How Much to Save for Taxes as a Business Owner
Almost everywhere I go, I get asked, “Should I be saving for taxes? And how much?” Most business owners feel like they should be saving something, and they often hear 25–30% is the right amount to save for taxes. But what does that mean? They don’t know if that means 25–30% of their gross or net, or whether that’s even enough for their specific business.
I will say—saving something is always better than nothing, so however you interpret the 25–30% number, it’s still not bad advice. If you’re saving something, don’t stop! But I want to give you a clearer calculation and greater confidence in your savings strategy.
First of all, your tax liability depends on your entity type.
Sole proprietors and LLCs are taxed as pass-through entities.
All the profit from your business will be added to your personal tax return. You fill out a Schedule C to figure out your net profit, which then rolls over to your 1040 (personal tax return). In essence, you are paying taxes twice. The net profit from your Schedule C is taxed at 15.3% on your personal return. THEN that net profit is rolled into your topline income and taxed at your normal tax rate (12%, 21%, 22%, or 25%, whatever it may be.) Given that information, the minimum you’re going to be taxed is 27.3% on your net.
My advice in this case is to save 15.3% of your gross for federal taxes. That ends up being a fairly high amount, since gross is larger than net. It allows room for the business to help pay the personal side of taxes.
When it comes to state taxes, ask your tax preparer what your tax rate is, and add that percentage to the 15.3% of gross that you’re saving for federal. So if your state tax rate is 6.7%, you’ll end up saving 22% of your gross to cover both federal and state. That might sound like a crazy high amount, but it will probably be closer to your actual tax liability than any other rough number.
S-Corps are a little different.
S-Corp owners get a salary, and federal and state withholdings come out of your paycheck.
You also aren’t taxed on the C Schedule, so you don’t owe that extra 15.3%. This brings your taxes down and proactively sets aside money for tax liability at the same time. I do still encourage you to save a little money on top of your withholdings, but it is very different from a sole proprietorship or LLC. Instead of 15.3% plus state tax percentage, I advise you to save around 7–11% of your gross.
Of course, all of these calculations depend on certain variables, like whether you have a spouse, children, investments, etc. So these numbers are close, but still won’t be exact until you get detailed info from your tax preparer.
Typically, if you owe, your tax preparer will print out vouchers for federal estimated taxes. If you’re already getting those, go by that amount. To be sure the numbers are current, meet with your tax preparer mid-year and update them on how your business finances are going so far this year and how you project the rest of the year to go. (This is where having a virtual CFO is so helpful because a CFO can provide those projections based on your year-to-date.) Your tax preparer will be able to run those numbers and tell you what’s changed and how it affects your tax numbers and savings plans.
It’s critical to communicate these things with all your financial people (your tax preparer, CPA, CFO), so your tax bill isn’t a shock. Thorough communication and strategic saving will reduce your unknowns and take the fear out of tax season. It also goes both ways—as bookkeepers and CFOs, we can do a lot to help prepare you for taxes, but we do rely heavily on numbers from your CPA or tax preparer to give us concrete data. This is a situation where everyone on your financial team plays an important, reciprocal role.
If your team is missing a virtual CFO, email me today (jen@assignedfinancialsolutions.com). Our CFO clients enjoy financial strategy, goal creation and accountability, and more, including projections that perfect their tax plans.