What Should You Know About Tax Estimates?
Jun 20, 2024In today's episode of "Keep What You Earn," Shannon delves into the complexities of tax estimates for entrepreneurs. This crucial aspect of financial planning often leaves many puzzled, especially with fluctuating incomes and a myriad of write-offs involved.
Tax estimates are prepayments based on the prior year's income, intended to help the IRS avoid waiting for a lump sum at the end of the year. For entrepreneurs, this "pay-as-you-go" system can prove challenging because their income isn't consistently taxed at the source as it is for salaried employees.
A common issue, raised by a question from Shannon's CFO on Demand service, is the inaccuracy of tax estimates. Often, entrepreneurs find themselves either overpaying, leading to cash flow issues, or underpaying and scrambling at tax time. Relying strictly on last year's figures can be problematic due to the ever-changing nature of business. For instance, a significant change in business circumstances, whether it be downsizing or a sudden growth spurt, can make previous estimates irrelevant.
Shannon offers practical advice to navigate this landscape. Firstly, she emphasizes the importance of maintaining accurate, up-to-date bookkeeping to understand your actual profits each quarter. Setting aside roughly 30% of your quarterly profit in a high-yield savings account allows you to maintain liquidity while preparing for tax obligations. Shannon also suggests considering skipping the first and second quarterly payments to gain a clearer picture of your annual financial situation, catching up in the third and fourth quarters if needed.
Additionally, Shannon advocates for the use of pro forma—essentially a "dress rehearsal" tax return. Mid-year, typically in July, run your financials from January to June through a mock tax return to forecast your tax liability. This practice provides ample time to save for your eventual tax bill, making it less of a surprise come the end of the year.
For those concerned about underpayment penalties, Shannon reassures listeners that these are often minor, usually amounting to a few hundred or thousand dollars. While not ideal, for some, the flexibility gained from retaining liquidity throughout the year outweighs the small penalty. It’s a balance of personal financial strategy and comfort.
Shannon also highlights her service, CFO on Demand, for those needing more consistent financial support. This monthly service offers real-time financial guidance to help entrepreneurs stay on top of their tax obligations and overall financial health. Personalized advice, delivered through various formats like voice notes and videos, ensures comprehensive support.
Shannon’s takeaway is clear: proactive, flexible financial planning is crucial in managing tax estimates effectively. Regular bookkeeping, setting aside funds, and leveraging tools like pro forma tax returns empower entrepreneurs to take control of their financial obligations.
By adopting these practical tips and seeking expert guidance when needed, you can maintain your business's financial health and readiness, no matter what comes your way. For more insights and resources, be sure to listen to the full episode and explore the show notes for additional information. Happy earning!
What you'll hear in this episode:
06:39 Unpredictable income warrants caution in financial planning.
10:30 Plan ahead for tax bill, take control.
11:51 CPAs operate traditionally, but modern business owners differ.
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The information contained in this podcast is intended for educational purposes only and is not individual tax advice. Please consult a qualified professional before implementing anything you learn.
