The Simple Tax Rule That Could Save You Thousands | 011

Charles (: 00:22

Hi and welcome to the Unsexy Entrepreneurship Podcast. I am your host Charles Harris and today it's just me. So I feel really bad for you as you get to listen to me talk about super nerdy accounting stuff. But when you're hearing this, it'll be after September 15th, which means that third quarter tax estimates were due. And so,

I just wanted to kind of talk about that because while I'm recording this, this is what I'm dealing with right now and talking through a lot of some basic tax things with clients. I'm just realizing that a lot of entrepreneurs don't really understand what's going on with their taxes and it's so scary and it just makes everyone really nervous because when you get a letter from the IRS, I don't think there's anything else that scares people more in their business.

because the IRS can shut you down tomorrow. Will they? No. But it's something to think about and to be worried about. that's, I think those are the biggest questions I get from people. Generally, you don't have to worry about the IRS. They make mistakes all the time. It takes some work to resolve anything from the IRS, which is the biggest issue. But usually it's not.

as scary as shutting down your business, even if they put in the wording, hey, we're going to shut down your business. Usually you have some wiggle room and some time to get this all figured out, to get it resolved. and as long as you're paying the IRS and you're trying to stay compliant, you really shouldn't worry about the government coming in and shutting you down. generally you have to worry about getting shut down when you aren't filing your taxes, when you're avoiding the IRS completely.

And so that's kind of the way I put it as long as we're trying we're filing we're gonna be okay penalties will happen But it shouldn't be significant and it shouldn't be super scary So I just want to kind of walk through Generally what I see So the first I'm gonna say a rule of thumb you need every time you get any income you need to set aside at 20 to 30 percent of that income for taxes

And it's hard because I can't tell you more than 20 to 30 % without seeing your previous year taxes. And it could even be less than 20%. But I just think that's a general good rule of thumb. You yourself will know if you're earning significantly more or a significant amount of money, then closer to 30 % makes more sense. And then if you're closer to like 100,000, 20 % should be plenty and should be very safe.

but it's gonna vary depending, right? And so I can't give you a hard fast rule, but 20 to 30 % is the general rule of thumb. The next thing that I get asked all the time, earlier on in the episode, I mentioned September 15th, this is your quarterly tax estimate. And a lot of people don't even know this exists. So if you have a W-2 job and you're just working, let's say for Amazon, right? They are going to pay you a W-2.

And in that W-2, when you look at the pay stub, you can see that they withhold 7.65 % of your income for taxes. so Amazon is actually responsible for paying that tax. And Amazon also has another 7.65 % that they have to pay for employing you. So if you're a business owner, you actually have to pay 15.3 % for employment taxes.

because you're paying the employee side and you're paying the employer side. So it's 15.3 % and there are some tax breaks for that and deductions.

But I just wanted to make you aware. So those are payroll taxes. The other thing Amazon's gonna do is withhold federal income taxes for you as well. So federal income taxes is really what we think of when we pay our taxes on an annual basis on April 15th, right? We're paying that federal income tax and not the payroll tax, not the 15.3 % or the 7.65 that Amazon is withholding, but we're paying federal income tax. And that's where the tax brackets come in.

So if you earn $30,000, most of it's going to be the standard deduction. You probably aren't going to owe a dime really. But as you kind of go up and you make more money, the tax brackets increase. And that's usually what we think of when we're talking about taxes. So a few things that I want to dispel real quick. First, if you get money back on April 15th, it does not mean the government is paying you. It means you overpaid the government.

you can underpay the government and you can overpay the government. I have never seen anyone hit it perfectly. That doesn't mean it doesn't exist. I've just never seen it. Because usually there are some things that happen that change your taxable income, including just inflation adjustments and things like that.

So when you file your taxes on April 15th, the money you get back or the money you give is not any money you're getting back from the government or giving more to the government. This is really just tax due and you are matching to what it should be instead of what it was withheld. So Amazon, if you were working for an Amazon and your W-2 job,

your federal income tax is withheld. so April 15th, you could get a refund. If you're self-employed and y'all are my people, right? If you're self-employed, if you're an entrepreneur, getting to the exact right amount is trickier because unlike Amazon, you don't have someone else doing it for you. You have to do it yourself. And so you can go onto the IRS website and pay what we call estimated taxes. And estimated taxes are owed three times a year.

or four times a year, I'm sorry. They're owed, I'm gonna get the dates wrong, you can easily Google this. But April 15th, June 15th, September 15th, and January 15th. So January 15th is Q4, so it's the prior year, so it's January through December. And then September 15th, the one that's just passed, is Q3, so this is

August, July, and June.

So June is kind of funny because it feels like it should be July, but it's really ⁓ for May and April. And then April is for January through March. I'm not sure why they do it in June instead of July. There's probably some reason. Probably government officials are off. I don't know. It doesn't really matter. So for our purposes, those are the four dates that we want to pay attention to, and they happen every year.

As a small business owner, you have to make sure that those are paid. And the reason why is you avoid penalties. So penalties accumulate over time if you don't pay any estimated taxes.

So it's really hard to calculate in April what your estimated taxes are going to be at the end of the year. And we can guess and make good approximations, but it's hard to know. And if you're following the rule of thumb of 20 to 30%, you're saving for taxes. Do you pay the full amount that you've been saving to the estimated taxes? And so there are a bunch of questions that come up around this. And so this is really why

I wanted to talk about it today because I just have been getting a lot of questions on it and so I want to answer them. So number one, there is a safe harbor rule. So what this means is that come April 15th, if you've paid this much in taxes through your quarterly estimates, you won't have a penalty and you'll be covered in safe. So there are a few different ways to do this and I'm gonna explain the easy way first and then we'll talk about the hard way.

So the first, easy way is 110 % of your previous year's taxes. So there is a caveat, if you make less than $75,000 or $150,000 if you're married filed jointly, it is 100%. So 100 % if you make less than 75 or if you're married, double that. So 100 % of those taxes that you had from last year.

And you can find this on your: 1040

So it should be at the top of page two. And so that's where we can find it. And we want to pay 110 % of that. Theoretically, it could be 100%. I usually say 110, safer. Most people with small businesses, and if their spouse works or their partner, they're making more than 150 a year. And that's why I say 110, I think, is the good rule of thumb, and it's safer.

So 110 % of the prior year's taxes. So if you paid $10,000 last year in taxes, then it's $11,000 in taxes this year. And so you'll want to split that up over the four periods of time. So you're going to want to pay 3.3, what would that be? 11 divided by four, I'm not even sure. It's probably, it's between three and 4,000 and you'd want to pay those every single quarterly estimate. And then you're totally safe.

taken care of and you won't have any penalties. You might still owe money in April, right? So this isn't saying that you're not gonna owe money in April. It's not saying that you're gonna get a refund in April either. It's just saying that you need that much to not accrue any penalties. So again, that's why I say follow the rule of thumb. Hopefully you're growing and growing quickly. So if you pay 110%, then you follow the rule of thumb.

The rest you should have in a savings account, keep it in a high yield savings account, make some money off of it, but keep it in a savings account and then move and pay that off the remainder come April 15th. Or if business does bad, right, you'll get a refund as well, that's very possible. So that brings up the second rule that you can follow for a safe harbor, and this one's a lot harder, which is why I don't recommend it. It's 90 % of the current year's taxes.

So where this is really helpful is if you were making a million dollars last year and this year you're gonna make 100,000, right? So think about those that sell their businesses, they're gonna make a huge killing the prior year and then suddenly the next year they're gonna have zero income. And those are the years that 90 % of current year's taxes make the most sense. So generally speaking, I try and follow the 110 % rule, 90 % is hard to follow, hard to calculate ahead of...

the tax deadline of April 15th. Which is why I say to follow the 110 % rule. All right, so now that I'm really confusing and I talk nerdy about accounting for a little bit, let's talk about some basic tax planning stuff. Because now you're looking at it and you're saying, I don't want to pay this much to the IRS. And we don't need to. They have plenty of money that they're already misspending.

So what I usually tell my clients is if you think you're outsmarting the IRS, generally you're doing something wrong. Usually there's not some special trust account that's gonna save you money like they talk about on TikTok, which is definitely not true. Generally you can't just buy a vehicle claimants for business because it's over 6,000 pounds, is that what they claim it is? Or 7,000. There are...

those rules do exist, right? So you can buy a vehicle for your business, but if you're a consultant, it doesn't make any sense. And you can't justify that to the IRS. So it has to be reasonable and necessary for your business, all expenses. But there are some things that we can do that the IRS wants us to take advantage of, but I think it's important to realize

Usually, except for ordinary and necessary expenses for your business, usually most of the tax saving plans and things that we can do are not.

stopping you from getting taxed. They're postponing taxes. So the most common one is an IRA or a SEP IRA or a 401k. If you own a business, if you don't have any employees, get a SEP, get a solo 401k. One of those two things is so, so, so important. But any way you look at it, you need some sort of retirement account and you should have one. So.

This is the most common way to avoid taxes is you can fund those straight from your business, right? So if you fund a SEP, I think the max is 69,000 based on your salary. So I think it's 25 % of your salary or 69,000. And I could be wrong on actual amounts. Please look these up, talk to a financial advisor or a tax professional where we can actually go through your situation with you.

But what you can do is put these into a retirement account or you can put money from your business to the retirement account pre-tax, meaning you're not gonna get taxed on this and then let it grow until you retire and then you can take out the money and use it for retirement. So this is why I say this is deferring taxes. This is putting off taxes. It's not saying there are no taxes. Because when you take it out in retirement,

you have to pay taxes on that. So there are workarounds too, like a Roth, a backdoor Roth and things like that, but those are, still paying taxes on. You're hopefully adjusting your taxes to pay the lowest amount possible, but you're still going to be paying taxes. And so it's really important to realize that even though we are saving money on taxes, we're really pushing off, we're deferring the taxes for later.

so that those taxes hit us hopefully when we're earning less money. Because as a small business owner, hopefully you're earning a lot of money, you're rolling in the dough, and you're doing really well. So we wanna push that off to when we're retired, we're not earning any income, so we're taxed at a lower rate. So that's really why a lot of these tax planning strategies happen and work. And this is the same for cost segregation. For those that have heard of that, this is a fancy way of pushing off taxes.

If you're small business owner, you bought a location, you have real estate and you want to do a cost seg study, it can be really helpful, but you're pushing off the taxes for later. So you're allowing depreciation to happen now so you can, so theoretically your taxes will be higher in later years. And so there are pros and cons. Generally cost seg study makes sense, but we don't want to.

just do it because it's gonna save us money. We wanna think through all of the ramifications and what that means in the future too. Because sometimes depreciation, we want it to happen this year and we don't want it to happen in the future. And sometimes we want it to happen in the future and we don't wanna happen now. Which seems kind of crazy to think about too, but it's just important to realize all the different balancing acts that can happen with taxes. And generally, you're not gonna outsmart the IRS.

They have rules in place. And if they don't, and they don't like what you're doing, they can still take you to court and they can still litigate it all to try and get your money. Try and get your money. And so it's important to realize that we're trying not to cheat the IRS, but we're trying to take advantage of what they've given us. And so if you hear some, you're never gonna have to pay 0 % or you're gonna.

pay zero on taxes for the rest of your life, like it's just a lie. It doesn't happen. If you're earning money, you're paying taxes. So that's the best way to avoid taxes is to earn zero dollars. And if you earn zero dollars, you can make money from the government. But I don't think many of us want to do that either. So there's a balancing act here and it's just important to really understand and then understand. So.

All right, so going through it all, I usually tell people to keep 20 to 30 % of your taxes. It's going to vary depending on how much money you're making. And it can be more than 30 % too, but I think that's generally a good rule of thumb. If you're making, or if you need to keep more than 30%, generally you're gonna have a CPA on hand who can really help you and make sure that you're calculating the right amount on estimated payments. And then on April 15th, June.

15th, think it was 16th this year, September 15th and January 15th, we're gonna make our estimated quarterly payments for our business. to calculate how much we need to make for those estimated payments, we're gonna take the safe harbor amount, which I generally argue should be 110 % of your previous year's that you owed. And if you do all that, you're going to be safe, you're not gonna have a penalty come tax time.

Is it perfect? No, that's why I say keep 20 to 30%. That way you can make sure to pay exactly how much you owe come April. Obviously if your business balloons from 100,000 to a million, we're gonna have to keep more than 30%. But these are all just helpful tips. And then for decreasing your tax bill, make sure you're putting your money into your retirement accounts. Now's the time to do it. It's not the end of the year yet, but if you've got a little surplus,

Now is a great time to do it. Talk to a financial planner, talk to a CPA, make sure you're not contributing too little or too much into those accounts. And then just make sure to count every ordinary and necessary business deduction for your business. And if you need help on determining what's ordinary and necessary, feel free to reach out. There are millions of great accountants out there that can help you. I guess not millions, but there are lots. And we wanna help you, we wanna work with you.

So reach out to someone if you need any help. Hopefully this helped. And if you haven't paid your estimated taxes, just pay in January, pay as much as you can. Keep the savings, and then in April finish it up.

that you are gonna have a small penalty, but it shouldn't be terrible. Like I said originally at the beginning of this episode, the IRS is willing to work with you and they're happy to work with you if you're trying to stay compliant. If you're not trying to stay compliant, that's when we have issues and that's when I worry about people. I don't worry if you're trying to pay your taxes. Anyway, long story short, thank you for listening to Unsexy Entrepreneurship Podcast.

If you have any questions, feel free to reach out. We're happy to help. We want entrepreneurs to succeed everywhere. Talk to y'all later.