How Much to Set Aside for Small Business Taxes
Managing small business taxes can feel overwhelming, but setting aside the right amount ensures you avoid financial surprises. Following IRS guidelines, this guide will help you determine your tax obligations, use the 30% rule for savings, choose a savings method, and manage your tax payments effectively.
Table of Contents
Step 1: Get Clear on Tax Obligations
Before setting aside money for taxes, you must understand which taxes apply to your business. Here are the most common types:
Self-Employment Tax
Self-employment tax covers Social Security and Medicare taxes. If you’re self-employed, you must pay both the employer and employee portions, totaling 15.3%. The IRS allows you to deduct half of this tax when calculating your adjusted gross income.
Income Tax
Federal income tax is based on your taxable business income. The rate varies depending on your total earnings and tax bracket. State income taxes may also apply, depending on where your business operates.
Sales Tax
If your business sells goods or certain services, you may need to collect and remit sales tax. The rate depends on your state and locality, so check with your state’s tax agency.
Franchise Tax
Some states impose a franchise tax on businesses for the privilege of operating within their borders. The calculation method varies, often based on revenue, net worth, or a flat fee.
Excise Taxes
Certain businesses, such as those selling fuel, alcohol, or tobacco, may be subject to excise taxes. These are typically included in the product’s price and paid directly to the IRS or state tax authorities.
Step 2: Use the 30% Rule to Save for Taxes
A general rule of thumb is to set aside 30% of your net income for taxes. This helps cover federal income tax, self-employment tax, and state taxes. However, depending on your tax bracket and location, you may need to adjust this percentage.
Step 3: Choose a Saving Method
There are several ways to save for taxes, depending on your cash flow and organizational preferences.
The Per-Payment Method
This method involves setting aside tax money every time you receive a payment.
When to Use It
Use this method if your income is unpredictable, such as in freelancing or seasonal businesses.
How It Works
Each time you receive income, transfer 30% to a separate tax savings account.
A Pro Tip for the Super Organized
Automate your transfers so that every payment automatically allocates a portion to your tax savings account.
The Monthly Method
This method involves setting aside money for taxes once a month.
When to Use It
Ideal for businesses with consistent revenue streams.
How It Works
At the end of each month, calculate 30% of your profit and transfer it to your tax savings account.
The Yearly Method
Some businesses prefer to set aside tax money annually, though this requires discipline.
When to Use It
This method may work if your business has low overhead and predictable income.
How It Works
You set aside a lump sum at the end of the year, ensuring you have enough to cover tax payments.
What Happens If You Underestimate Your Taxes Owed?
If you underpay your taxes, you may face penalties and interest charges from the IRS. To avoid this, make estimated quarterly tax payments based on your expected income.
What Happens If You Pay Too Much?
Overpaying taxes means the IRS owes you a refund. However, this money remains inaccessible until you file your return.
Save for Next Year
Instead of requesting a refund, you can apply the overpayment to next year’s tax liability, reducing your future payments.
How to Manage Your Savings for Taxes
- Open a Separate Account – Keep tax savings separate to avoid spending it unintentionally.
- Automate Transfers – Set up automatic transfers to ensure consistent saving.
- Track Expenses – Use accounting software to monitor income and deductions.
- Consult a Tax Professional – A CPA or tax advisor can help optimize your tax strategy.
By planning ahead and following IRS guidelines, small business owners can manage tax obligations effectively and avoid financial stress.
