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 segment of the "Under The Covers" podcast, the hosts discuss the Profit First method for setting aside money for taxes. Speaker B explains that a common rule of thumb is to reserve roughly 15 % of total revenue for tax payments. The calculation is illustrated with a $10,000 revenue example: after $5,000 in operating expenses, $5,000 of profit remains; at a 30 % effective tax rate, the tax liability is $1,500, which equals 15 % of the original revenue. The 15 % figure is presented as a baseline that may need to be increased (to 16‑20 %) as a business becomes more profitable, or could be reduced for very thin‑margin businesses. A follow‑up question addresses payroll‑based owner compensation (typical of S‑corp or C‑corp structures). Even when taxes are withheld from payroll, the Profit First system still recommends keeping a 15 % reserve, which is later used to reimburse the owner via a distribution check that covers the payroll‑withheld taxes. The conversation emphasizes the practical, rule‑of‑thumb nature of the 15 % reserve while acknowledging that individual tax rates and business profitability will affect the exact amount needed.

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.