Using our Emergency Fund and the Reality of Business Taxes

Life has an interesting way of throwing curve balls. We can never know exactly what is going to happen in the future, no matter how hard we try to plan.

I want to talk about what happened when we just filled up our emergency fund, and how our plans changed. We learned a lot from this experience and are passionate about preventing this from happening again in the future.

Sometimes life takes an unexpected turn, and you need to roll with the punches.

What Our Plan Was

Our general plan was that by April 1st, 2019, we would fully fund our emergency account with 4-5 months of base expenses. We paid off our debt and funded our personal emergency fund, but then the shit hit the fan.

Granted, this was not a “real” emergency, as we are still healthy and we didn’t lose our jobs. But this situation opened up our eyes to the benefits of having an emergency fund, and how important it is to understand your tax situation.

What Ended up Happening

Towards the end of 2017, Andrea and I launched a salon. We got about $9k back as a tax refund for the 2017 tax year, mainly because our expenses from our salon was more than what the business brought in for 2017. There were a ton of startup costs relating to designing a logo, purchasing signs, buying equipment and purchasing hair stations.

For context, in addition to Andrea working at the salon, I also have a full-time job as a web developer and bring in a good amount of income. In years where I was bringing in the only income in our family, we would consistently receive a tax refund every year.

Since our expenses were low for the salon last year (mainly from startup costs), and the profit increased, I was well aware we were going to owe money on taxes. However, we weren’t paying estimated taxes, and when I brought this up with our accountant, she said she wasn’t worried about it because we were paying taxes from the paycheck at my job.

Instead of pushing this issue, I ignored my gut feeling and figured we would probably owe some taxes at tax time from the salon. But I was not expecting an $11,500 tax bill!

On top of that, I learned that since we are an LLC/Partnership, we had to submit our taxes on 3/15/2019. She contacted us about having our taxes done on that day. In order for her to file our taxes by the deadline, we had to pay the $405 in accounting fees by the end of the day. We could then pay the amount of taxes we owed by 4/15/2019.

This frustrated me for a few reasons:

  1. Why did it take our accountant up until the last day when we needed to file (3/15), to have our taxes done? Was she so busy she couldn’t have this done earlier? I had sent her all the required info to do the taxes by early February 2019.
  2. Given that we talked to her about our account and taxes mid last year, and she took a look at our Quickbooks account, why did she not realize we would be looking at a 5-figure tax bill for 2018?
  3. Since we are almost through the third month of 2019 (when this article was written), we need to start setting aside at least $1,000/mo to cover this year’s taxes, and maybe more, if our profit from the salon goes up. We should also start paying estimated taxes.

It ended up being a double whammy. 1) Realizing we have to cover a massive tax bill, and 2) coming to terms with being behind on saving for taxes this year.

We need to figure out how to prevent this from happening again with the business and get our personal finances plan back on track.

You Can’t Ignore Taxes

At this point, it would be easy to put the full blame on our accountant for not preparing us for what ended up happening. We need to think about whether we want to continue to use this accountant, but the main point is that I should not have ignored my gut.

I can’t expect our accountant to care more about our financial picture than we do.

As long as she is helping us account for as many tax deductions as possible, and making sure we are providing the necessary details in Quickbooks, that is her primary job. Maybe we are expecting too much from our accountant?

I am always in Quickbooks and can easily see how much profit we are bringing in from the salon every month. I should not have ignored my thoughts in realizing that when you profit $40k from a business, the government is going to expect you to pay your marginal tax rate on that income.

In other words, the numbers were screaming that we would owe at least $10k in taxes from the profit from the salon throughout last year.

I need to have a better pulse of our tax situation for our business. And I need to make sure to communicate with our accountant more often throughout the year.

Our Emergency Fund Saved Our Asses

I never thought our emergency fund would need to cover a hefty tax bill. I especially didn’t expect this to happen right after we filled our emergency fund!

But I’m grateful this is happening when we do have a large emergency fund. If this happened last year while we focused on paying off debt, this would be a much worst situation. We would probably have to go with the IRS monthly payment plan, and our debt repayment plan would get delayed.

Instead, we now have to re-fill our emergency fund, which will delay our current plan by 2-months.

Two months is not a tremendous amount of time in the grand scheme of things. In fact, it is a significantly small amount of time. It shouldn’t affect our long-term plans too much, and before we know it, we will have our emergency account fully funded again.

But this is a lot of money. If we paid this tax bill through the year, as we should have, we would still pay the same amount in taxes. However, that burden would have been spread out over 12-months instead of a DAY.

Technically Not Been An Emergency

There is a logical formula in how taxes are calculated. Granted, the U.S. tax code is complicated, but we can get a general idea in how much our business will owe after rough estimating the yearly business profit.

Taxes need to be a part of your business plan and not an after-thought.

If you regularly have to pay your tax bill out of your emergency fund, there is a hole in planning your business finances. Your tax burden should be calculated like a regular monthly business expense and accounted for as your profit comes in.

This experience was a painful wake-up call. Instead of focusing on making sure we cover our tax burden throughout the year, we faced a huge tax-bill that wiped out our emergency fund.

I want to fill our personal emergency fund, and never use it, unless something significant happens that we cannot plan for. Taxes should not be one of those things. But as they say “you live and you learn”.

We are Grateful

It would be easy to look at this situation in a negative light. There’s no doubt we learned our lesson, but we are also extremely grateful for having the ability in handling this massive tax bill. Even if it meant we wipe out most of our emergency fund.

And ultimately, that is what our emergency fund is meant for — preventing the need to go into debt for unexpected large expenses.

We are grateful we didn’t have to dip into the emergency fund because we lost income, had a major accident or anything else that directly affects our well being.

We will recover from this unfortunate event. With all things considered, we are blessed to be at the position we are at, be able to handle this massive tax bill, and continue to pursue our financial goals.

Business Emergency Fund

I’ve started to wonder if our salon business needs to have its’ own emergency fund to help handle situations like this.

Our personal emergency fund is great, assuming it only is meant to cover our personal finances. But since we also own a business, I’m considering one of the following:

  • Having a separate business emergency fund, specific to the salon
  • Increasing our personal emergency fund, to be able to handle business-related emergencies.

I’m leaning towards having a separate business emergency fund, as it separates our personal finances with the business. We also might use the business emergency fund more loosely than we would use our personal emergency fund.

If you have an opinion on how to handle a business emergency fund, please share in the comments! As a relatively new business owner,  there is a lot we can learn. And I’m curious about how other people are handling this problem.

It is going to be a challenge to push our personal finances as much as possible, build a separate business emergency fund, and get caught up with taxes for this year. But if we can make it through this year and better prepare our business for the future, it should end up benefiting both the business and our personal finances.

New Accountant?

I’m currently torn on whether we should keep our accountant. She seems to be good at what she does and is helpful, but my gut tells me she should have made it more clear in preparing us for the taxes we ended up owing for 2018. She had all the data already and could have easily projected this outcome.

I would be curious to hear in the comments, if you think I should look for a new accountant, or if you think I’m knowledgable enough now to catch this kind of thing going forward. It takes work finding and switching accountants, but I think it might be worth it if we will receive more attention on our account throughout the year.

If you have any other thoughts on taxes, accountants and how we handled this situation, I would love to hear from you below.

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Grokking Money
Guest

We didn’t expect owing taxes this time around but ended up with a $4,400 tax bill. Fortunately we cash flowed it even though we did have reserve funds. But it taught us 2 lessons:
1. Adjust our withholding appropriately for 2019
2. Max out our 401k (my wife didn’t do her 401k) in 2018 since we wanted debt freedom.

So this should offset a lot of our tax liability for 2019.

Also I would hold the accountant responsible for being late and make it clear that it’s not helpful.

Abigail @ipickuppennies
Guest

I would definitely get a new accountant. The fact that she left it til the last minute AND told you not to worry about taxes because of your paycheck… I mean, that just smacks to me of not paying attention to details or just flat-out not being great at her job. I wouldn’t trust her again after she failed to prepare me for something as huge as a $11,500 tax bill. But maybe that’s just me. It wouldn’t hurt for you to have a small EF for your business to cover things breaking or whatever. But I wouldn’t make it… Read more »

Little Seeds of Wealth
Guest

Sorry you had to use your emergency funds to pay taxes. Sounds like you need to find a new accountant! She’s supposed to be there to fill the knowledge gap and help you focus on the business after all.

Caveman
Guest

The thing about any adviser is that you have to be able to trust them. That’s probably the biggest question you need to ask yourself about whether to stick with her or not. On the wider point I always feel grateful that I have an emergency fund but, oddly, always feel slightly resentful if I ever have to use it. I don’t know why as it’s there precisely because of unforeseen incidents. In fact I even expect to use some of it at various points during the year as you will always have a washing machine break down or a… Read more »

Juan R.
Guest
Juan R.

Saw your article referenced on MarketWatch.com! Writer on MW was making it seem like the new tax code was to blame for your huge tax liability. Based on previous tax fear mongering articles by MW, I decided to check out the referenced material. MW at it again! Glad I checked you out, you found yourself a new reader. Enjoyed you opening up and providing your lessons learned.