Death and taxes: the two things that are certain in life. But while you can't do much planning for death, you can certainly plan ahead when it comes to your taxes.
I can't tell you how critical it is to get your business tax liability under control—it's absolutely essential to the life of your business. I’ve seen more than one company go under because the owners couldn't pay their taxes, and while those businesses nearly always had other problems, too, a massive, unexpected tax bill can throw any entrepreneur for a loop … unless you’ve planned ahead.
The problem is, most entrepreneurs draw funds from their general business bank account when it comes time to pay their taxes. But bank balance accounting isn’t a realistic way to properly plan for tax liabilities. Instead, you must find a way to separate the money you’re going to owe Uncle Sam from the money you use for other business expenses.
I call my tax liability plan the "Thanksgiving dinner" approach. Work with me here: On Turkey Day, you and your family don’t eat off the serving tray that holds the entire turkey, nor do you all shovel in mouthfuls of your mother’s sweet potatoes straight from the casserole dish. Instead, you take the turkey, sweet potatoes and other foods from their serving dishes and allocate them to each person's individual plate. When it comes to taxes, think of your revenue as the turkey, then allocate that revenue to different accounts that serve different functions.
This four-step process will walk you through the details of my plan:
1. Create a separate account for your taxes. Every time (and I mean every time) you make a deposit into your regular business account, deposit 15 percent of the total into your tax account. While most of us probably pay a higher tax rate than 15 percent, after you deduct your expenses, 15 percent of your gross revenue should cover your tax liability. If you want a more accurate figure, a brief conversation with your accountant can give you an idea of the percentage of your income that you should set aside for taxes. This step is critical—it’s impossible to overestimate the importance of physically setting aside your tax money.
2. Call your tax account “The Government’s Money.” This concrete reminder that one of your roles as an entrepreneur is being an agent for the government will help you keep your hands off the money you’re going to owe in taxes. If it’s labeled as "not yours," you’ll be much less likely to borrow from your tax account. The whole point of setting the money aside ahead of time is that it keeps you from spending it and having to scramble to cover the tax bill when it comes due.
3. Think of that income tax you owe as a little like a sales tax. OK, we all know that sales and income taxes are different, but it can help with your perspective if you think of the 15 percent of your revenue that you’re setting aside as a tax on all the sales you make. Separating your “sales tax” out from the very beginning means you won’t fall short when it’s time to pay the government piper, and it forces you to look at your business’s financial picture more realistically.
4. We all have to pay for our sins. Don’t jump the gun here: You’ll never catch me saying that earning money is a sin. Far from it! What I mean is that for businesses currently using their revenue to pay off debts, it may feel like a double whammy to set aside 15 percent of the money you’re using to cover expenses. It can feel like the money that’s coming in really isn’t income if it’s all going back out, but it is and you'll owe taxes on that income.
If you try to find a way around setting aside the full 15 percent, trust me, you’ll get caught short, and the IRS will get their share, one way or another. If you consider nothing else sacred, you must respect the power of the government to get what they’re owed.
This Thanksgiving dinner approach to handling your taxes so you’re not hit with an unexpected bill you can’t afford to pay fits into a larger accounting philosophy that I call Profit First. It’s a simple, yet fundamental, shift in the way we think about the financial health and priorities of our businesses, and it guides us to build wealth consistently and responsibly.
Making sure you can afford to pay your taxes is essential to the success of your business and frees you up to focus on the more important task of growing your company.
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