This time of year always brings about the 'T' word - Taxes...
April 15th is typically the last day to file your income taxes and pay taxes owed, this year the Internal Revenue Service pushed that date back to May 17, 2021.
Many new business owners end up with tax problems—sometimes it happens quickly, and other times it takes longer to occur. Having a good understanding of the tax system and how to account for and pay taxes will help you avoid problems. You don't have to be an accountant or know how to fill out your year-end tax forms, but you do need a basic understanding of the system and your responsibilities. I want to show you how to develop some systems and habits to keep you out of trouble with the IRS.
The first thing you must realize when you become an owner-operator is that you now own a business. Many of you will be making a transition from company driver to owner-operator, and the basic daily tasks you perform will not change. The main event, however, has changed drastically. You are no longer an employee of another company. Youarethe company, which is a very exciting change. Most people who work for others hope to have their own business someday—well, your "someday" is now. To make your endeavor succeed you must run it like a professional business. One of the unpleasant parts of doing business is paying taxes.
No matter how unpleasant taxes are, they are an important issue to understand and manage. Many of you have talked to other owner-operators who say, "I never pay any tax." In the same conversation, they'll tell you how great they are doing. Well, guess what? You can't have it both ways year after year. If you earn profit, you owe tax. Either they are not doing as well as they want you to believe, or something fraudulent is taking place.
I don't want you to pay any more taxes than you have to. I want to educate you and prompt you to dig further into issues, rather than just have you believe what you hear. Most companies have entire divisions or departments to handle their taxes. You have yourself and a good tax preparer. So, let's get down to the business of your business!
Self-employment tax is easy to understand. It is your FICA (Social Security and Medicare) tax. Let's use an example to show this better.
As an employee, you earn $100. On your check stub you see $7.65 ($100 × 7.65%) taken out for Social Security and Medicare. The company also takes $7.65. The company sends the total $15.30 to the IRS for you.
As an owner-operator, you earn a profit of $100. Nothing is deducted on your settlement for FICA tax. Instead, you take $15.30 ($100 × 15.3%) and set it aside to send in with your quarterly estimated payment.
Self-employment tax is calculated using the net income from the business, which is determined by taking the gross income (which will be on your 1099 from the carrier or carriers you contract with) and subtracting all the expenses for the business. The idea is to come up with the smallest net income you can without violating any IRS codes.
Gross Revenue - Expenses = Net Income
You need an accurate bookkeeping system and a tax preparer who knows the industry to be certain you are receiving all of the deductions to which you are entitled.
Quarterly Estimated Taxes
If you recall, when you are an employee your company sends your FICA tax along with their matching half to the IRS each week. As a one-person operation (two-person for husband/wife teams), the IRS doesn't require that you send it in that often. Instead, you only have to send it in four times each year, or once per quarter. These dates are April 15, June 15, September 15, and January 15 of the following year. (Note that if the 15th falls on a Saturday or Sunday, the due date is the following Monday. Also, if there is a pandemic, this dates are subject to change) Due date compliance is determined by the postmark date.
If you do not send in the correct amount on time, you will suffer a monetary penalty. Usually, a bill appears in the mailbox about six weeks after the IRS has received the annual 1040. The amount of penalty is based on several factors: how much you should have paid in, how much you ended up owing, and how late you were on the payments. The formula they use is complicated so you make these quarterly estimates. Doing so is one more way of gaining control of YOUR money and not paying any more in taxes than is required.
There are several ways to come up with this number. According to the IRS, you can pay 90% of your expected tax liability for the current year, or 100% of your tax liability for the previous year. We know what your tax liability was from the previous year, so it is easier to use that number than to try to determine what 90% of the current year might be. Therefore, take your total tax liability for the previous year and divide by four to determine the amount you pay each quarter to avoid a penalty. This amount may or may not be enough to cover all the tax you will owe on your current tax return. Regardless, it will eliminate a penalty. If you feel you will owe more, put the money into a savings account to earn interest until the year's end. Don't send it to the IRS and let them use your money for the year.
The ideal tax return for everyone would result in a zero balance: you owe nothing to the IRS and the IRS owes nothing to you. This kind of tax return means that you had the use of your money during the year, and it also means you won't owe a penalty for under-paying or not paying your estimated taxes.
If the number you come up with seems overwhelming, here is a hint that might make it seem a little easier to handle. There are 13 weeks in a quarter. Take your number and divide it by 13. This amount needs to be set aside each week in order to have your quarterly payment. For example, imagine last year's tax liability was $3,400. Neither spouse worked as an employee, so there was no withholding. Take $3,400 and divide by four ($3,400/4 = $850). You have $850 due each quarter to avoid penalty. Take the $850 and divide by 13, and it comes to roughly $65. That's how much should be set aside every week. Of course, your actual numbers might look quite differently, but this is the basic concept.
Here's another helpful hint. If you file a joint return and your spouse works as an employee, he or she can choose to take out more withholding from his or her paycheck. Your spouse's employer then sends the money to the IRS for you. If you have the extra taken out of the paycheck as withholding, you would not need to send in the voucher and payment each quarter. Another advantage to this is that you can't be tempted to spend any of the money you have been setting aside for the quarterly payments.
Discipline yourself to set aside the amount you have calculated. Then, when the next quarterly estimate is due, you won't be overwhelmed trying to come up with the tax money. It's the right thing to do and will give you a sense of control and peace of mind.
I should note at this point that your quarterly estimates include your self-employment tax and federal income tax. You will pay more in FICA than you did as an employee. You do have to do more paperwork, but that is just part of owning your own business. Once you have a basic understanding of the taxes, you will begin to feel more in control and that will allow you to make better business decisions. After all, you are doing this to make money, which happens when you learn to make decisions that put more of each dollar you earn into your bank account, rather than someone else's.
Another method will help you to stay on top of estimating your taxes. Each week when you receive your settlement, set aside 9% of your gross revenue. Gross revenue means the total amount you received from your carrier that week before any deductions are included. In order to understand what the gross revenue is, you need to make sure you know how to read your settlement. I'll cover reading settlements in more detail in the chapter about choosing a carrier. The 9% is not perfect because every tax situation is different, but it will put you close and if you develop the habit of setting aside that amount, you will stay out of tax trouble.