Small business owners know a larger than expected tax bill could put a wrench in their company’s cash flow management, a scenario everyone is eager to avoid. But accurately forecasting your tax obligations may seem difficult, particularly when you’re busy running a company. Not only that, tax laws change from year to year.
“Many small business owners have no idea what they will owe in taxes until it’s time to pay them,” says Paul Gevertzman, CPA, a tax partner at Anchin, Block, & Anchin in New York. “This may be because they are either not working with an accountant or they are not providing any data to the accountant until right before tax time.”
There are other reasons small business owners get blindsided by their tax bills. Sometimes owners track profits and losses in different ways than the method required for taxes, Gevertzman says. Or they may have included some expenses as deductions that actually must be capitalized for tax purposes (or depreciated over several years) because purchased items are used for longer than a year.
Whatever the reason, being unprepared can create a cash flow crunch that recurs year after year. By incorporating tax forecasting into your cash flow management strategy, you can stop the cycle and ensure funds are flowing as you’re expecting.
Here are four tax planning steps every small business should take:
1. Understand your tax obligations
Business owners often overlook certain types of taxes. “With the proliferation of online commerce, for example, sales and use taxes are among the most commonly missed,” says Dane Dickler, tax and business services partner at Marcum LLP. “If your company has customers in states where you do not have a physical presence, you may be responsible for collecting and remitting sales and use taxes to that state. Or, if your company purchases products from out-of-state providers that do not collect sales tax, you may be responsible for paying it.”
“It gets very tricky because every state has its own regulations,” Dickler says.
Also, Gevertzman notes that some municipalities have location-specific taxes that business owners may not know about. For example, New York City’s commercial rent tax is charged to tenants only in certain parts of Manhattan and only on rents paid above a certain annual threshold. “Tenants moving into an area subject to the tax, or tenants whose rents have increased, are often unaware that the obligation exists,” he says. “And if the unaware owner is not filing the proper tax forms, the statute of limitations is generally not going to run, meaning that the jurisdiction can attempt to assess the hidden tax all the way back to inception.”
Also, owners of sole proprietorships or partnerships often forget to add the self-employment tax on top of their income taxes, says Los Angeles-based Rick Norris, CPA. “This is the Social Security and Medicare tax that is usually paid by an employer for a normal W-2 employee,” he says. “But in the sole proprietorship or partnership situation, you are the employer, so you pay all of this tax.”
2. Set aside tax money every month
It can be tempting to use all available funds to run and grow your business, but doing so means that money will not be available when taxes are due, causing a cash flow challenge. Instead, set aside the percentage of your revenue you owe toward taxes every month in a digital saving account that you can dedicate purely to your taxes and earn interest on those funds.
“If you are an S corporation owner earning a salary, pay the taxes with each paycheck starting in January,” Norris says. “This helps prevent a large amount due to catch up later in the year. If you own an LLC or sole proprietorship, allocate a portion of each draw to a tax saving account and learn to live on the net draw. Then when your estimated taxes are due, pay it out of this tax saving account.”
Think of payroll withholding taxes or sales taxes collected as “trust fund taxes,” Gevertzman says. You are simply the trustee holding on to these funds on behalf of others. Because they do not belong to you or your business, never treat them as your own.
3. Regularly check your projections
Even when you’re fastidiously setting aside funds for taxes, you can still end up owing more to the IRS than originally planned. Are you enjoying a better-than-expected year of business? It’s great to have profits you hadn’t planned for, but you may find yourself with a cash flow surprise. Tax forecasting helps you keep pace with your projections throughout the year.
“The key is to revisit this often,” Dickler says. “Many small business owners have a general sense of their tax responsibilities, but things can change quickly. The more often a small business owner reviews interim financial statements, the more accurate the tax liability forecast will be, and the less likely it is they will be caught off guard.”
For his clients, Norris prepares multiple tax forecasts during the year to ensure their tax projections match their revenue. “The first is around May after the tax return is filed,” he says. “The second is in November, and then there’s a quick check under the hood in December to make sure withholdings or estimated taxes are still in line with the projected income.”
4. Get outside help
The U.S. tax code is thousands of pages long and changes regularly. That’s not even counting the ever-changing tax statutes of states and municipalities.
Since it’s a lot to keep up with, many business owners rely on tax professionals to help them stay on track. “Get the best tax professional that you can afford,” Gevertzman says. “It is hard enough for professionals to keep up with all the nuances and continuous tax law changes. By letting a professional help you with taxes, you’ll be able to spend time doing what you are best at—running your business.
Understanding your tax obligations and planning ahead for taxes can help you save money and reduce stress when tax season comes around. This proactive approach will help you to better manage cash flow and to stay focused on other aspects of managing your business.
This should not be construed as tax advice. You should always confer with your accountant or financial consultant before making a decision about taxes for yourself or your company.
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