By guest author Marie Poliseno, CPA, of Dollars & Scents Accounting Services.
Don’t have the money to pay your taxes this year, for whatever reason? Maybe you’ve just started your new dog walking business and are struggling with cash flow issues. Or your trusty dog walking vehicle gave up the ghost, forcing you to clear out your savings to replace it. Or it could be that you were genuinely blindsided by the number you owe. Whatever the reason you’ve fallen short this year, you’re not alone. Millions of taxpayers find themselves in exactly the same position, and it doesn’t have to mean the end of the world. There are people and resources available that can help you deal with the situation—and avoid it, too.
Avoiding nasty surprises: Understanding how your taxes are calculated
I often hear clients express surprise when their tax returns are prepared. Perhaps these sentiments are familiar: “I don’t understand. I always got a refund in the past, why do I owe taxes now?” or “I barely made any money last year, how could I possibly owe taxes?” All too often people focus on the amount of the refund or the payment due as being their “tax.” This too-simplistic understanding of liability is often part of the problem.
As a small business owner, you have more than one tax applied to you. Here’s how it works: There’s your personal income tax—what most people think of as the “tax bracket” they fall into. Next, there’s a self-employment tax that is added to your personal income tax. This is where a lot of confusion comes into play. Regardless of the tax bracket you’re in, if 92.35% of your net earnings from your business (your revenue minus your expenses then minus the new small business tax credit) comes to $127,200 or less (note that this number changes annually), your self-employment tax rate will be 15.3%. (Tax on net earnings over $127,200 is 2.9%.) This amount of tax will be due and payable, even if your taxable income is zero. Forgetting or overlooking this key point is what often results in the unpleasant surprise of owing when you didn’t think you would.
If you were paying close attention to the previous paragraph you might be wondering how your taxable income can be zero if your net earnings show a profit. Here’s a quick summary of how taxable income is calculated for a typical self-employed dog pro:
Net Earnings from your business (revenue minus expenses)
Minus: 20% small business tax credit (new for 2018)
½ self-employment tax
Health insurance premiums
Standard or Itemized Deductions
= Taxable Income
Your personal income tax is calculated based upon your taxable income and then the self-employment tax (which is based solely on your net earnings from your business minus the new tax credit) is added to that tax to derive your total tax liability. If you’ve made any quarterly estimated tax payments, that amount is subtracted from your total tax liability to arrive at the amount you still owe.
What to do if you can’t pay
What if you didn’t make any estimated tax payments during the year, or that new vehicle wiped out your tax savings, or you’re new at this and didn’t realize how it was all going to go down? In short, what do you do if you don’t have enough money to pay your taxes? The answer is don’t panic. The IRS offers various solutions for taxpayers who can’t meet the April 15th deadline.
Short Term Extension
If you find yourself temporarily short of cash on April 15th, the IRS provides a 120-day extension to pay, giving you until August 15th to pay your tax bill in full. You actually don’t need to file any paperwork with the IRS to receive this automatic extension, but it’s a good idea to give them a call to let them know your intentions. You can pay a lump sum at the end of the 120 days, or make as many payments as you like along the way.
Note that the IRS will add penalties and interest if you take this option, and be sure to still file your taxes on time even if you don’t include a check. The penalties for not filing on time are 10 times steeper than for not paying on time!
Medium Term Extension
If your current and expected cash flow over the 120 days after April 15th is insufficient to pay your taxes, and you owe less than $50K, you can apply for an installment agreement with the IRS. Over the past few years, the IRS has simplified the process through the Fresh Start program and your application is automatically approved when you submit it. All you need to do is complete a brief online application process and pay a small fee. You’ll then have 72 months to pay off your tax debt.
A few important details: The application fee is reduced from $107 to $31 if you apply online and elect to have your payments direct debited from your bank account. Penalties and interest will again be tacked on to your bill, but the penalty is reduced by 50% (from .5% per month to .25% per month) if you request the agreement before the 120 days expire.
Long Term Extension
Long term extensions, called Offers in Compromise, are a way to settle a large tax debt for less than the amount owed. This is not an easy row to hoe, however, and will likely require the help of a tax professional and/or an attorney to navigate you through the process.
When the IRS contemplates a settlement they look at all the available equity in your assets, including your home, your 401K, and any other assets you own that could be liquidated. They could, for example, require you take out an equity loan to pay down the amount, or withdraw your 401K savings or sell what they term as non-essential assets before accepting your offer to pay less than the full amount you owe.
But if you’re suffering from more than short-term cash flow problems and the IRS determines your financial condition renders you unable to pay the full amount within a statutory period of time, this could be an option to help you hit the reset button. Do note that there are additional criteria to be met, including having paid all your other payroll and estimated taxes when due. You also cannot be in an active bankruptcy proceeding. As you can see, this is an extreme measure for an extreme situation.
Non-IRS solution option: Borrow elsewhere
If you owe the IRS and find yourself unable to cover your debt, another option is to look into borrowing money from a cheaper source than the IRS, such as from a low-rate or interest-free credit card. If you can find the right deal you’ll save yourself in interest payments.
How to make sure you have enough at tax time
Planning ahead and paying estimated taxes is the first line of defense against getting hit with an unexpected bill at the end of the year that you might not be able to pay.
Budget for your taxes throughout the year. Put money into a savings account each month for the purpose of paying your taxes. This can be hard to do, but if you discipline yourself to live on less than 100% of the income you take in, you’ll have an effective cash management strategy.
Last but not least, engage the services of a CPA or tax professional who can help you plan, estimate, and budget so you’re always on top of your tax liability. This is especially important for growing businesses, as your tax numbers will change as your business grows.
Marie Poliseno is the Managing Partner of Dollars & Scents Accounting Services. She is a Certified Public Accountant (CPA) who works exclusively with dog pros, as well as a professional dog trainer (CPDT-KA) and honors graduate of the SFSPCA Academy for Dog Trainers (CC). To work with Marie to create a plan to get out of a tax pickle or avoid a future one, e-mail firstname.lastname@example.org or visit www.dog-pro-cpa.com to learn more about her services.