Unexpected Tax Bill? Survival Tips and Advice for This Year

This episode of Ask Connie is a question that comes up often when I talk to business owners, especially this time of year – tax season:

I was shocked about my tax liability and am struggling on how to pay for that and not have that same situation happen next year. Perhaps I need to relook at my tax entity. Perhaps the tax professional made a mistake. Perhaps I should move. What do I do next?

I have even had this question come up for myself in prior years, so I felt it was important to explore the question a little more and give you concrete solutions on how to change the situation.

Paying prior liability

Okay, so you just got a tax bill you weren’t expecting. That happens. Before you shut down entirely and decide not to file my suggestion is quite the opposite.

  1. File your return, even if you feel there is an error. This will show the IRS that you have the intention of filing on time. You can always go back and have the returns reviewed and amended. This will also save you a penalty for late filing.
  2. Pay something with your return and then make a similar payment every month until you hear from the IRS. This again, shows the IRS that you have the intention to pay your liability. Even if it’s $25 or $250 or more, just pay something.
  3. Become okay with having a payment plan. There is nothing wrong with this, it is something you’ll prioritize and add to your budget. Now, if there is something you really don’t need in your life right now there is an option of selling it and using it to pay the liability. There is also an option for a part-time job to pay for this specific bill – that is why Uber is such an interesting option for folks.

Tax entity changes

Being self-employed filing a Schedule C on your personal return (for sole proprietors and single-member LLCs) you do get a big blast of tax owed on your income. When I was a home-based sole proprietor with very little business deductions I had that same problem. Changing your tax entity can change some of that and it can also create more problems. This is where a creative conversation with your tax professional or business attorney kicks in. The best time of the year is not during tax season, so scheduling it now is perfect!

Here is some basic info to digest before your meeting. Please note, I am not a tax professional the items shown below are based on my own personal journey and the experience I have working in the industry since 1994. Please review these items further with your tax professional or business attorney.

1. Schedule C – you are paying both sides of self-employment tax (social security/medicare) on your taxable profit. Best options here are to find other tax deductions that still add benefit to you the owner like health insurance and pension options. Most tax professionals will tell you to increase your expenses, which might be something to look at. Having a conversation with your tax professional about what deductions are best for you and diving into what you have been claiming is great, especially if you aren’t working with a bookkeeper that already does that or are new to the business ownership game. Get educated first before adding expenses that might not even qualify as tax deduction worthy.

2. S Corporations – you will be required to put yourself on payroll so the business will take an expense of 50% of the self-employment tax and you will now have a W2.

What you will also have:

  • Another tax return to file (due 3/15)
  • Add payroll services to your expenses with employer taxes
  • Add a corporate tax/license for your state
  • Ability to do other pension-related and other owner benefits not available at Schedule C-level
  • An added layer of liability protection between the business and your personal items, as long as you don’t personally guarantee anything. Make sure to have contracts reviewed with your attorney if there are questions.

3. LLC – a single member LLC for tax purposes is treated like a sole-proprietor and you get an extra level of liability protection if you take the extra steps. Sorry – just claiming yourself as an LLC with the IRS or your state is not enough! You need to set-up the LLC with intention and do some paperwork. You can take the LLC a step further and choose to be treated like an S-Corp which requires a special form to be filed with the IRS. If you didn’t file one, check with your tax professional and then you’ll follow #2 above.

It will be well worth the small investment you will make to have a conversation with your tax professional or attorney rather than spending a lot of time researching it yourself. Get to know the basics so you can ask awesome questions at your meeting. Here is an article to check out for education purposes.

Reviewing finance team

You have this sinking feeling the info is just not correct – either your bookkeeping didn’t capture everything or the tax return is wrong. Now what? Just like when you get a bad diagnosis from your doctor, perhaps it’s time for a second opinion. Now that tax season is complete, you can connect with other tax professionals to give your returns a second review and even ask them some of the questions above. There may be a fee to have this done, so ask that up front.

As far as your bookkeeping is concerned, take off the blinders and sit down to review the black and white of your numbers. Doing this at the end of the year can feel a little overwhelming so here are a few hints to look for:

  1. Consistency in coding – when I look at the accounting for a business I want all like expenses to be together and I want the category to make sense. If these things aren’t happening, ASK for it to be corrected.
  2. Recurring monthly bill means 12 months of expenses – make sure if you pay rent, that there is rent showing up 12 times in last year’s info. If not, why? Sometimes businesses will get in the habit of paying early, and that may have happened. Or cash flow as too tight so it was paid late. Either way, I look to make sure there is a monthly (or quarterly) fee showing for each “normal operating” expense.
  3. Personal accounts – Even the best businesses occasionally pay with their personal funds. Remember to check personal credit card statements and bank activity. Also, consider cash used. I normally buy items for my office when I am grocery shopping for my family – remember to pick up these expense items.
  4. Only YOU the business owner really knows what the expenses are for. Now that you’ve looked under the bed for the missing gremlins, look at the activity as a whole. As the business owner, you know that you traveled three times this year or had your license renew or did practice development/education. Do those expenses show up? If not – why and see the items above.

 What about this year?

You’ve looked and resolved items from last year and here you are in April of the current year. Time to create a plan on what to do this year so you are prepared for next April.

Step 1: Set-up a new savings account (or allocate an existing account) to be your new tax reserve account. This is the only purpose of this account. No stealing or borrowing. If you aren’t using the funds to pay taxes, then you won’t use them.

Step 2: Allocate funds to your tax reserve using one of these methods.

  1. If you think business will relatively be the same and you know your tax liability for last year divide it by 9 months (or 12 if you want to push it into next year) and that is how much you need to have in reserves. Treat this like an actual bill and transfer that amount to your account.
  2. Not sure where your business will be at, the Profit First system recommends 15% of your real revenue. That is a BIG step to take if you have been doing 0% so use baby steps. Start with 3% or even 5% and adjust each month. This allocation is going to come off the TOP before you pay your other expenses. To be successful this gets priority right after you pay yourself.
  3. Pay estimated taxes – your tax professional can help you create these and normally they are paid quarterly. I find this is too long and too big of an amount for some businesses. IRS doesn’t care how often you pay them, just that you do. Break it down to monthly and ask your tax professional for more coupons or set-up the payments via EFT.

Step 3: Get a tax projection – The only real solution for not having an unexpected tax bill is to have regular conversations with your tax professional. If you don’t have a tax professional that you can have these kinds of conversations with, then it’s time to make that change. Here is a post on that subject.

  1. Schedule a current year planning session and review some of the items above
  2. Schedule a tax planning in Sept/Oct/Nov so you have enough time to adjust your tax liability savings
  3. Connect with them when anything MAJOR changes.

As with most questions I get, check your mindset around this issue. If you think it will be hard, it will be. If you think it will be easy, then you look for ways to make it so. The same goes for that mindset that may indicate you don’t have the skill set or aren’t a numbers person. To measure the success of your business, you need to look at the numbers. So if you want to have a successful business that supports you, then you need to check that mindset at the door.

As always, my suggestions were tested out on myself first and fine tuned before I ever use them to guide others. Do any of these bring up resistance or ah-ha’s? Share them with me or schedule a consultation to discuss these items, or anything accounting, further. You can get that process started by visiting our consultation page, here.


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