Erika Jones, CFO, CCTAProfit First Professionals · Certified Fractional CFO and Profit First Professional

What Percentage To Allocate For Taxes Using Profit First System 'Under The Covers' Ep #2

10 Oct 2019 · 2 min

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1:38

In this short Q&A segment, the host asks about the 15% tax reserve recommendation used in the Profit First cash‑flow system. The expert explains that the 15% figure is a rule‑of‑thumb that works for most small businesses: it represents the portion of total revenue that, when set aside, typically covers the actual tax liability calculated on profit (revenue minus expenses). A numeric example shows $10,000 revenue, $5,000 expenses, leaving $5,000 profit; at a 30% tax rate the tax due is $1,500, which equals 15% of the top line. The expert notes that the reserve may need to be adjusted upward (16‑20%) as profitability grows, or could be lower for very thin margins. A follow‑up question about paying oneself via payroll (common for S‑corp or C‑corp owners) is answered: even though payroll withholds taxes, the business should still reserve 15% of the tax account and treat the withheld amount as a distribution reimbursement to the owner, ensuring the tax reserve remains intact.

Ready?
Yes.
Okay. So in profit, first you talk about setting aside money for taxes and you say set aside 15%. Where did you get that percentage from? And is it the same for everybody?
Yeah, so it's typically the same for most people. And how it works is that we get taxed in the US Particularly specifically on the amount of money you have left over after the operations are expenses of the business. So for example, if a business makes $10,000 in revenue, but we spend $5,000 on expenses, that remains or leaves over $5,000 that will get taxed on. So 15% of the top line, 10,000 will be 1500 si. Now the tax rate in the US depends, but let's say it's 30%. It could be 35, could be a little bit lower, could be a little bit higher. Let's say it's 30%. You're getting taxed on that leftover 5000. So 30% times 5000 is 1500. 15%. 10,000. 1500. So it covers it. Now your business, as the profitability increases, we take more money. That 15% taxes may have to go up to 16 or 20%. And a business that's running 30 thinner, meaning you're spending a lot of money, there's not as much profit left. You may be able to curtail the taxes. 15% though, is a good rule of thumb.
Follow up question. What if I pay myself through payroll? They're already taking out the taxes. Can I lessen that percentage or do I keep it the same?
Good question. So if you pay yourself through payroll, you probably have what's called an S corp or a C corp. And that means your taxes by law are required to come out of your paycheck. Even though you're the owner of the business. We are still going to reserve money at 15% of the tax account and then do what's called a distribution reimbursement. It's a distribution of money, quick profit to the owner as a single check. But it's a reimbursement for the taxes that have been withdrawn out of your paycheck.
Perfect.
Thank you.