Not All Surprises Are Good: Know What to Expect on Your Tax Bill

It’s virtually unavoidable. When your business makes a profit, you pay income tax.

Some of your business earnings automatically belong to the government, which means you get to hold on to that money only for a limited period before handing it over to the tax collection authority. But you don’t have to be surprised by this bill. Plan ahead and use careful accounting to avoid unexpected tax bills.

Examine your business balance sheet regularly. This statement should have a liability account for accrued taxes. Consequently, the true amount of funds available for spending in your bank balance is the total minus the tax liability you must eventually pay.

Since most small businesses operate with cash-basis accounting, accrued liabilities on the balance sheet are not technically correct. Cash-basis expenses are counted only when they’re paid, not when they accrue. To keep your books in order, move the reserves for income tax into an entirely separate bank account. In your bookkeeping, you will transfer funds from one asset bank account to another.

This provides the advantage of having government cash out of the business operating account. Instead of an accrued liability for taxes appearing on the balance sheet, the funds available for business functions are simply the bank operating account on the balance sheet. Tax payments are remitted from the tax account.

The optimal amount of money to save for taxes is a subject to discuss with your tax accountant at the end of every year so you can appropriately plan the next year’s reserves.