Nothing makes this ol’ noggin hurt more than trying to understand taxes. Federal taxes. State taxes. Self-employment taxes. Social Security and Medicare and Sales and Gasoline taxes and uggghhhhh.
You probably have a similar attitude towards taxes, so we’ll try to make this installment of Small Firm Startup as simple as possible. Just know that if you fail to plan for the tax man, it’s going to be a lot more painful come next April.
Also, though this is a great starting point for tax planning, you really should be consulting a CPA. Much like your clients you for legal expertise, you’ll need an accountant for tax advise. Plus, the CPA fees might even be deductible.
This is the meat of the money that goes to Uncle Sam. When you finally start to get clients, and finally start to earn money from the retainers in your IOLTA accounts, you'll be tempted to spend your newfound income. After all, you've probably been living on the McDollar menu for the last few months.
Stop now. You have two choices: save for taxes now or be sticker-shocked at the end of the year by accrued assessments and penalties. Your best bet is to open a savings account and put approximately one-third of your earnings into that account. This is your tax fund.
Assuming you exploit business expense deductions to their fullest extent, a lot of this will come back to you in the spring. Even still, it's safer to set aside a bit too much than to be hit with an unaffordable tax bill and late payment penalties. Besides, you didn't forget about state taxes, did you?
The federal taxes don't stop at the income tax. There's also the self-employment tax, which covers your social security and Medicare assessments. Yep, even if you aren't working for "the man" you still have to pay "the man." The self-employment tax is set at 15.3% (12.4% social security tax and a 2.9% Medicare tax).
Estimate and Pay Quarterly
Depending on your income level, you may be required to estimate these amounts and pay them quarterly. According to the IRS's website, generally, you have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return. You are exempt from quarterly payments if:
- You had no tax liability for the prior year
- You were a U.S. citizen or resident for the whole year
- Your prior tax year covered a 12 month period
If this is all making your head hurt, we don't blame you. This is why it is advisable to hire an accountant. Understanding the above information, however, will prepare you for discussions with the CPA. Also, we'll be back with more titillating tax information, including formalities such as Employer Identification Numbers and tax benefits of other business formations besides the informal sole proprietorship.
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