How to best keep track of tax liabilities of a sole proprietorship

[Buddha Buck]

My basic approach to such questions is to think about the "5 W's" of
reporting (after all, "accounting" is fundamentally about telling an
accurate story of what is going on with your money.

How you tell that story is dependent on what the standard practices in your
local jurisdiction, as well as how you choose to think of things.

Here's how I would think about it.

*What* are the taxes? Taxes that I pay are fundamentally an expense, so I
will need an "Expense:Taxes" account. For me in the US, I'd probably break
that down into different tax accounts based on the nature of the tax
(Federal income tax, State income tax, property taxes, self-employment tax,
FICA/Medicare, etc).

I may also be asked to collect taxes ultimately owed by other people, such
as wage withholdings from my employees, or sales taxes on goods/services
sold. These are funds I have, but aren't mine, and don't count as income or
expenses for me. Rather, they are liabilities.

*Where* is the money? If I haven't paid the taxes yet, the money is in a
bank account. After I send off the check, I don't have it any more.

*When?* This is multiple questions. When do I recognize the expense? When
do I cut the check?  What's the overall timing?


There are a few ways to go about this.

One way is to work off a "cash" basis: the tax expense doesn't occur until
the check is cut and paid (when you fill out your annual tax return), but
you want to set the money aside as you go so you have the cash to pay it.
Of course, you are setting aside an estimate, since many cases you won't
know your actual tax liability until you pay it.

In that case, I'd would open a 2nd bank account and split your deposit
between your main account and this tax reserve account:

6 June 2017: Receive payment from Acme Inc for consulting work
    Income:Consulting Cr. $1000
    Asset:Bank:Checking Db. $700
    Asset:Bank:Tax Reserve Db. $300

15 April 2018: Income Tax Payment
    Asset:Bank:Tax Reserve Cr. $300
    Asset:Bank:Checking Cr. $25
    Expense:Taxes:Income Db. $325

Another way is to recognize the tax on an ongoing basis, "paying" it from a
liability account. :

6 June 2017: Receive payment from Acme Inc for consulting work
    Income: Consulting Cr. $1000
    Asset:Bank:Checking Db. $1000
    Expense:Taxes:Income Db. $300
    Liability:Unpaid Taxes Cr. $300

15 April 2018: Income Tax Payment
    Asset:Bank:Checking Cr. $325
    Liability: Unpaid Taxes Db. $300
    Expense:Taxes:Income Db. $25

You might be required to prepay estimated taxes during the year, especially
if your estimated tax liability gets too large:

6 June 2017: Receive Payment from Acme Inc for consulting work
    Income: Consulting Cr. $1000
    Asset:Bank:Checking Db. $1000

15 July 2017: Estimated Tax Payment
    Asset:Bank:Checking Cr. $300
    Asset:Prepaid Taxes Db. $300

15 April 2018: Income Tax Payment
    Asset:Bank:Checking Cr. $25
    Asset:Prepaid Taxes Cr. $300
    Expense:Taxes:Income Db. $325

Which is best, or proper, will depend on local law and practice, which we
(obviously) cannot advise you about.

On Wed, Jan 10, 2018 at 9:58 AM <davelist at mac.com> wrote:

>
>
> > On Jan 9, 2018, at 8:04 PM, Chris Smith <chris at cgsmith.net> wrote:
> >
> > I am using GnuCash for my freelance business. My dad always taught me to
> > set 30% of a check aside for the government's share.
> >
> > How would you enter this to keep track of the tax liability? I am
> thinking
> > I'd have to enter it against my *Income:Sales* account as a transfer to
> > *Liabilities:Tax*
> >
> > I figure at the end of the year *Asset:Checking Account* can transfer to
> > satisfy the true Tax liability.
> >
> > One thing to note, I *don't* want the liability to effect reports on
> sales
> > reports. :/
> >
> > Am I just overthinking this?
> >
> > --
> > Chris
> > <chris at cgsmith.net>
> >
>
> What I do so I have a basic idea of what my income/expenses are is to make
> an expense for taxes and a liability for taxes and do a transaction between
> those two each month. And then when I pay the taxes, the transaction is
> between the checking account and the liability tax account.
>
> So it won't affect income, but it will affect your net income (income -
> expenses) as it should.
>
> Others may chime in with more definitive answers as IANAA.
>
> HTH,
> Dave
>
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