Wouldn’t you, as a Sole Proprietor, like to save money on your tax bill? You can only save money on your taxes if you know what the net income [income minus expenses] or profit from your business looks like before December 31st. If you wait until April 15th, it is too late!
1) Why do I need to know my net income before tax preparation?
First, you need to know your tax bill before December 31st rather then after when it is too late to do any tax planning. Before December 31st we can do some tax planning and come up with strategies to reduce the amount of taxes you will owe. Tax preparation will become much less painful.
Second, you need time before December 31st to implement tax strategies such as; buy that piece of equipment you need, put money into a retirement plan, pay extra bills, and delay receipt of income.
Also, not only do you pay federal and state (if applicable) taxes on the net income from your business but you also pay what is called self-employment tax on the net income. Self-employment tax is social security tax and medicare tax and for self-employed people that is 15.3% of your net income. For example, if your net income is $50,000, then the self-employment tax will be $7,650 [50,000 x 15.3%]. Many business owners are surprised by this tax. They don’t plan and put away enough money for the self-employment tax.
And finally, according to the IRS rules quarterly tax payments must be made when you know you will owe on your tax return and this will allow you to avoid the ‘Failure to File Timely’ penalties. Also, a plus for you is, you won’t have a big tax bill on tax filing day, April 15th.
2) What is my net income and how do I calculate it?
Bookkeeping is a very important part of tax preparation and tax filing. Here are a few tips to help you calculate your net income.
- Have a separate bank account for your business and use it only for business – no personal expenses.
- Get your income and expenses into an accounting system – We recommend QuickBooks Online. You can download your bank account and credit card account transactions right into it and there is an App for when you are on the road. There are many advantages to QuickBooks Online such as, on the spot invoicing, the ability to take credit card payments, uploading a photo of your receipts and much more. We, here at Bakken CPA, are Certified QuickBooks ProAdvisors. Ask us about our QuickBooks Online Set-up package.
- Gather any cash receipts that you didn’t pay through your bank account and enter them into your accounting system.
- Subtract your expenses from your income – remember that you can only deduct 50% of your meals and entertainment. Health insurance does not get subtracted here (it is elsewhere on the 1040). Retirement plan savings is not deducted here either. Other expenses not deductible – personal use auto, clothing that you can wear on the street, or dry cleaning.
So remember; don’t wait until April 15th for the IRS to give you a tax bill. Be pro-active and get some expert tax planning before December 31st. September or October is best. Are you a procrastinator when it comes time to do your books? Then, consider talking to your CPA about bookkeeping. If your CPA doesn’t offer you bookkeeping and tax planning services then you can always give Bakken CPA a call!