Here we are, just a week away from April 15th. Tax Day. Hopefully by now, you have 2020 wrapped up or at least ready to file. So, what happens next? Do you close the book and not worry about taxes again until next year, hoping it all just works out? You could, but I don’t recommend it! Instead, put a plan in place that will require a minimum amount of attention throughout the year. Profit First prepares you for taxes without the stress. Now, that’s a great plan! Here’s how it works.
The Profit First Framework
First, the standard Profit First bank account we call the Tax account is for income tax only. It is the account that you will allocate money to twice a month. The amount of your allocation is 15% of your real revenue. Real revenue is not your total sales, it is your cash receipts less any cash spent on inventory or other cost of goods sold type activity. This 15% of your current activity should set you up to have an adequate amount set aside come tax time.
If you are paying quarterly estimated taxes for your business, the funds in this bank account will be used to pay the estimated taxes. There are a few twists to note. First, your sales this year may be significantly different than last year. This can create a couple of scenarios that require upfront planning.
When your sales are much higher than last year, you will be setting aside the funds needed based on this percentage approach and that should be adequate to cover the tax liability for the current year. Your estimated taxes, however, are based on the prior year. In this case, the estimated payments you make may be much less than the funds you are setting aside. Do not assume these funds are “surplus” and therefore can be used for other purposes. They are greater than the estimate from the prior year because your estimated tax liability is expected to be greater because of an increase in sales. It’s a terrible feeling to have had a great year in sales but then you must borrow money to cover the taxes.
Another scenario is when your sales are less during the first and second quarter and you may not be setting aside enough funds to cover your estimated tax payments. The estimated taxes are calculated based on a complete year of sales. The taxes for the entire year are calculated and simply divided by 4 to get an equal quarterly payment for each quarter of the year. If you have a big quarter say in Q4, then you may not be generating enough cash in the “off season” to meet the estimated taxes. You may also have hit a bump in the road and sales are down from the same period last year. In this case, paying estimated taxes on the prior year is causing more demands for your smaller pool of cash. If you find either of these situations occurring, then talk with your tax preparer about a new strategy for making those estimated tax payments. They can help you create a more realistic plan for making estimated tax payments and for setting aside the funds needed based on your current business activity. Don’t scrap the allocation to your tax bank account. Adjust the amount based on your current situation, not on your past tax year.
How to Handle Sales Tax
There are also other taxes to be considered, one of which is sales tax. The Tax bank account that we discuss in Profit First is not created for sales tax. The 15% allocation discussed earlier is for state and federal income tax. It does not include a percentage for sales tax. Each state has its own laws for registration and collection. You may be collecting for many states and will remit them in the future because remittance is only required quarterly or annually. To ensure that you have set those funds aside for remitting later, we recommend creating a separate bank account for sales tax. You are required to collect and remit these funds for the benefit of the state government. Remember these are not your funds. Do not fall into the trap of using these funds for another purpose and then be required to borrow the money to pay the state because you don’t have adequate cash reserves.
What About Other Tax Types?
There are several other types of taxes you may encounter—property tax, franchise tax, etc. These taxes are paid from the Operating Expense bank account in your Profit First structure. They are not included in the 15% that is set aside for the Tax bank account.
Taxes are no one’s favorite subject, but they are much less stressful when you are prepared to make the payments. First quarter is already in the books, so make sure you are preparing now to cover your tax obligations. Profit First gives you an easy way to segregate those tax funds to ensure you are poised for making the payments.
Interested in Profit First?
If your ecommerce business isn’t where you’d like it to be in terms of profitability, check out my book, Profit First for Ecommerce Sellers. It answers important questions about how to implement Profit First in an ecommerce business. Take control of your money and your business, and put Profit First to work for you!
You can also sign up for the Profit First for Ecommerce Sellers Online Course. As a Mastery Level, Certified Profit First Professional, I will teach you why Profit First works so well for ecommerce businesses and the particular challenges for businesses that have physical products requiring inventory management. You will learn how your behavior drives your money management habits for your business and how you can set up your business bank accounts to work with your habits.
Check out all of our ecommerce accounting and profit advising services here!