Reserving enough for Uncle Sam

With TaxDayâ„¢ in the U.S. rapidly approaching, thought I’d share a small tip for anyone who recently went out on their own to freelance or start a business, or is thinking about doing so. This won’t apply to everyone. And it may not even be appropriate to those that already are on their own. I’m not an accountant, nor a tax professional. It’s just a common-sense change I made recently that helps keep a little extra order and separation to Stopdesign’s finances come estimated tax time each quarter.

After three and a half years of running my own business full-time, I’ve learned a few lessons the hard way. One of the lessons I’ve learned concerns money. Specifically, business revenue: where it’s kept, how it’s accounted for, and what other funds it’s mixed with. I won’t go into details. Let’s just say going on an installment plan with the IRS isn’t as much fun as a trip to Disneyland.

Since I keep the books and do my own accounting, I’ve benefited from having several separate bank accounts. And I’m not just talking about one for personal and one for business.

Anyone running a sole proprietor business under a DBA usually has a business checking account that’s separate from their personal account. This past year, I added another account to the mix, in addition to a standard business checking account. This one exists solely to keep Stopdesign’s tax savings separated from any other funds. A certain percentage of revenue is transferred directly into this account immediately upon receiving any payment. The account is only used for paying taxes Stopdesign owes, nothing else.

Even though I use financial software to keep the books and track accounts, I’ve found having this extra interest-bearing account is helpful. I always know exactly how much I owe the IRS. And I’ll always have enough to pay Uncle Sam when tax time comes around. Your mileage may vary.

Make sure you’re not getting dinged with monthly service fees. It should also be paying you interest. The more, the better. But it’s obviously best to stay away from stocks and other high-risk investments if it’s money you owe the IRS.


  1. Simon Wright

    Great advice, Doug. We do the same thing at my small business here in Australia, putting aside money for taxes regularly throughout the year so we’re not hit with a big bill. Luckily we pay a mix of monthly/quarterly and not yearly, which helps too.

    Most banks here offer existing customers special Internet-only savings accounts that earn high(-er) interest, which is perfect for this sort of thing.

  2. Dave S.

    Great advice, and this applies in Canada too. It strikes me as a something you should do no matter where you pay tax. I just set up my own tax account this year, and now I set aside a percentage of every cheque I receive.

  3. George Penston

    If you’re looking for a savings account to have your reserved tax money really work for you, I highly recommend trying out ING Direct (

    Although I don’t have my own business, I do the same thing to save up for our property taxes twice a year. Anyone owning a home in the California Bay Area knows my pain. My average yield these days is 4.26%, which I believe is much better than what you can get your average walk-in bank to offer you.

  4. 4rn0

    This is exactly what I do. Over here in Holland we have income tax and some sort of VAT (19%). Both of those go directly into my extra bank account as soon as I receive a payment.

    The nice part is I don’t even think of the money in that extra bank account as my own money. I used to mix these funds up in one account and I always hated paying taxes etc out of that one account.

  5. Scott A

    This is very sound advice, and it appears that it’s already in common use. We do the same thing, however we’ve found that we tend to over-estimate the percentage of revenue that will go back to Uncle Sam (darn expenses…. employees like to get paid). Assuming things are looking up, we’ll pay the balance of the account out to the owners as a yearly bonus.

  6. Andrew

    Yep, I represent another Australian small business that agrees wholeheartedly with this method of establishing a tax management account. It definitely reduces the risk of finding yourself with a cash deficit at the wrong time!

  7. Dan Wilkinson

    If you don’t mind me asking, what financial software do you use?

  8. Jamie Hill

    Great advise, I have just set this up myself however my bank won’t do automatic percentage transfers when money is paid in so I still have to calculate this (roughly) myself.

  9. Douglas Bowman

    Dan: I was hoping to leave that bit out, since I’m not very happy with what I currently use for business finance software: QuickBooks on the Mac. I’ve heard the Windows version is leaps and bounds better then the Mac version. But I don’t feel like switching into VirtualPC just to run QuickBooks. Maybe once I have an Intel Mac and can use something like BootCamp (or whatever Apple’s next gen OS and machines allow for switching to Windows without rebooting…)

  10. David Mohrman

    Actually I do something similar for my personal finances.

    I have several checking/savings accounts that help me keep my personal finances organized.

    I have one that’s just for Household expenses: mortgage, utilities, phone, insurance, medical, etc. Whatever comes in on a regular basis each month.

    Another for Gas, Groceries and misc. expenses.

    One for Savings.

    I pay a little bit in service charges on one or two of the accounts but I save big time in bookkeeping time!

    I haven’t bounced a check or balanced my checkbook in years, yet I know to the penny what’s in each account because I do everything online as much as possible.

    Works great for me, but drives the wife nuts.

  11. Richard

    Doug: your advice is good and I’d say it generalizes well to anyone with a credit card (keep enough money around to pay it off each month) but you failed to mention quarterlies and I’m wondering how you’ve set up your taxes? It sounds like you’re paying the whole tax at the end of the year.

    I’ve been successfully self-employed for over 20 years. I pay quarterly taxes. They’re an estimate based on what I earned the year before and I can increase or decrease them each quarter according to my books for the actual quarter. Yes, I give up the money earlier than paying it all at the end (and potentially some interest) but quarterlies take care of at least some of your forced discipline and spread it out throughout the year.

    In twenty years of doing it this way the worst that has happened to me is that I mistakenly underestimated and had to pay a bit on April 15th but it wasn’t the whole year’s worth, just a small amount. These days I’m doing much better at money management (and earning) and overpay a bit and get a bit back. Just got the check today in fact.

  12. Douglas Bowman

    Richard: Agreed — and yes, I pay estimated taxes quarterly too. I mention that in the first paragraph. ;-)

  13. The same idea is good for any other kind of reserve, too. For instance, I tend to have very large projects, meaning a single check can cover several month’s worth of income. Going to Tahiti when the check appears is possible, but really really dumb. Into the reserve it goes. Or, on the expense side, I’d rather pay for a big capital purchase by socking money away up front than paying the credit card companies after the fact.

  14. David

    Doug, this may be a silly question but how do you estimate the amount of tax you will owe? Is there a round percentage for deducting tax money from your income?

    Also, why sole proprietorship and not LLC? A lot of folks seem to think the LLC is a good idea for a people wanting to start their own design business.

  15. Mike

    @David: I’m not your lawyer, nor your accountant, and this is not legal or tax advice. In fact, you’re not even sure that I’m not some kind of comment-bot posting this, so take with a grain of salt.

    There are two main reasons to consider forming a business entity (LLC, Corporation, etc.): tax benefits and legal protection. These reasons apply in vastly different ways depending on the number of principals, number of employees, nature of the business, location of the business, and so forth.

    Hypothetically speaking, if one were to start a business, consulting a lawyer and an accountant ought to be among the first two things on the “to-do” list. Budget for them and plan accordingly.

  16. Jake

    I think this is a very helpful hint and as a designer working on getting my own business going, I am very thankful for this tip. Hope you’ll share more with us!

  17. Paul Whitener Jr.

    Quarterly taxes payments are the way to go. If I remember correctly, while I was “self-employed” (prior to organizing as an LLC) it reduced my self-employment tax. At the time, I think it was a 10% hike on my standard taxes.

    LLC rules appear vary from state to state. I’m based in Austin, Texas. I had to apply for a retail tax permit in order to charge sales tax on income derived from labor towards the creation of a web site. This only applies to my Texas for-profit clients, although the state does request a report of my earnings elsewhere.

    I’d recommend looking into your specific state/province laws to see what privileges and restrictions are put on an LLC.

  18. Olav

    That’s a great tip. Currently, I’ve only got one account for my own firm.. Think I’ll consider this.

  19. Random from Chicago

    Man, let me tell you the other side of the story.

    I didn’t do this last year, and this year’s tax day was a nightmare.

    1. I made a whole bunch of money last year, about twice what I was making at a permanent job.

    2. I didn’t withhold a single dime in 2005.

    3. I had to make up the difference this year. I had to make my taxes back from Jan to Apr of ’06. It sucked – I’m talking 80 (no exaggeration) – 80 hour weeks for about 3 months.

    I finally made up the difference, but not without aging a few years in the process.

    Set it aside, you’ll be happier in the long run.

  20. art

    Definitely pay quarterly to avoid the withholding penalties. Remember, or the IRS will remind you, that we have a “Pay as you go” system here in the US. However, if it’s your first year on your own, you only have to withhold up to a certain percentage of the previous year’s income (I believe it’s 110%) to avoid the penalty.

    However, if you think writing that $30k+ check every three months is bad, try writing a bunch of little $10k checks because you think you’ll go back to normal employment or the money will dry up soon. If you’re fortunate enough to make it through the year fairly consistently, January 15 starts to look pretty scary.

    My first year, I did a $10k first quarter payment, because I expected to be unbillable much of the year, then a $15k second quarter payment, because how much longer could this go on, really? $25k third quarter, because I could see that I was going to be in trouble soon and shouldn’t have pushed everything into less liquid investments, and I basically worked October and November (paid around 20 days after invoice) for nothing other than my Q4 payment in January.

    This wasn’t strictly necessary, because I could have gotten away with a much lower payment (see the 110% figure above) but I really didn’t want to write an even bigger check on April 15th.

    Since then, whenever the quarterly withholding is due, I just write a check for whatever my most recent invoice is. That may be a bit high, but it also seems to cover capital gains and interest income, so there’s less of a surprise when I get my returns back from the accountant.

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