When you are self employed the first thing you must do is separate your business money from your personal funds.  Being self employed takes start up dollars and you must have money in a business account to run your business.  Every business must have collateral to operate until it is established enough to began making money and that business money must not be co-mingled with your person account.  If that separation is not made up front as soon as you start your business it becomes exceedingly difficult to decipher at the end of the year which expenditures are business and which are personal.

Why you must separate business and personal funds:

Being self employed means you can take business deductions for tax purposes that you are not eligible for if you work for someone else.  All business deductions must be documented so they can be calculated at the end of the year.  The reason you start tracking those deductions when you start your business with a good financial software program, such as  Quicken or Quick Books, is the total of those business deductions at the end of each year is subtracted directly from of your gross income.  Thus reducing the dollar amount you will be required to pay taxes on.

Open three separate business bank account:

I always suggest that everyone I train to operate a self employed businesses open an account with a credit union if they are eligible to use one.  In most credit unions you are allowed 3 separate bank accounts; a savings account and two other separate accounts.  If you do not have access to a credit union use a regular bank but open regular personal accounts not a business account.  Right now you are getting started you don’t need or want the cost or services of a business account yet and depending on your type of business maybe never.  All you need is to separate your business money into three separate pots of money. The three accounts will be:

  1. Savings account
  2. Operating account
  3. Tax payment account

Later when you have money in the savings account I will talk about opening a 401K, Roth IRS or some type of long term profit account where you will be saving for your retirement and earning more interest on the money than the savings account will generate.  This account will also be a major factor in the future in establishing the value of your business in preparation for a future sale.  Though your profit account is not sold with the business, it is your retirement fund, the amount of money that your business has generated over the years and deposited in this fund speaks to the value of the business.

Why would you want to think of selling your business up front before it is even established – Begin with the End in Mind:

Most people only think in the “now”.  If this is the first time you have been self employed you are struggling to survive and hoping the business will be profitable.  Making the mistake, according to Stephen Covey in his book 7 Habits of Highly Effective People, of working in your business not on your business.  You are at the beginning of your business and working on it means you establish and set business structures up front so your business runs smoothly.  Structure  will make running your business much easier and more profitable because you will have prepared for taxes, business expenses and retirement in the very beginning plus you will have established a daily routine to make sure that the structure and organization is current.

What Paying Taxes has to do with how your business is set up:

Many new self employed individuals are not taught up front to prepare for paying their own taxes or setting aside money regularly for retirement.  I have seen this syndrome especially in real estate self employed independent contractors.  They work on commission.  In this current market with short sales and foreclosures being a very prominent vehicle of sale it can take months for a transaction to close.  Without adequate funds in start-up money to tide you over until you start making sales and getting closings you can quickly run out of money before you run out of month.  When the check does arrive most probably have never had a pay-day when the check was so large.  Or, if under extreme financial pressure due to lack of planning to be properly funded through slow times the entire check  is spent to pay bills with nothing set aside for taxes. Unfortunately when you are self employed and receive a check only a small portion is yours to keep and spend as you please.  The majority is committed for taxes, profit and running your business.

How the three bank accounts are used:

  1. Savings account

Every check you receive is deposited into the savings account.  No matter how large or small.  Often a real estate agent will receive a referral check that is no more than $50.  Yes, even that small check is deposited into savings.  Making it a policy to deposit every check documents your income.  You need to be able to check the amount of your income deposits with the 1099’s that you receive at the end of the year from whom ever gave you the check.  You don’t want to pay taxes on income that you didn’t receive.  Therefore, you need the check and balance system set up in your account for deposits.

The next reason you want every check you receive deposited into your savings account is because you are going to take 10% off the top of every deposit and that amount will remain in the savings account to build interest and be considered your profit account.

Now you will move half of the amount you deposited to your tax account.  You are thinking, wait!.  I have already pulled 10% off when I made the deposit.  Let me show you how the numbers will look:


Amt. of check $1,000

divided $1000 by 2 = $500 – You will move $500 from the savings account to the tax account

You will move $400 to your business account and leave $100, the 10%,  in the savings account.

I know you are asking why do you tell me to put more than the 28% or what ever tax bracket you are in into the tax account.  The reason is for:

Paying quarterly Tax Estimates:

Account 2 – the Tax Account:

The purpose of depositing half of each of your checks into the tax account is to have enough money to pay for the calculated estimates and any income increases from last year.  Therefore, if you exceed the income amount from the previous years estimates you will have sufficient funds above the estimated amount to pay taxes on the increase in income.  You will have  surplus dollars to cover taxes on earned income above the estimate figure you have paid for the year.

W2 Form  – Received from Employer:

If this is your first experience as a self employed individual you are not familiar with paying quarterly estimates.  When you worked for an employer, your employer with-held money from your earnings to pay taxes and insurance and the check you receive was yours to spend.  At the end of the year your employer provided you a W2 form documenting your earnings and with-holdings that you attached to your income tax return to document that your quarterly tax obligation had been paid by your employer from deductions from your pay check.  You may have had to pay extra taxes in the past if the employer did not with hold enough money from your pay check.  Or, you may have received a refund from IRS if more was taken out of your check during the year by your employer that requied.  Either way you did not worry about taxes but once a year and that was to have your return figured and attach your W2 form.

1099 Form – Received by Self Employed Independent Contractors:

When you are self-employed you owe taxes at the end of the quarter you earned the money.  Now, you are going to think I am crazy and I may be a bit over anxious regarding taxes but I am going to make an unorthodox suggestion because I want everyone who reads my blog or attends one of my seminars or classes to be cognisant of the necessity and power of their IRS tax obligation.

One of the first business appointments you should make is with the CPA who will be filing your tax returns for you.  Have him give you the percentage you should  use to calculate taxes earned in each quarter and provide the address where these tax checks are sent.  From the beginning you need to be paying your quarterly taxes as earned rather waiting until the end of the first year.  If you go through the entire first year without paying estimates you will be responsible for paying all the taxes earned plus interest and penalties for estimates not paid on time by April 15 following your first year of business.  I have known many good self employed independent contractor real estate agents who have made goog money but not saved for taxes ending up forced to leave the real estate business and find a job working for an employer to earn enough money to pay their outstanding tax bill.  Reason being,  they came into the business with no understanding of the tax obligation of self employed independent contractors, no capital to tide them over until income started to come in, spending all of every commission check and no preparation for saving any money to pay their tax obligation.  They enjoyed the big checks with no through of the obligation of saving the portion obligated to pay the IRS taxs due.

Chose a Good CPA:

When you have your taxes prepared after your first year in business the tax preparer will tell you the amount you owe from the previous year that must be paid by April 15. Many times you will make more in a year than you did the previous year.  Keep in mind estimates are figured on the income you made the year before.  The CPS will also give you the estimate amount he has calculated to be paid of each or the 4 quarterly estimates you will be responsible for the next year.  These estimates are figured based on the income you have made in the previous year.  The first quarterly estimate for the coming year will be due on April 15.  On that date you will also be responsible, that you are to you pay each of the next 3 quarters of this current year along along with the addressed envelopes to send the tax deposits.  Hopefully, you have already paid the January-March estimate based on the original % figure the CPA gave you when you started your business.  If not that amount will be due to be paid by April 15 plus any overage you may have made in the previous year or any mistake you may have made in your calculations.

Their in is the reason I suggest you place half of each check in the tax account.  The estimate you pay will not be half of the checks earned in a quarter, there by leaving the overage in the account earning interest to cover taxes owed at the end of the year if you made more money that the accountant estimated and reported to IRS when your tax return was files.  If that is the case you will owe that amount and it will be due April 15.  The tax account acts as a pad against this happening and provides a reserve to cover this eventuality.  If you do not use the extra funds you have two choices.  Either leave them in the account, earning a small interest but readily available or move them to your retirement account which should earn a greater interest but is never to be touched or withdrawn from until you actually retire.  I suggest leaving the overage in the tax account because it is accessable until there is a subbstancial amount and move part to un-touchable retirement and leave the rest in the tax account.

Estimated tax is just that.  The tax preparer will calculate your estimated taxes per quarter based on what you earned the past year.  When your return is filed with IRS the estimate is given and IRS expects that you pay that amount by the deadline date each quarter.  In other words IRS looks at that estimate as a debt you owe the government each quarter.  If you don’t pay on time and the amount due there will be a penalty and interest added for late payment.  So, paying on time is a must and having the money to make that payment is the object of the division of moneys earned deposited into different bank accounts.

Why your tax perparer should be a CPA:

I always advise that a self employed individual or independent contractor have taxes prepared by a CPA.  Reason being, IRS does not look favorably on self employed and inpendent contractors because of the deductions we are able to use to reduce our gross income.  In the over 30 years that that I have been self-employed we have been audited many times.  When a self employed individuals tax return goes it it is almost flagged to scrutenized closely.  The CPS’s name is on the return along with yours and you have an expert to stand beside you if you are audited.  There was only one of those audits that required us to go to IRS and our CPA was right there with us and proved that our return was correct.

Account 3 – Business Operation:

Out of the business account you will pay yourself a salary and fund the cost of day to day business activities.

Now we are down to the part where you get some money to spend on yourself, pay household bills, etc.  Hopefully, it is now clear why you can’t operate your business out of your personal account.

In a later post I will talk about how to calculate your salary and create a business plan that structures a budget for monthly business operation.