ABMP Financial Literacy Series
In the May/June column of the Mind Your Money 2020 series, we covered how to manage your cash flow.
You probably have a vague understanding of how tax stuff works: You make money, pay your business bills, pay taxes on the remainder, and take home what’s left. The bits and pieces of the tax process can feel tedious, which is exactly why we spent the first two columns in this series talking about bookkeeping. (You can catch up at www.abmp.com/money.) Saving receipts, learning money software, and just staying all-around organized is an obstacle for many of us.
Familiarize Yourself with the Process
Getting familiar with the process of running a business and learning a few details about small business taxes can lower your tax preparation costs and your annual tax bill. This knowledge will also increase your confidence and decision making abilities in your business. It’s a win-win.
Let’s clarify and review to get a better grasp of how this all works. When you own a small business, you pay several kinds of taxes. You’re likely familiar with federal income tax, self-employment tax, and state income tax. Some of us may also pay income tax to our town or city.
Most sole proprietorships (the default business type) and LLCs pay taxes based on a Schedule C filed along with your personal tax forms. Some LLCs and corporations may file as an S-Corp, which is a little more complicated and usually requires a payroll system and bookkeeper. In this column, we’ll focus on the process for Schedule C filers.
Gross income minus allowable deductions equals your net profit.
All your self-employed income, known as your gross income, goes on that Schedule C. You then list all your expenses, and the form helps calculate your net profit. You pay taxes based on that net profit.
Even if you have a wonderful bookkeeper and a reliable tax preparer or accountant, it helps to have a solid grasp of how allowable deductions work. This way you can make better financial decisions in your business. And if you do all the bookkeeping, it’s even more important to understand the details.
What is an allowable deduction, and what is not? There are a bunch of hard and fast rules, but there is also a great deal of gray area.
There are many obvious and clear allowable deductions for a massage business. Equipment and furniture for your office, rent, massage oil and linens, and general supplies (like paper clips and pens) are allowable deductions. Utilities, continuing education fees, and the fee you pay your tax preparer are all clear allowable deductions.
There is plenty of gray area too. The IRS states that an expense must be both “ordinary” and “necessary” to be considered an allowable deduction. Is it ordinary and necessary to stock up on nail files at a massage office? Most tax preparers would say that is an allowable deduction, considered an office supply. But is a weekly manicure an allowable deduction? Ask three tax preparers that question and you’ll get a firm “Yes!” a confident “Never!” and a “Maybe, depending on the situation.” (Check out our companion video above for a closer look at the gray area of allowable deductions.)
Who makes the final decision? Well, ultimately, you and your tax preparer decide what to include on your Schedule C. If you are ever audited, the IRS auditor will decide whether they were truly allowable deductions. Should that auditor disagree, you could end up paying taxes and penalties.
Often, the first tax preparation of your business comes with surprising chaos. There’s the confusion of having to organize a year’s worth of transactions into categories coupled with the shock of owing the IRS money instead of getting a refund.
To prevent the “I owe HOW MUCH?!?” shock each year (and also to avoid penalties), you should pay estimated tax payments to both your state and the IRS. Four times each year, you will pay a portion of what you expect to owe for that year’s taxes. Estimated tax payments are due on April 15, June 15, September 15, and January 15. (Please note: Some of these due dates have been temporarily changed in 2020 due to the COVID-19 crisis.)
In earlier columns, we encouraged you to have a separate savings account to hold your tax money and to set aside a certain amount (or percentage) to cover your estimated taxes and final tax bill each year. It can be hard to save that money for a bill that feels so far away. But that feeling of relief when you have cash in the bank to pay the bill? Priceless.
What Happens if You Can’t Pay?
If you underpay your estimated tax payments (or you don’t pay them at all), you could find yourself owing a big bunch of money on April 15. It happens, especially to new business owners—but it even happens to experienced ones.
If you can’t gather the money by the due date, you still have options. The IRS has a process to pay within 120 days (with some low interest and penalties), as well as a longer-term installment agreement that allows for monthly payments over several months to years. You can make these arrangements right at the IRS.gov website, and if you need help, call them! They’re very friendly and helpful.
Not everyone will love the nitty-gritty of bookkeeping and tax preparation. Good news: there’s help for that! You can hire a bookkeeper to handle the regular chores of tracking income and expenses. Tax preparers and accountants are available to handle your annual tax returns and calculate your estimated tax payments.
There are also plenty of resources to help you get tax savvy so you can make better decisions. Our personal favorite is Can I Deduct That? 100 Things You Can (and Maybe Can’t) Take as Business Deductions by Margo Bowman and Kelly Bowers. The IRS also has all kinds of guides and resources created especially for very small businesses at www.irs.gov/businesses/small-businesses-self-employed. Understanding taxes will make you a more powerful and conscientious business owner and will ultimately keep more money in your pocket!
Allissa Haines and Michael Reynolds can be found at www.massagebusinessblueprint.com, a member-based community designed to help you attract more clients, make more money, and improve your quality of life.