A Simple Tax Plan
A Simple Tax Plan
US Employers, bless their cold, dead hearts, usually take care of a worker’s taxes by:
Oh, and sometimes they even kick in to pay for health insurance and retirement. But those are topics for another day.
When you’re self-employed, though, you’re fully responsible for your own “withholdings.” And also for the other half of the FICA.
This additional 7.5-ish% for FICA is what is often referred to as the “self employment tax.” And it’s also the source of much pain for the newly self employed. Why? Because it boils down to a significant “tax hike”, levied for no other reason than you dared to strike out on your own.
After several years (some handled better than others), I’ve worked out the following somewhat simple approach to handling my taxes:
Why 22.5%? My original plan for 2005 was 20%. But I got paranoid about March (hey, the year was clicking along pretty good at that point) and adjusted up.
Why the 5/6th and 1/6th splits? Comparisons of my Oklahoma state taxes to my US federal taxes the past couple years showed that as the approximate proportion.
At the end of the year, depending on how my overall revenue weighs in, I expect I’ll owe a bit on federal taxes, and get a bit back on state taxes. My goal is hit within $500 of what I owe, either over or under. However it goes, I’ll adjust to compensate for 2006, and start the process over again.
I use a simple Excel worksheet that calculates my “projected taxes” from revenue, and also tracks my “actual” payments made. When I add new income, “projected taxes” are updated automatically, and I can see how much I need to send off into low-interest-earning obscurity for the next few months.
Why do I do it this way? Mostly because I like Excel worksheets and approximations more than going through the tax tables (or hiring a CPA) and figuring it out accurately. That’s also why I try to overestimate a bit.
The Most Important Thing with tax withholding, as I see it, is that you make it as automatic as possible, and you make the money as difficult to tap for other purposes as you can. That’s where a single, simple calculation (like 22.5%; well, it’s simple if you let Excel do it for you) comes in handy, as well as a bank account that is in no way connected to your main personal or business checking account. Out of sight, out of mind, and, hey, it earns a bit of interest if you do it right.
Someday I might add a bit of complication in the form of additional corporate layers (and paperwork) in an effort to reduce my tax rate, but I’m still building to the point where the revenue would seem to justify the extra effort. Right now, I’m more interested in simplicity and getting it done as painlessly as I can over protecting every possible cent.
Hopefully, this post has one of two results:
I’ll take either one.
-David
“(currently earning 1.51%; hardly exciting, but I opted for liquidity over interest rate, and it was easily available).”
Hmm that is a completely suck ass intrest rate, you need a cash management account, stat!
Nice post, David. That sounds like a simple and reasonable approach to me. I wish I’d had some advice like this for my first self-employed year, it would have been easier.
Have you looked into using an ING Direct Orange Savings Account? That’s what I’ve used for several years now. You’re still liquid and the current rate is 3.40%:
http://home.ingdirect.com/products/products.asp
Somehow, I knew that interest rate would generate comment…
I have shifted most of my personal savings to ING Direct, actually. I opted to leave the tax savings account with my handy-dandy credit union account (one of the few remaining souveniers from my days in corporate America) for a couple reasons:
1. I can access the money with a phone call and a short drive downtown instead of having to wait at least 48 hours. For some reason, being able to quickly (ish) access and pay my taxes makes me feel better.
2. 1.51% is, at least, better than a personal savings account, most of which pay .7% currently.
When I get more comfortable using ING Direct (and their rather ridiculous transfer times), I’ll likely move the tax savings over there. Until then, though, I’m content with what I have.
Thanks for the comments!
-David
[...] That’s it! It sounds easy…a little too easy. Of course, there is the issue of the federal tax, which is supposed to be pay-as-you-go. When you’re self-employed, you’re required to estimate your income and submit your tax obligations quarterly. David Michael wrote about his simple tax plan, which doesn’t sound too different from what a friend of mine does. [...]
What is the 22.5% you withdrawl composed of? In percents?
ZaK,
Since then, due to rising income (so it’s not a *bad* thing), I’ve adjusted this plan a bit. I now take out 25%.
That 25% covers both state (Oklahoma) and federal taxes. When it comes time to send in the estimated quarterly taxes, I divided it up this way:
5/6 – federal
1/6 – state
That seems to come pretty close. I guess I could be more precise…but I just make up the difference on April 15.
-David
[...] Following in my tradition of simple plans, I’m enacting the following Simple Plan for 2006: [...]
[...] Read the rest of this great post here [...]