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How to Save for Taxes as an Entrepreneur

A question I get asked all the time by my new financial coaching clients and other coaches and entrepreneurs is: How do I know what to save for taxes?

After being a financial coach for over 7+ years, I can tell you that in order to figure this out, you need to know:

Exactly where you are sitting so far for the year
What have you made in gross income
Net income (gross income minus expenses)

First, let’s talk about how you’re taxed and how to know how much you’ll be paying in taxes.

This context is going to be for a sole proprietor.

How You’re Taxed as a Self Employed Person

Gross – Expenses = Net Income (what you’re taxed on)

Gross Income – the total amount you’ve made in sales, ex: when you hear someone say they’ve hit a $10k+ month or they have a 6 figure a year business, that is gross income they are referring to.

When it comes to NET Income, that is your gross income minus your expenses. So your total sales minus everything it took for you to make that money (ex: minus courses, coaches, payment processor fees, subscriptions, etc)

When Should You Start Saving for Taxes?

The first thing you need to be doing is tracking your income & expenses closely.

When Your Monthly NET Income

(Gross Income- Biz Expenses)

Is a positive number (meaning you’ve made more than you’ve had in expenses), you are going to want to start saving for taxes.

If you are brand new in your business and it’s the only income you have coming in and your business expenses are more than your business income, you might not have to pay taxes because you’re not profitable yet. It depends on the specifics of your situation, but that might be the case for you.

Two Ways to Figure Out How Much to Set Aside

These numbers are for educational purposes only. They’re for small business owners who are sole proprietors who live in Canada or the US. Please speak with your accountant about your specific numbers and they can give you a much better estimate, but these 2 methods below are great to start getting a decent amount set aside.

Either take very roughly 15% from all income that comes into the business and set it aside into a dedicated Tax Savings account right away
Or ~25% of your NET Profit each month

Personally my favorite is doing it based on your Net Profit because that is the most accurate number, but what I commonly see happen is that people aren’t up to date on their bookkeeping, which means they don’t know what their Net Profit is. So in those cases, it’s more important to be setting something aside and not procrastinating because you don’t know the numbers, therefore setting money aside based on the sales coming in can be helpful.

You aren’t just taxed straight across the board on all of your income, you’re taxed based on the tax bracket where you end up at the end of the year. Here’s where you can view the Canadian tax bracket rates.

Open a Tax Savings Account

Then title it something that reminds you that it’s NOT your money!

You could call it:

The Government’s Money
Not My Money
Taxes Because I’m Profitable
Government Holding Account

Taking the extra step to name your biz taxes account something, other than just a number or Business Taxes, helps your brain subconsciously to remind it that you really don’t want to tap into this money. This money belongs to the government and you’re just holding it for them.

If you have done this and you need even more help, you can have this separate savings account at a different bank so it is even less convenient to transfer from it. And when you log in to your normal accounts online, you aren’t seeing this money, so subconsciously, it’s not available to you.

Out of sight, out of mind. It actually works well in this case!

Now that we’ve talked about how you’re taxed and how much you’re taxed, now let’s talk about the pieces to make it easier to actually set that money aside for taxes.

3 Pieces Needed to Make it Easier to Be Prepared for Taxes

1) Have enough money coming in

I know this might sound silly to say because it’s obvious, but it needs to be said. Sometimes you truly can’t set anything aside for taxes because your business isn’t bringing in enough and you do need to increase the income coming in the door (especially if you’re full time in your business and your business needs to provide fully for your own income).

This is where really analyzing your KPI’s, your income and expenses can be super helpful so you can be really strategic to see what changes can be made to increase cash flow coming in.

2) Up to date bookkeeping

It is really hard to know what to accurately set aside for taxes, if you’re behind on your bookkeeping and you don’t know what the business’s financial health is.

This is a service we offer & we actually tell our clients how much to set aside each month for both income taxes AND sales tax if applicable.

3) Cash Flow Management

Sometimes there’s more than enough coming in but you need help actually managing your business and personal cash flow, to allocate everything (ex: you getting paid personally, setting money aside for taxes, paying business expenses, etc – this is what I help my entrepreneurs financial coaching clients with who make over 6 figures in their business)

This is what I mean by cash flow management, taking into account all of the areas that need to be addressed.

Timing is a big piece that’s often overlooked when it comes to running a business (& managing your personal finances) and this is something I coach my financial coaching clients on.

Timing takes into account:

When your clients are billed vs when you actually receive payment available in your chequing account
When your personal expenses are (you might have a lot of fixed expenses in the 1st half of the month like rent or a mortgage, so the first half of the month feels more stressful)
When your business expenses are
When your credit cards are due
When taxes are due, estimated taxes, sales taxes, etc
Etc

What to Do If You’re Behind on Taxes

So you know you have made more this year in income in your business than you’ve had in expenses and you’ll be paying income taxes next year. But you haven’t saved anything so far and it feels overwhelming.

Don’t worry, I’ve got you.

I’m going to share with you exactly how I help my financial coaching clients who come to me in this predicament.

The first step I have my financial coaching clients do is to open up a separate savings account that they ONLY put money in to save for paying income taxes.

Figure Out Your Current Years Net Profit

What I do with my clients is first of all, figure out approximately what they should have set aside.

We do this by first making sure their income & all expenses are updated for the year and we are looking at the most current numbers.
Then, based on their NET income (income – expenses), we multiply that number by a percentage (typically 15-30% depending on where they live [American or Canadian], etc) and come up with an amount for approximately what they should have saved thus far.

Now that you know it, you can use that as fuel to increase your income the rest of the year and until tax time.

Instead of trying to figure out how you can fully catch up on what you owe in taxes so far this year, take that number and break it down into the number of months that are left in the year or until tax time. Then divide it by 4 to find out what you would need to be transferring each week (or transfer once every 2-weeks or once a month depending on the cash flow in your business), to catch up on what’s already happened this year.

And then when you have more revenue come in, transfer bigger amounts to your tax savings accounts.

It doesn’t have to feel overwhelming, scary or something to be feared of!

I help my financial coaching clients to feel EMPOWERED about paying taxes and saving for them on a regular basis.

Because if you are going to be owing money in taxes, that means your business income was less than your expenses and this is something to be CELEBRATED!!!!

Focus on How You’re Managing Your Cash Flow to Have More Saved for Taxes

You need to recognize the season of life you’re in and that you’ll need to make different decisions while. you’re paying back previous years taxes, plus saving for the current year.

What got you here, won’t get you there. Recognize that you’ll need to do different things (dive more into the money, be on top of your finances more often, evaluate and plan where you’re spending your money and consistently be projecting the income that’s coming in)

Consider your expenses and if they’re focusing on stabilizing your business income, or scaling it. Those are 2 very different things.

Evaluate Income Streams

Evaluate income streams. Maybe something takes a lot more time, energy and money to make money from. You might have other income streams that are lower cost to run and easier to market. This will help you to make sure you’re marketing the right services, to help bring more money in the door right now.

Projecting Income to Set Aside More in Taxes

When you have higher income months, put more of that towards taxes. Be projecting your income so you can tell you have more coming in, so you do in fact set that money aside in your Tax Savings account and it doesn’t just get “absorbed” and disappear (which is what commonly happens when you’re not focusing on seeing your cash flow).

This is something I help a lot of 6 figure+ entrepreneurs with when we’re working together on cash flow management. I help them with tying all of these pieces together: paying themselves personally, business expenses, setting money aside for the current year’s taxes and paying off previous years. This is something that definitely takes time because there’s a lot of factors, so we typically work together for 6+ months to create their solid financial foundation and get them on track with taxes.

If your service based business isn’t at that 6 figure+ level yet and you want support when it comes to taxes, look into our bookkeeping services. We tell our clients how much to set aside each month for taxes based on the previous month’s net profit. Most bookkeepers don’t do this, but it’s so important to me that it’s easier for entrepreneurs to know what to set aside for taxes, so it’s standard that we provide that. Then it is up to them to manage their cash flow in a way that they can set that money aside.

Want to really dive into improving how you manage your personal finances too? Check out the Intentionally Wealthy podcast!

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