The 5 Ways to Avoid Being Surprised by Taxes
True confession: Seven years ago, I was on the verge of bankruptcy. I managed to get my creditors paid off (very, very slowly), but I was still looking at a huge tax liability. It was so bad, I had to go on an installment plan with the IRS to pay off the $40,000 or so I still owed in taxes. The interest rate the government charged me was surprisingly reasonable—something around 7 percent. But when it added penalties, the rates moved up to somewhere around mafia loan shark territory. It cost me a fortune to pay off that year’s tax liability, and I swore I would never, ever be in that mess again.
We may all want to pay as little as possible in taxes, but realistically, we can only reduce our obligation so far. What can be even more important than maximizing deductions is ensuring we have the funds to pay that bill when it inevitably comes due.
Before we even get started, we should understand the money we pay in taxes each year isn’t really our money. We’re actually acting as agents for the government, and we’re simply collecting the taxes and forwarding the government its funds. It helps me to remember that if I bring in $1,000, only a percentage of that money is truly mine.
Here are some specific things you can do to get ready to pay Uncle Sam his due:
1. Set Up a Reserve Account
This new account (ideally at a separate bank than you’re currently using) should be solely for the purpose of collecting the money you’ll owe in taxes. Here’s how it works: I talked to my accountant, and we determined the percentage of my gross revenue I needed to reserve for my tax liability. In my case, it’s 15 percent, but your percentage may be different. For every single payment my business takes in, I divert 15 percent to my reserve account. When it’s tax time, I never have to scramble to pay the bill. Why can’t you just use the same account or the same bank? You want your tax money to be out of sight. If you see those funds in your bank balance, you may spend it, or at least you’ll be tempted to “borrow” it. The idea is to put the money someplace safe, so you have it when you need it.
2. Set Up a Quarterly Meeting With Your Accountant
Once per quarter, I sit down with my accountant, and we review several items. First, he checks to make sure I’m setting aside the right percentage of funds in my reserve account. He also takes a look at the changes in my business since our last meeting. He looks at trends, and we discuss my company’s trajectory. It’s a checkup for my business. Finally, he lets me know of any changes in tax laws that might affect the way I’m currently operating. This meeting doesn’t take a lot of time, but it makes sure I’m doing the right things and heading in the right direction. It gives me time to make course corrections before I stray too far.
3. Monitor Tax Laws
My accountant is my best, most consistent source of information about important changes to the tax code. But you can’t get lazy and expect a third party to do everything for you. If you’re an active partner in making sure you’re up to date on the tax laws that affect you, you can be better positioned to take advantage of opportunities to reduce your liability and ensure you’re not caught short when it’s time to write the government a check.
4. Manage Life Events
Marriage, divorce and the birth of a child: All these events can have enormous impact on your tax obligation. Make sure you reevaluate your liability and the percentage of revenue you direct to your reserve account anytime you go through one of these major life events.
5. Maximize Tax Deductions
While you certainly want to pay all the taxes you owe, there’s no sense in paying more than you’re legally obligated to. Consult with your accountant to make sure you’re positioned to take advantage of the tax breaks you’re entitled to.
While none of us particularly enjoys paying taxes, it’s far less painful when you have the funds to cover your obligation. Careful planning and regular checkups can help ensure you’re never scrambling to pay Uncle Sam again.
Read more articles on small-business taxes.
The information contained in this article is for generalized informational and educational purposes only and is not designed to substitute for, or replace, a professional opinion about any particular business or situation or judgment about the risks or appropriateness of any tax strategy or approach for any specific business or situation. THIS ARTICLE IS NOT A SUBSTITUTE FOR PROFESSIONAL TAX ADVICE. The views and opinions expressed in authored articles on OPEN Forum represent the opinion of their author and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions (including, without limitation, American Express OPEN). American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any opinion, advice or statement made in this article.
Mike Michalowicz is the author of Profit First, The Pumpkin Plan and The Toilet Paper Entrepreneur and is a nationally recognized speaker on entrepreneurial topics. He is founder of Profit First Professionals, an organization of accountants, bookkeepers and business coaches who guide their clients to optimal profitability. His small-business blog shares strategies and techniques for entrepreneurs.
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