How To Calculate Your Tax Liability

Here’s Exactly the Process Every Small Business Owner Needs to Know About Tax Liability

Tax liability can feel unnecessarily complicated when you own a business. You have federal taxes, state taxes, estimated payments, deductions, different business structures, and changing income throughout the year. Then someone tells you to “save for taxes,” as though knowing how much to save is somehow obvious.

I prefer to turn tax liability into a predictable expense. Instead of picking a random percentage of every deposit and hoping it is enough, I work with a tax professional to estimate the actual annual liability, break that number into smaller amounts, and consistently move the money into a separate TAXES bank account. The process is simple once you have the right number to work from.

Step 1: Set Up Your TAXES Bank Account

Your TAXES account should be completely separate from your OPERATIONS account because the money sitting there already has a future job. The goal of this account is to hold your estimated annual tax liability until your quarterly payments are due.

I recommend using a High Yield Savings Account (HYSA) or regular savings account because you do not need this money for everyday business expenses. Separating it also removes the temptation to look at a large OPERATIONS balance and accidentally spend money that will eventually be needed for taxes.

Step 2: Meet With Your Tax Professional

This is the most important part of the entire process because I do not recommend guessing your tax liability yourself. Meet with a tax strategist, Enrolled Agent, CPA, or accountant who understands business taxes and can provide an estimated annual tax liability.

Your tax professional will use information about your revenue, organizational structure, such as a sole proprietorship, LLC, LP, or corporation, and the deductions you share with them to create the estimate. Your specific situation matters, which is exactly why a generic percentage found online cannot replace working with someone who understands your business.

Step 3: Divide Your Estimated Liability by 26

Once you have your estimated annual tax liability, divide that number by 26 if you are making transfers every two weeks. This turns a large annual number into a much smaller flat-rate transfer that can be planned for throughout the year.

For example, if your estimated annual tax liability is $65,000, the calculation looks like this:

$65,000 ÷ 26 = $2,500

Instead of trying to find $65,000 when taxes are due, you would transfer $2,500 every two weeks into your TAXES account. And then once a quarter, you would make your prepayment of $16,250.

Step 4: Automate Your Tax Savings

Once you know your flat-rate amount, set up an automatic transfer into your TAXES account every two weeks. This is where tax planning becomes part of your normal cash flow instead of something you have to remember to deal with later.

Automation also makes your OPERATIONS balance more truthful. If $2,500 belongs to future taxes, moving it out means you are no longer looking at that money as though it is available for payroll, hiring, marketing, equipment, or other business expenses.

Step 5: Put Your Quarterly Tax Payments on Your Calendar

Saving the money is only half of the process. You also need to know when your estimated tax payments are due and schedule those dates on your calendar based on the payment schedule your tax professional gives you.

Missing required payments can lead to interest or penalties, so this is not something I want sitting on a mental to-do list. Put the dates on your calendar and create reminders well in advance so you have time to confirm the payment amount with your tax professional.

Why Your Tax Professional Matters

Working with a tax professional who understands business taxes is a must because the entire system depends on having a reasonable estimate in the first place. If your estimated tax liability is significantly off, you could spend the year transferring too much money and unnecessarily restricting your cash flow, or transferring too little and finding yourself with a tax bill you were not financially prepared to pay.

Your business can also change throughout the year, which means your estimated liability may need to change with it. Significant changes in revenue, profit, deductions, or your business structure are good reasons to reconnect with your tax professional rather than assuming the original estimate will still be accurate.

Final Thoughts from Your Favorite Accountant

Your action step is to schedule a meeting with your tax professional and ask for your estimated annual tax liability. Once you have that number, divide it by the number of transfers you will make during the year and automate that amount into a separate TAXES bank account so you can begin preparing for your tax bill long before it is due.

Because at the end of the day, positive cash flow isn’t luck, it’s strategy. And it’s my goal to make that strategy as simple as possible for you.

Download my CEO Budgeting Workbook to start building your tax liability into your business budget.