TAXES & ACCOUNTING • January 30, 2015
2 minutes Read
Small businesses paid the IRS $4.5 billion in penalties and interest for late employment tax payments in 2013, reported Bloomberg Businessweek. That’s $4.5 billion above and beyond what was owed, all because those payments were made late.
“When you don’t pay taxes on time, the IRS charges penalties and interest,” says Mike Michalowicz, author of Profit First: A simple system to transform any business from a cash-eating monster to a money-making machine. Depending on how late those payments are, the penalties range from 2 to 15 percent of the original amount due, according to the IRS. Those are substantial extra payments businesses shouldn’t need to make.
Why do small business owners wait so long to pay? Some of it may be due to simple psychology and feelings of loss aversion, says Michalowicz. “We see paying the government as painful. We feel a loss,” and since humans are hardwired to avoid loss, we will take action to preserve what we have. That includes not paying taxes when they are owed. “We need to realize that we are agents for the government,” he says, and that a portion of all the money a business earns belongs to the government. Taxes are simply funds that you are legally required to collect on the government’s behalf, he says.
So how can you ensure that you always have money in your account to pay your taxes? It’s as simple as the old envelope budgeting technique your grandmother used years ago, explains Michalowicz.
Most businesses make their tax payments out of one general bank account. They deposit all their payments from customers into it and write all their checks for expenses out of it. Simple enough, but this approach becomes problematic when there isn’t enough in there to cover the withholding or sales tax payment that is owed.
But if you do what your grandmother did and separate your business income as it comes in, you’ll always be prepared to pay what is owed. Grandma put money into envelopes for groceries, transportation, the mortgage and the like. Similarly, the Profit First method involves proactively allocating a portion of each payment received from clients when it arrives—for taxes, salaries, rent, accounts payable and retirement (Michalowivz himself maintains seven or eight accounts). Whatever you do, don’t use the money for purposes other than the one for which it was intended.
How much should you allocate for taxes? Michalowicz recommends small businesses set aside 15 percent of every payment collected to a tax reserve account to start, “just to get into the habit.” You may discover that you need to set aside a larger percentage, especially if you are behind in making payments.
Of course, paying taxes of any amount can feel painful, so Michalowicz recommends asking your accountant for advice on reducing your tax liability. Make an appointment every quarter to review where your money is going and what you may be able to do to reduce the percentage of revenue you have to set aside for tax purposes. Bottom line: With a little forethought, and some discipline, staying in the IRS’ good graces doesn’t have to be such a hardship.
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