Paying Taxes: Using Your Tax Account

Following the Profit First system one of your essential bank accounts should be dedicated to individual income taxes. John Briggs goes over how to use this tax account when paying your taxes and what to do if you are left with extra money or not enough at the end of tax season. 

John Briggs | Tax Genius
info@incitetax.com
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Chapters

• 0:00 What Do I Do With My Tax Account?
• 1:11 Transfer Full Balance to Personal Account
• 1:45 Hold Funds and Pay Taxes When Due
• 2:18 Example: Paying Tax with Leftover Funds
• 3:06 What If You Don’t Have Enough in Your Tax Account?
• 4:44 Adjusting Percentages to Fix the Issue Going Forward

Transcript

What do I do with my tax account, whether I have money left over or didn’t have enough?

Let’s start with having money left over. As a reminder, in the Profit First system, we recommend having the essential seven bank accounts. The top one is an income account, and the purpose of that account is to receive income. One of the other seven is the tax account, and its purpose is to save for your income taxes. The tax account is purely for your income tax burden—other taxes you have as a business are related to operating expenses.

With that being said, throughout the year you’re taking a percentage from the income account and putting it into the tax account. December 31st comes—the year is over—and there should be a balance in your tax account. Unless you’re not running at a profit, you should have saved some money. Most of us will have at least some balance there.

You probably won’t know what you owe in taxes until March or April, if you’re like most people, because that’s when your taxes get done and the income tax burden is calculated. Now you know the exact number you need.

There are a couple ways to handle this, and it really comes down to your preference.

Option one: You can just take the balance on December 31st—whatever that balance is—and transfer it to your personal account, because that tax money was set aside for the purpose of paying income taxes. You’ll be paying your income taxes out of your personal account (unless you’re a C corporation). So that’s the first suggestion.

To summarize, you could take the December 31st balance in your tax account, put it into your personal account, and however the chips fall—hopefully you have some money left over—it would stay in your personal account. You wouldn’t transfer it back.

Option two: You hold the money in the tax account until you find out what your tax bill is—hopefully no later than April 15th, because that’s when taxes are due. (Even if you file an extension, taxes are still due April 15th.) Once you know the tax owed, you can then transfer that amount from your business’s tax account to your personal account and pay the bill. Then, if there’s any money left over from the December 31st balance, you would take that as a distribution.

I emphasize the December 31st balance because you’ll still be putting money into the tax account for the current year.

Example: Let’s say I wait until the last moment and pay my tax bill on April 15th. I finally know I owe $6,000, and I had $10,000 in my tax account as of December 31st. Over January, February, March, and maybe one allocation in April, the balance in my tax account is now $20,000.

I'm not going to pay the $6,000 and then take the remaining $14,000 as a distribution—because part of that $20,000 is meant for the current tax year. That’s why we only look at the December 31st balance. So in this case, I’d take $6,000 out to pay the tax bill, then take the other $4,000 (from the $10,000 balance) as a distribution.

Now, let’s say you don’t have money left over—meaning you’re short and need to figure out how to cover your tax bill.

If I owe $6,000 in taxes but there’s only $3,000 in my tax account, I’ll obviously use that $3,000 toward the bill. But what do I do about the remaining $3,000?

There are a couple ways to handle this. First, we need to solve the immediate short-term problem: the taxes are due on April 15th, and we don’t want to be on the IRS’s radar more than we have to be.

In this case, I’d take any balance in my tax account, including money that may have been set aside for the current tax year. So if it’s April and I had $3,000 in the account as of December 31st, but I owe $6,000—and through allocations in January, February, and March the balance has grown to $6,000—I’m still going to take that full amount to pay my tax bill.

If you still don’t have enough, the next place I’d pull from is the profit account. We leave half the balance there on purpose. This would be a valid reason—once, not habitually—to dip into the profit account to cover the shortfall.

If that still isn’t enough, then I’d look at owner's pay or even my personal funds. You could technically use your operating expenses too—wherever there's cash available. The goal is just to solve the immediate issue of paying taxes.

After solving the short-term problem, the next step is to increase your tax allocation percentage moving forward. If I took money out of the tax account that was supposed to be for the current year, that means I now need to oversave for the rest of the year. Not to mention I need to catch up on the months I missed.

This isn’t a situation where I’m “loaning myself money and now I need to do something crazy.” No—I'm just going to change the percentage. That’s it. No fancy tricks required.

Most likely, I’ll decrease my profit percentage. Then I’ll look at cutting back on operating expenses. Then, as a last resort, I’ll look at team member expenses. Just normal, healthy business analysis to free up some cash flow. The very last place I want to cut from is my owner’s pay—but if it’s needed, it’s needed.

And of course, I’m going to meet with tax geniuses like Incite Tax to figure out how to reduce my tax bill in future years. We’ll do some forecasting and try to estimate what the tax burden will be by year-end so we can get ahead of it.

The IRS sucks with a cold steel grip.