We’ve previously covered back taxes and how to resolve them, but how do you prevent tax debt?
What is Tax Debt?
Back taxes are when you owe the IRS, and you either don’t pay your taxes or you pay the wrong amount. If you continue to miss payments, you have tax debt.
Tax debt is calculated by subtracting the payment made towards taxes from the total amount owed in taxes.
Now that you know what tax debt is, let’s dive into how to prevent it.
Pay Estimated Taxes Correctly
One of the most common ways businesses rack up tax debt is that they don’t follow the IRS guidelines on how to pay their taxes – namely, paying estimated taxes. Then, when their tax bill comes, they simply cannot pay it.
To resolve this, it’s important to follow the IRS guidelines from the very start – or at least as soon as possible.
Estimated tax amounts include:
- the individual’s federal income taxes of 10% to 37%
- state/municipal taxes up to 13.3%
- self-employment taxes of 15.3% for self-employed individuals
Small business owners are not informed by the IRS and state tax authorities about their failure to pay estimated taxes until after they have filed their year-end tax returns. Unfortunately, by that time, it is too late for them to avoid the estimated tax trap and they find themselves burdened with a substantial tax bill accompanied by penalties and interest that they are unable to manage financially.
So how do you prevent tax debt by paying estimated taxes correctly?
Maintain Accurate Financial Records
Before you can pay estimated taxes correctly, you first need to know how much you’ll pay in estimated taxes. Keep meticulous and up-to-date financial records, including income, expenses, and deductions. Using accounting software can help streamline this process. Working with an accountant and/or tax professional can help ensure you’re calculating deductions accurately and that you’re not missing any other details.
Set Aside Funds for Taxes
You already know to keep your personal and business finances separate. For tax purposes, you need to take this a step further.
Create a separate savings account to set aside money for tax obligations. Regularly deposit a portion of your revenue or profits into this account to ensure you have the funds to cover your tax bills when they come due.
Learn Your Tax Obligations
Familiarize yourself with your business’s specific tax obligations at the federal, state, and local levels. Be aware of filing deadlines and any changes in tax laws that could affect your business.
File and Pay Taxes on Time – Even Estimated Taxes
File your tax returns and pay any taxes owed by the specified due dates to avoid penalties and interest charges.
Can I File an Extension?
There is a common misconception that business owners can file an extension and pay their taxes later. False! The IRS only offers an extension of time to file your tax return. You still must pay any owed taxes by the deadline to avoid penalties and tax debt.
Can I Do a Payment Plan?
The IRS does offer payment plans in some situations. See if you qualify.
Just remember that starting a payment plan will give you cash flow challenges later on, especially if you’re not used to allocating money for taxes, so it’s best to pay estimated taxes on time starting right away. Plus, if you start a payment plan now, you will still need to pay upcoming quarterly taxes, so you will be saving/paying twice as much for taxes if you take this route.
There are No Shortcuts in Taxes
To recap, paying your estimated taxes on time is the best way to prevent tax debt.
While no one enjoys paying their taxes, the estimated taxes system is in place so that businesses avoid owing the IRS a large tax bill at year-end. So add your estimated taxes to your monthly business budget. Then sign up for a free eFile360 account to easily e-file 1099, 1098, ACA, and W-2 forms.