226 - Reviewing Your Tax Return
On today’s episode of the podcast we’re getting actionable and going through your tax return. Grab your tax return then hit play on today’s episode.
While going through your tax return, we are going to do some exercises to help you:
- Complete a profit analysis for business
- Determine how much money you’re spending on taxes to help you calculate how much you’ll owe next year
Doing a profit analysis of your business looking back at last year will help you forward plan. You can also look at your P&L to get a better understanding of these numbers.
First, we want to look at your Schedule C. Assuming you’re a sole proprietor or a single member LLC, the Schedule C is where your business taxes go. If you’re an S Corp, you want to look at your 1120-S, and if you’re a partnership, you’ll want to look at your 1065.
When we’re talking about calculating profit, what most people would do is look at Line 1, which is gross revenue and then look at the last line, Line 31, which is net profit. Take net profit/gross revenue to get profit percentage. Now while you could do that, we’re going to get more detailed to get a better reflection of your finances.
To start, we want to look at Line 3. Line 3 is your amount after returns and allowances. I don’t like to calculate the gross revenue before returns. This line is gross income after returns and refunds. If Line 2 is high and you’re having a lot of refunds, you want to get a better understanding of that first. Was that a pain in the ass $5000 client you refunded or if it’s a lot of smaller amounts adding up, that’s a bigger issue.
We want to figure out what percentage of our money is going to cost of goods. Cost of goods is typically only if we are selling physical products, like your ingredients if you’re a baker, flowers if you’re a florist, etc. If you’re a service provider, you typically won’t have a cost of goods. To do this we take Line 4 and divide it by Line 3. For example, if you have gross receipts after returns of $100,000 and you have cost of goods of $30,000, your cost of goods would be 30%.
From here it’s time to look at your expenses. This is located on Line 28 of your Schedule C and you’ll divide that by Line 3. Going with our example, if your expenses were $25,000 and your Line 3 is $100,000, the percentage would be 25%. Note that this does not include your home office (that is in Line 30).
To calculate our profit percentage, there are lots of ways to do this but since we’ve already calculated cost of goods and expenses, our profit percentage is simply what’s left over. So if we put 30% from cost of goods and 25% expenses together we get 55% meaning we have 45% profit. This is telling us the financial health of our business.
There are a few ways to increase profit.
- Make more money (increase revenue) without increasing expenses/fixed costs. If you are in a goods-based business your cost of goods are likely going to increase equivalent to your income. If your cost of goods stays at 30%, your expenses could decrease from 25% if you make more money without increasing cost of goods.
- Keep revenue the same and lower expenses
- Keep revenue the same and lower cost of goods (get them in bulk, find different deals, etc.)
You can also calculate profit by taking Line 31, your net profit on the tax return after including home office deductions, and divide by Line 1, your gross receipts before considering returns and refunds. This would give you a lower profit percentage because of home office and returns included.
Although we get a tax deduction for our home office, I don’t like to think about it as a business expense. It’s a hybrid expense. Hybrid expenses are ones that we pay for that are both personal and business use such as cell phones. It’s an expense that we would have regardless of the business. Take a deeper look at your finances and see what you would have even if you didn’t have a business. Also, think about trips. I have a few coming up and they are ones that I will fully deduct because they will be business trips, but I would bet that if I had a salary job, in lieu of going to these places I’d be going on vacations so I consider these work trips personal enjoyment and I like to back these things out when doing my profit analysis. I like to look at this number because taking it out can give me a better comparison to if I had a salary job.
For example, assume you make $70,000 at a full time salary job. You quit your job and start a new business in the new year and you have $80,000 in revenue in the first year in your new business and you have $10,000 in expenses so that’s $70,000 net and you also get a $5,000 deduction for your home office and you take some trips where you get a $5,000 deduction, you have some other expenses including a cell phone that add up to a $2,000 deduction so your tax return will show a profit of $58,000. But think about it from the lens of a full time job. It may look like you’re struggling, you made less profit than you did in your full time job, but some of these deductions in your new business (cell phone, travel, other quality of life expenses) would not be deductions at your salary job. It’s a different lens to look at it when you look at what your business is providing you.
Moving on to quarterly taxes, start by finding your total household gross income. This adds up all sources of income. Look at Line 1 of your Schedule C, plus gross income from any other forms like forms from rental properties. If you have five Schedule Cs, you want to add them all up. You also want to take Line 1 from your 1040 which is your wages and add that in. Add them all together and this is your total household gross income. Then, add up Line 16 from your 1040, your total federal income tax, and Line 23, which is other taxes mainly self-employment tax. Then subtract any credits and that’s your total Federal tax that you paid to the IRS. Then add any state taxes. This is going to give you your total tax, your total federal and state taxes added together, then divide by total household gross income and this is your tax percentage. This tells us that 20% (or whatever percentage you calculate) of every single dollar that came into this household went back out toward taxes. If you anticipate making more money this year, you can make your best estimates.
The very first thing we do in Profit Rx is calculate this tax percentage by doing a forward projection and then setting up a tax savings automation so then you take that amount and pay it each quarter for your quarterly estimated taxes.
How to Turn Your Business Into a Wealth Generating Machine is my free training where I dive into more details on how to calculate this percentage, how to look at your profit margins, and give you more info on how to join Profit Rx at a reduced rate. You can sign up for this webinar by scrolling down on my homepage here.
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