Taxes are scary.
And get confusing, fast.
No wonder its an area entrepreneurs tend to avoid.
But today, we’re going to shed some light on the (not so) mysterious tax calculation so you can finally get ahead of your largest surprise expense.
I hope I didn’t lose you already.
We’ll keep it very high level.
Want to skip all the mumbo jumbo? Here’s a simple template for estimating your taxes:
Before we dive in, here are some tips to streamline your tax estimate:
- Look at your prior year return and use this to guide current year (Form 1040 box 24).
- Don’t worry about being exact - it’s an estimate.
- Don’t forget to include self employment tax!
Step 1: Calculate your total income
This is simply estimating how much money you’ll earn this year.
Don’t forget common income sources:
- Business net income
- Your partner’s income
- Investment income
Step 2: Calculate your total deductions
Enter tax jargon.
For simplicity, we’re assuming you are a married taxpayer filing your taxes with your partner.
Most entrepreneurs use a standard deduction and can claim the home office deduction.
Instead of going too deep here, simply look at your prior year return and use that as a starting place.
After getting your income and deductions, subtract the two to get your taxable income.
Step 3: Calculate your total credits
The most common credits are dependent deductions here, but again, simply follow your prior year return for simplicity.
Subtract your credits from taxable income and this will give you your estimates tax due.
Step 4: Don’t forget self employment tax
Self employment tax is usually 15.3% of your net income from your business.
But you get a deduction for 1/2 of it, so the amount you pay tax on is 7.65%.
So include 7.65% times your business income as part of your taxable income.
Step 5: Calculate your estimated taxes
Combining all of this together (in the template) will provide you an estimated amount of tax that you owe for the year.
Compare it to prior year (Form 1040 box 24) - is it close? Any other nuances that you need to add or remove?
Then check how much tax you have paid year to date.
The goal is to pay estimated taxes throughout the year to reduce the burden and eliminate the surprise.
To learn more IRS guidance around estimated taxes, you can click here.
Taxes scare a ton of entrepreneurs so kudos for making it through this.
And if you have specific questions, respond to this email!
Action Items:
- Begin your tax estimate using the Estimated Taxes Template
- Check your results to your prior year tax return (Form 1040 box 24)
- Make estimated payments to avoid penalties and lessen the financial burden.
