How to Understand Your Taxes

By the time you read this blog, the 2021 tax return submission deadline will likely have passed. But that’s okay for two reasons:

First, next year is already on its merry way.

And, second, as the owner of a rapidly-advancing, profitable small business, you can no longer afford to segment tax consideration and preparation only to the months of March and April. At this level of small business ownership, the consequences of lacking a firm understanding of your small business’ tax situation are detrimental to its life and longevity. 

YOUR UNDERSTANDING OF TAXES IMPACTS YOUR SMALL BUSINESS’ LIFE AND LONGEVITY

Because, at this level, your small business’ tax situation not only directly correlates with, but also directly affects, its holistic financial situation. Which is where you, regular reader and cherished friend of the Balanced By Stevie Blog, know the real difference is made between a solid attempt and a healthy, successful small business.

So keep reading.

TAX STRUCTURE RECONSIDERATION AND SMALL BUSINESS PROFITABILITY

Enduring small business profitability introduces the need for tax structure reconsideration. And selection of the proper tax structure cyclically protects and encourages your small business’ enduring profitability. 

That’s what Google has to say on the subject. But what a mouthful of financial jargon. Let’s break that down.

You know that to be profitable, your small business needs to make more money than it spends. Income/revenue minus expenses equals profit. Got it.

SAVE ON TAXES THROUGH CONSISTENT BOOKKEEPING

And you see that here lies major implications toward the importance of consistent bookkeeping. In order to be made aware of your small business’ profitability, you’ve got to accurately track streams of income as well as outgoing funds. 

Your doing so is important because your small business’ level of profitability represents its tax liability. Its profit is its taxable income. 

HOW SOLE PROPRIETORSHIPS AND LIMITED LIABILITY CORPORATIONS (LLCS) ARE TAXED FOR SELF EMPLOYMENT

And if your small business is classified as either a sole proprietorship (which, by the way, is the same thing as a Single Member LLC), its entire profit is categorized similarly to the wages you might have earned while employed by someone else’s business prior to your entrepreneurial leap. 

Except now, of course, you’re the employee and the employer. So your profit/taxable income won’t just be subject to the ~7% FICA tax withholding, but the entire ~15% FICA tax withholding, which is also called the self employment tax. And that’s in addition to your personal tax liability that’s determined by your big-picture financial situation--your household income, etc. Phew. 

And, naturally, as your small business’ profit increases, and especially if it’s doing really well, that corresponding tax liability can really climb. 

But, there’s something you can do about it that’s perfectly legal and totally fine. 

If, at the appropriate time, you prompt your tax expert to help you restructure your small business classification to that of an ‘S-Corporation’, you can save literally thousands in taxes. 

SAVE THOUSANDS IN TAXES BY CLASSIFYING YOUR SMALL BUSINESS AS AN S-CORP

Becoming an S-Corp essentially allows you to pay yourself a salary from your business. That salary then becomes subject to the 15% FICA tax, but the remaining net profit does not (but, keep in mind that the remaining net profit is still subject to your individual income tax).

Making this change will bring instant tax relief. I’m so excited about it, I’m screaming these words.

Not quite seeing it yet?

Picture this: If, say, your small business generated $100k in net profit/taxable income this year, and your personal income tax rate is 27%, as a sole proprietorship or Single Member LLC, you’ll be taxed on that entire $100k at both the 27% individual income tax rate and the 15% self-employment tax rate. Your tax liability will be steep.

If, however, you elect to be taxed as an S-Corp, you’re now an employee of your small business in the eyes of the IRS, and the 15% self employment tax rate will only apply to your salary.

Legally, you’re required to draw a ‘reasonable’ salary in proportion to the net profit generated by your small business. (AKA, don’t be thinking you can officially draw a teeny salary in order to be taxed less, and then make up for it by unofficially fudging distributions to yourself later. That’s a huge no-no, and you’ll regret it when you end up on the IRS’ radar and have to pay a boatload in penalties.)

So, let’s say that from your $100k-net profiting small business, you elect to draw a $60k annual salary. Now, as an S-Corp, instead of paying self employment tax on $100k, you will only be taxed on $60k. Huge!

Those savings could represent for your small business opportunities to hire needed help, make innovative investments, and so much more!

WHEN TO RESTRUCTURE YOUR TAX CLASSIFICATION TO AN S-CORP

But, reaping the benefits of S-Corp classification is, like I mentioned before, about appropriate timing. In order for this type of tax classification restructuring to achieve its desired effect, your small business needs to generate a level of enduring profitability of $50k annually or more. 

You’ll not want to make a largely impactful change if your profit growth has only temporarily spiked with the likelihood of falling as a result of any changes in external factors such as seasons, holidays, etc. You’ll want to be sure that your growth in profit is not only sustainable, but likely to increase. 

Why wait, you ask? Because there are additional costs associated with being taxed as an S-Corp. The tax savings typically don’t outweigh those additional costs until you reach that $50k net profit level.

BOOKKEEPING FOR ENDURING SMALL BUSINESS PROFITABILITY

And, again, consistent and accurate bookkeeping is how you’ll know you’re there. Consistent and accurate bookkeeping enables helpful analysis of the factors that led to your profit growth, as well as educated projections regarding whether that growth will sustain itself--the stuff you’d rather not guesstimate about. 

So, what’s your relationship with your books?

As the owner of a rapidly-advancing, profitable small business, you’re totally busy--I get it. And you may have put off the financial/bookkeeping stuff. I completely understand. But you can’t ignore it anymore. You can’t afford to.

ACCESS THE MONEY IN THE BANK FREE MASTERCLASS 

To help you quickly get your financially-savvy-small-business-owner feet under you, to get you to that place where you feel ready to receive, process, and impactfully act on the valuable insight your books are trying to give you, I’ve put together a FREE Masterclass for the high-achieving entrepreneur. 

The ‘Money In The Bank’ FREE Masterclass will teach you all about when to consider tax classification restructuring; how to implement systems for cash flow forecasting (AKA how to know whether your profit growth is durable); the nitty-gritty of keeping a small business budget; the financial checklist items you should be crossing off on both a monthly and quarterly basis; what to look for in a tax expert who can help you with all of this stuff; and more. 

If what you read today is pinging lightbulbs in your head, the Money In The Bank FREE Masterclass is for you.

This is a regularly released LIVE masterclass that you can catch within THIS facebook group! Join today to stay up to date on new release dates of this class!

And, as always, feel welcome to reach out with any questions.