Death and taxes … the two things that are certain in life … and it’s as much fun to talk about one as it is the other. Getting your tax liability under control requires planning and discipline, and it’s impossible to overestimate the importance of handling it properly. I’ve seen more than one business go under because they can’t pay their taxes, and while there are nearly always other problems in those businesses as well, a massive, unexpected tax bill can throw any entrepreneur for a loop … unless you’ve planned ahead. The problem is that bank balance accounting – if your tax money is included in your bank account – isn’t realistic. You must find a way to separate out the money that you’re going to owe Uncle Sam. Here’s my solution:
I call my plan the Thanksgiving dinner approach. Work with me here: on Turkey Day, we don’t eat off the tray that holds the entire turkey. We don’t shovel in mouthfuls straight from the casserole dish of your mother’s sweet potato recipe. We allocate turkey from the serving platter to individual plates. If you think of your revenue as the turkey, you need to allocate that revenue to different accounts that serve different functions.
1. Create a separate account for your taxes.
Every time (and I mean every time) you make a deposit into your regular business account, deposit 15% of the total into your tax account. Now most of us pay a higher tax rate than 15%, but after you deduct your expenses, 15% of your gross revenue should cover your liability. If you want a more accurate figure, a short conversation with your accountant can give you an idea of the percentage of your income that you should set aside for taxes. It’s impossible to overestimate the importance of physically setting aside your tax money.
2. Call the account “The Government’s Money.”
This concrete reminder that one of your roles as an entrepreneur is being an agent for the government helps you keep your hands off the money that you’re going to owe in taxes. You’ll be much less likely to “borrow” from your tax account if it’s labeled as not yours. The whole point of setting the money aside ahead of time is that it keeps you from spending it and having to scramble to cover the tax bill.
3. Realize that income tax is a little like sales tax.
Okay, we all know that sales and income taxes are different, but it can help with your perspective if you think of the 15% of your revenue that you’re setting aside as a tax on all the sales you make. Separating your “sales tax” out from the very beginning means that you won’t fall short when it’s time to pay the government piper, and it forces you to look at your business’ financial picture more realistically.
4. We all have to pay for our sins.
Don’t jump the gun here; you’ll never catch me saying that earning money is a sin. Far from it! What I mean is that for businesses that are currently using their revenue to pay off debts, it may feel like a double whammy to set aside 15% of the money that you’re using to cover expenses. It can feel like the money that’s coming in isn’t really income if it’s all going back out, but it is, and you will owe taxes on that income. If you try to find a way around setting aside the full 15%, you’ll get caught short, and the IRS will get their share, one way or another. If you consider nothing else sacred, you must respect the power of the government to get what they’re owed.
This whole approach to handling your taxes so that you’re not hit with an unexpected bill that you can’t afford to pay fits into a larger accounting philosophy that I call Profit First. It’s a simple, yet fundamental, shift in the way we think about the financial health and priorities of our businesses, and it guides us to build wealth consistently and responsibly. Making sure that you can afford to pay your taxes is essential to the success of your business and frees you up to focus on the important task of growing your company.