yet, you have to forecast (or guess) what your profit will be at the end of the year.
To simplify knowing how much to pay in quarterly estimated taxes, the IRS wants you to pay the tax balance for the previous year in quarterly installments (or 110% of the previous year’s tax balance if your adjusted gross income is greater than $150,000 if married filing jointly).
But what happens if you have a revenue spike? While the IRS’s method is designed to be simple, it doesn’t account for drastic changes in income or profit. Its method will help you to avoid a penalty, but you still must have the remaining tax balance paid by April 15.
As stated earlier, the way to get the most accurate estimates for your tax liability if your income spikes is to have a tax planning session with a tax professional who can give you estimates based on accurate and up-to-date financials.
But here’s a simpler way to stash away extra dollars for taxes in the event your income increases so you don’t have to worry if your tax estimations are a bit off: Use the Profit First system.
Generally, we set aside 15% of revenue for tax reserves. Being that this system is based on percentages, the amount in your Tax bank account will vary in proportion to the income that you generate. If you make a little money, you’ll have a small amount in the Tax account. If you make a lot, then you’ll have more in your reserves. Which is exactly what you need.
This is by far, the simplest system to making sure you always have enough in reserves to cover your income tax liability, no matter how much or how little you earn. Continue to make your quarterly estimated taxes based on the tax liability from the previous year, and you should have ample cash in reserves to make up the difference if needed.
To get the most accurate percentages to set for your Tax account (and any of the other core accounts), we’d be happy to help. Just reach out for a consultation.
There are several mistakes that a business owner can make while implementing the Profit First system into their business. And chief among them: not following the instructions to a “T.”
A bit about me: My wife loves it when I cook (which I could do more often), and she often likes what I cook. And I tell her, “I don’t cook. I simply follow the instructions.”
Now I’m nowhere near my mom or grandma’s level of culinary genius; they don’t use or need measuring utensils the way I do. But, my food almost always comes out good because I follow the instructions to a “T,” despite my lack of experience.
The same is true for following the Profit First system. It works well. And I suspect you know it works well too, or you wouldn’t be reading this article. It works because it’s based on time-tested, solid financial principles.
(It also works for personal finances, if that’s something you struggle with.)
Now, in terms of which points in the system should be adhered to the most closely, at the top of the list is limiting business spending to what’s available in the OPEX account.
In my humble opinion, being able to keep business spending to what’s available in OPEX (i.e. making the hard decisions when it’s low, avoiding using funds from other accounts to handle the business’s spending, etc.) is the crux of the entire system. If everything else is done correctly except for compromises in this area, you will not get the promised results. It’s that simple. We guarantee our profits by keeping strict limits on what the business can spend as a percentage of revenue.
It is super important to be watchful and vigilant over monitoring your business’s monthly expenses. We must be proactively innovative and creative when it comes to limiting our expenses. I’m not suggesting we be cheap, but we should cut all unnecessary spending and make sure we are receiving maximum value for every dollar spent. And if it comes to it, we must make the hard choice to cut or reduce whatever is necessary to stay within the amounts of the OPEX account whenever there are more expenses than cash available within that account (with emphasis on “within that account”).
Life will happen, and there are times when we’ll have to adjust, although not frequently. And that’s OK. But there are also ways that we can preempt large or unexpected expenses:
So, follow the system. Don’t take shortcuts when implementing Profit First. The system is already simple and broken down to its simplest form for maximum results; there’s nothing added to it that isn’t necessary. If you want the results that the system promises, just follow the system and instructions to a “T.”
If you need help implementing Profit First in your business, let’s talk!
First, the tax law is constantly changing, which can cause your tax liability to change, even if all other factors remain the same.
Also, the final tax bill that business owners receive often includes income from sources outside of the business, as well as deductions, credits, and penalties outside of the business.
And to complicate it further, let’s just say there’s a reason the IRS calls them “quarterly ESTIMATED taxes.” You can’t know your tax liability until you close your books at year’s end.
The best and most accurate way to project your tax liability is to have tax planning sessions throughout the year with a tax professional.
Tax pros keep up with the constant tax law changes and can include business and non-business factors to provide very (but not completely) accurate projections throughout the year. A tax pro can also proactively look for tax savings opportunities to make sure you’re keeping your taxes as low as possible.
First, the IRS doesn’t project your tax liability; it suggests you pay your estimated taxes for the present year, based on the tax liability of the previous year. So, if last year’s tax liability was $4000, the IRS wants you to pay $1000 in quarterly installments throughout the year.
This method (for paying estimated taxes) is better than nothing, but if you have a drastic increase in income, you could still end up with a very high tax bill using this method alone.
The Profit First cash flow management system doesn’t project your tax liability either (which is very complex). But what it does really well is to make sure that you always have enough in reserves for whatever tax bills come your way.
The Profit First system works off of percentages, so you’ll have a lot of money in reserves if you did well, and not so much if you had a bad year. Either way, you’ll have enough in reserves based on the performance of your business. And you don’t have to be a tax nerd to get it right.
At Fit For Profit, we can help you with implementing Profit First into your business so you can feel secure that you’ll have enough saved for taxes. Fill out this form and book a call to get started.
One of the beautiful things about the Profit First system is always having enough in reserves to pay your taxes. But what happens when tax time rolls around and there’s simply not enough cash to pay all of the taxes?
I started my business as a tax preparer before I started serving as a Profit First Professional. One of the major issues of my business was the uneven revenue throughout the year.
From January to April, revenues were strong, so I paid myself a lot–and frequently. But after April 15th, revenues would drop dramatically. I’d be able to pay myself from the excess throughout the summer. But fall and winter months, I was barely able to pay myself anything from the business, if at all.
Here’s how Profit First allowed me to pay myself a steady salary throughout the year WITHOUT having to earn extra revenue:
The Profit First system required that we set up our 5 core accounts, and allocate predetermined percentages to each account. The core accounts are income, profit, owner’s pay, taxes, and operating expenses. Here, we’re going to focus on owner’s compensation because you deserve to be paid for the work you’re doing!
It’s important to establish a lifestyle lock amount, the amount you need to maintain the lifestyle you want to live. It’s what you will pay yourself each month, consistently.
The lifestyle lock puts a limit on how much you will take from your owner’s compensation account, no matter how much money is in there, to support your lifestyle. My lifestyle lock number was $3,500 a month. So, during tax season, even though my owner’s compensation accounts easily had more than $10,000 in there, I’d only pay myself my lifestyle lock number ($3,500).
Revenue would still come after tax season, but much slower. But because I only paid myself the lifestyle lock number, I was able to pay myself consistently throughout the year from the owner’s compensation account, well into the fall.
The post-tax-season revenue, although much slower, would make sure that money was still being allocated to my owner’s compensation account. And there was extra revenue built up there from tax season to make up for that lower revenue. The end result was being able to now pay myself year-round, as well as greater confidence in my business’s finances, and a much happier wife (true story).
Every year, especially since implementing Profit First, I have at least one month where I do not generate revenue. Using the lifestyle lock helped (and still helps) me to take a month off, but still be able to pay myself in full. This is huge because typically when solopreneurs stop producing revenue, the impact on the salary is normally felt immediately. The lifestyle lock helped me to break the month-to-month, check-to-check cycle.
Profit First works and paying yourself with your own lifestyle lock works wonders for any business owner who experiences high seasonality with their income. It offers peace of mind for yourself and your loved ones and takes the stress out of the question, “Where’s my next paycheck coming from?”
If you’d like to learn more about how to even out your salary or take-home pay using the Profit First cash flow management system, we’d love to see how we can help you. Schedule an appointment, and we’ll talk about it!