One of the best things about Profit First is that the money you need…for payroll, for expenses, for taxes…will always be there because you have a system and you’re using it consistently.
And while payroll and expenses are things that come up consistently, month over month, taxes can sometimes be overlooked. Or they’re something you’ll start to save for when revenue picks up or after this bill or that bill gets taken care of.
Everyone likes being profitable, yet no one likes paying taxes. So, how can we reduce taxes without reducing net profit?
Making contributions to your qualified retirement plan (SEP/SIMPLE IRA; Solo 401-K; etc) through your business can reduce your federal income tax, but does not reduce your taxable net profit. The cool and unique thing about this deduction is that the IRS allows you to make retirement contributions beyond December 31, up to the filing deadline of your main tax return, in order to maximize your deduction for the previous year.
The health insurance premiums paid on behalf of the owner(s) work very similar to retirement plan contributions: They reduce your federal income tax, but not your business’s net profit. Health savings accounts can be used to achieve the same objective. First, make sure you’re eligible for the deduction. For example, if your spouse has health insurance through their employer and they have the option to cover the entire family, you may not be able to claim the deduction through your business.
If your small business is profitable (especially beyond $50K/yr) and you file taxes on Schedule C, you may benefit from electing to be taxed as an S-Corporation. This strategy will help you to legally reduce self-employment tax. But be careful when adopting this strategy. Electing to be taxed as an S-Corp comes with increased compliance issues, which means more fees. You’ll have a separate tax return to prepare, and you’ll have to run a payroll for yourself (which will require payroll tax returns). You’ll want to do this with the help of a tax pro. Make sure all of the extra fees associated with becoming and maintaining an S Corp do not eat up what would have been your tax savings.
All business owners will eventually end up filing a Form 1040 (the main tax form), and it includes all of the credits and deductions that aren’t business-related. Make sure you are maximizing all credits and deductions outside of the business. They will not reduce your net profit at all but the tax savings can be great.
The main thing to remember about the 1040 tax return is that it includes ALL sources of income, and well as all of the available credits and deductions; not just the business stuff. The popular ones are the student interest deduction, charitable contributions, the Child Tax Credit, Earned Income Credit, etc. Reach out to your tax pro to see which credits and deductions you may qualify for.
Tax season is around the corner. Getting everything together and filed can be really stressful, especially for business owners; but it doesn’t have to be. You simply need to know what you need and have it ready by the start of the filing season.
Primarily, you’ll need to:
Your “numbers” are your annual net profit, to be exact. Hopefully, you are able to produce a Profit and Loss statement for the year because you’ve kept really good track of your books or had a bookkeeper working with you.
The Profit and Loss statement (P&L) will tell you (or your tax preparer) how much the business made in revenue, how much was spent in business expense, and the difference (profit or loss); all of which is needed to prepare the business portion of your tax return. An accurately-completed balance sheet is also helpful, but the P&L is critical.
If you use your vehicle 100% for business, tracking vehicle expenses are easy. But if you use it for both business and personal reasons, you’ll want to track the number of miles you drove for business and separate that from the personal miles. Your tax preparer will need this number to give you credit for the business use of your vehicle (56 cents/mile for 2021). If you didn’t keep good track of your business miles, use your calendar to track old appointments and meetings, and get the total for those miles driven throughout the year. You’ll also want to report the parking and toll fees you incurred during the year.
You may get a deduction for the business use of your home, but you’ll need to be able to provide some information to take advantage of it. Typically, these items should not show up on your P&L, but you can still use them to reduce your taxes. In order to claim the home office deduction, you’ll need:
Typically, you’ll be able to get a deduction for these expenses based on how much space your home office takes up (i.e. you’ll be able to deduct 8% of the total annualized expenses if your home office takes up 8% of your home).
To learn more about the home office deduction, you can get more information on the IRS website or ask your tax preparer.
Having all of these numbers ready in advance will save you a lot of stress, time, and potentially some money. So start early! And while you’re at it, start setting up some systems for next year so you’re gathering this information year-round. If you need support with this, be sure to contact us!
While income tax filings have an annual deadline, the management of your taxes is ongoing, especially as business owners.
The key to managing your taxes is Proactive Tax Planning. This can mean many things to business owners, depending on the size and complexity of your business. But for the sake of keeping things simple and pragmatic, we’ll refer to proactive tax planning as a periodic review of your financials and projected tax liability DURING the tax year. This allows you to forecast your potential tax liability and position yourself to maximize any credits or deductions you may qualify for. This is the best way to make sure you’re paying the least amount in tax that you’re legally obligated to pay. But what does this look like in practice?
It is currently the beginning of the 4th quarter in 2021 (early October). If you were actively managing your taxes throughout the year (with the help of a tax pro, of course), you will have done these things:
One of the biggest benefits that we have as business owners is the ability to control how much our businesses are taxed. How? By controlling how profitable we are. But we can only exercise that power by having up-to-date financials (a profit and loss statement and balance sheet).
You can’t know what your tax liability will be until you close out your books after December 31. This is why they call it ESTIMATED taxes. However, by having accurate financial statements, we can make very accurate projections of what you may owe. And by knowing how profitable you are as we near the end of the year, you have the ability to increase or decrease business spending, which ultimately gives you great control over what you’ll be taxed on.
There’s one popular, yet horrible strategy that I want to warn you against. There are accountants and “advisors” who will encourage business owners to sped off all of their profit in order to save on taxes. This is equivalent to spending $10 to save $3. It’s not illegal, but it’s just a bad strategy if you’re looking to build wealth. Instead, you want to focus on increasing PROFIT while budgeting for and minimizing your tax liability.
Profit First has a wonderful system to help keep sufficient tax reserves. It’s simple, painless, and can help make sure you have enough for taxes and helps you prepare for tax season, no matter how little or how much you make. Sign up now for an assessment and let’s get you started!
There can be a lot of confusion around who should be on your business money team and their roles (including your role as the business owner). But without a solid team, you may feel confused about your finances–which is never a good feeling.
No matter how long you’ve been in business, it’s time to pull together your team now or revisit the individuals who are supporting you.
The term “accountant” is broad and is mostly misused by business professionals. For this article, we’ll limit it to the role of tracking your business’s finances and producing accurate financial statements with them. Think P&Ls, balance sheets, reconciliations, and all of that good stuff.
At a basic level, a bookkeeper will focus more strictly on recording your financial transactions. An “accountant,” however, can give you insight into your financials to help you make strategic decisions. Newer or smaller businesses may suffice with a bookkeeper initially but may have to hire an accountant as the business grows and becomes more complex.
Oftentimes, it’s not the best use of the owner’s time to keep the books. However, you still must understand how to read your financial statements and conduct your financial affairs in such a way that it’s easy for your accountant to track everything (i.e. no commingling of funds between personal and business accounts). Also, if you don’t understand your financial statements and don’t review them regularly, you may put yourself at risk of being stolen from. You want to find an accountant with the heart of a teacher, who will help you understand your financial statements.
Business owners often think that all accountants prepare taxes. This is not true. Tax and accounting (bookkeeping) are two processes. The accounting needs to be complete before the taxes can be prepared. When seeking out a tax pro, find someone with the heart of a teacher (see a recurring theme there?) who will explain to you how to minimize your taxes and stay in compliance with the IRS and state. If you really want to save on taxes, you’ll meet with your tax pro on a quarterly basis, but definitely at the end of third quarter as you near year-end. Proactive tax planning is the best way to keep taxes low and to ensure there aren’t any surprises come tax time.
You can make your tax pro’s job easier by having accurate and complete P&Ls and balance sheets. Your accountant actually does the heavy lifting in this regard. Be sure to ask your tax pro about any tax savings opportunities or recent changes in tax law that might affect you (a great tax pro will tell you before you ask). Last, make sure you pay your quarterly estimated taxes to the IRS and the state.
NOTE: If your tax pro encourages you to spend off your profit to reduce taxes, seek a different tax pro.
We can’t talk about money teams and neglect to mention Profit First Professionals! While accounting tells you where your money came from and when (via financial reports), cash flow management directs where your money goes. We use the Profit First cash flow management system to help business owners become permanently profitable, pay themselves regularly, reserve for taxes, and know exactly how much they need to budget for their business’s expenses. A Profit First Professional can help you design a system that works for your business and your goals.
Contact a Profit First Professional Firm (that’s us!) to do an assessment of your finances and build out a customized cash flow strategy for you. If you contact us, we’ll give you step-by-step instructions.
Accounting, taxes, and cash flow management are different disciplines, although closely related. There are some professionals who can do all three, but it’s probably best if you separate some of it out to protect yourself and your money. But all the members of your business money team should be in some type of communication with each other. Just make sure that they are familiar with your business, your industry, or goals, and have the heart of a teacher.
Who doesn’t want a more profitable business? We’re in business to help people, sure, but we’re also here to make a living. And if we want to make a good living with a business, we need to be profitable.
This article will focus on the latter—reducing expenses to increase your profitability. Because while increasing revenue is important, most businesses forget that increased revenue is not an excuse to lose sight of expenses. The beautiful thing about this strategy is that it simply involves cutting some expenses to increase what you keep. Expenses that you probably don’t need anyway.
To reduce your expenses, simply conduct an Expense Analysis. There are many ways to conduct one, but here’s a simple method that anyone can use:
Make a list of your common and recurring business expenses.
Trash or Trim your list.
Contact the vendors to cut/trim expenses.
Any business can do this in a couple of hours. The more your cut, the more profitable your business becomes–as long as you’re not cutting out vital services in an effort to save a few dollars. It’s worth weighing whether cutting out a service will mean less fluidity of workflows or more time investment for you.
We recommend going through this process on a quarterly basis at a minimum. This practice will keep you financial efficient and profitable.
Not sure if you can eliminate a particular expense? Try this test…
Eliminate the expense for a month, but be prepared to regain if needed. How do your customers react? Does your team notice its absence? Are you having to spend any additional time connecting dots that are no longer connected? If no one is negatively affected, then you could probably eliminate the expense.
Remember the old saying, “It’s not what you make, it’s what you keep.” Doing a quarterly expense analysis will help you keep more of your money, and help you earn higher profits. If you need help implementing Profit First in your business, let’s connect. Schedule a call with us today.
Many of us have a rainy day fund for when (not IF) things go south. Your car needs a new transmission, your roof has a leak, a child gets ill. These things happen, and our personal emergency fund is there waiting to save us, or at least minimize the impact.
But very few business owners seem to have an emergency fund for their business. And knowing your personal emergency fund is there to bail you out if needed is not what it means to have an emergency fund for your business. Business and personal funds should always remain separate.
There’s a lot of unexpected expenses that could come up in a business, from losing a big account to needing a new HVAC system to a water leak that needs to be fixed ASAP, attorney fees to help with a disgruntled employee or former client. We hope that none of these happen, but the reality is that they can and they will at some point.
The beautiful thing about the Profit First cash flow management system is that your business will start building a business savings for itself if you run the system correctly.
Twice a month, you’ll transfer a percentage of revenue to your Profit bank account. (How much depends on your own profit allocation percentages.) Over time, your Profit account grows.
Then, each quarter, you’ll transfer half of the funds in the Profit account to your own personal account to do with as you wish. It’s your reward as the business owner. Use it to pay down personal debt, buy something fun, take a trip, you name it.
The other half will stay in the Profit account as an emergency fund, and you can let that fund grow. Now, when (not IF) things go south, the business has its own support.
Ideally, you’ll want to reserve three to six months for business expenses in your Profit account or another emergency account. It’s generally not a good idea to have too much cash due to liability, so once you have a fully-funded emergency fund you can use 100% of the funds in the PROFIT account.
And no matter what the size of your current business savings, know that every dollar will help you rest a little bit easier.
Need help getting your accounts set up or determining your distribution amount? Let’s talk!
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.