Back taxes. They’re maybe way more common than you think. If you’re reading this and you feel super alone, don’t. There’s no shame is getting behind.

Because taxes are a mystery for most small business owners. We don’t learn much about taxes in school, and it’s not a popular topic at the family dinner table (or really any dinner table). But, before we begin our entrepreneurial journeys, this is largely fine for most of us.

Turbo Tax and similar programs make filing relatively doable, and most of us have employers who withhold our taxes. Easy peasy. We file hoping we get a decent refund, and that’s the end.

But when we start our businesses, it’s a different story. We don’t really know what we’re doing. Ideally we figure it out, but some of us get stuck in what I call the “Oh-Shit Cycle.”

The Oh-Shit Cycle

I’ll explain with an example.

Katya starts her business as a life coach. For the first year of her business, Katya isn’t even aware that quarterly taxes are a thing. She never thought about saving for taxes. In year one, Katya earns $22,000. She’s pumped. Her goal was really just to get a couple of clients to start building up her testimonials. 

She took Marie Forleo’s B-School course, grabbed a couple of social media programs from Jenna Kutcher, built a website on Squarespace, and had a few other monthly expenses. In total, she spent about $6,000 on her business, leaving her net business income of $16,000. After her standard deduction and qualified business income deduction, her taxable income was only $600.

She only ends up owing $150. Bills are still tight for Katya, but right around the time she filed her taxes, she landed another new client. She thinks “awesome. I’ll just use part of the client’s retainer towards the tax. No problem.” 

At this point, Katya’s friend gives her the lowdown on quarterly taxes. Katya is well-intentioned, but she has bills to pay, wants to make a couple more investments in her business, and tells herself she’ll start saving in a few months. She doesn’t.

The following tax year rolls around. Over the year, her income doubled. After expenses and deductions, her taxable income is now $30,000. She’s disappointed she never got around to saving, but keeps telling herself “It won’t be too bad. Last year, I only paid $150.” But now, tax on $30,000 of taxable income comes out to $8,000. That’s an oh shit moment. She panics for a moment.

After thinking about it for a week, she decides she’ll market really hard that month. Since she’s let her expenses proportionately increase along with her income, she’s still not making a ton of profit. With the promotion and a month of hustle, she scraps together $4,000 for taxes. She creates an installment agreement to pay down the other $4,000 over the next 12 months.

The problem is that now she’s making monthly payments towards the back taxes without saving for next year’s taxes. She makes even more that year, files taxes for year three, and piles that tax debt onto her balance, and the oh-shit cycle continues. This is the slippery slope with taxes. I see it everyday.

Business owners tell themselves, “oh I’ll take care of that when I’m making more.” But every time we get more money, we get normalized to it. We increase our spending and nothing really changes. This cycle is a big part of why I created the Unf*ck Your Biz Framework that I teach in my book and inside of my signature program.

For more info on quarterly taxes and how not to get stuck in this cycle, check out my blog on quarterly taxes.

Back Tax Strategy

If you’re still reading, I’m assuming you may feel like you’ve been caught in the ohh-shit cycle. First of all, deep breaths friend. About 25% of the students in Unf*ck Your Biz deal with some kind of back tax. It’s more common than you think. You’re not alone, and there’s lots of options. Here, I’m sharing my philosophy with regard to back taxes.

I’m assuming that you won’t be able to pay the debt in one lump sum. If you can, great! Do that. If not, you need a plan as to how to pay on an installment agreement. When it comes to developing a strategy, I generally recommend one of two options.

You need to think about how much cash you can reasonably put towards your tax debt each month. Also, consider whether you plan to seek any special circumstances like an “offer in compromise” (OIC). An OIC is essentially an offer from you to the IRS to settle your debt for a total less than you actually owe. Approval is conditioned on your ability to pay; thus, it’s largely income based. 

There are a few other settlement options as well. If you decide to go done a settlement route, you’ll want to do that first. Then, you can get on a payment plan for the balance. Make the decision as to whether you want to work with a professional and/or apply for an OIC or similar relief. That's your first step.

The second step would be getting set up with an installment agreement to pay down any remaining balance owed. That's what we'll focus on here.

Quick tip: Many cities have Low Income Taxpayer Clinics. The clinic can help you with filing back taxes and even applying for OICs to resolve debts. If you think you may qualify, search for a clinic in your area.

I find that many business owners begin working on back taxes without also planning and saving for current year quarterly taxes. It's difficult to take care of both. I totally get it.

But what happens if you're always focused on the back tax? You're basically always one year behind. So by the end of this year, you may have last year covered, but when you go to file taxes again, you're still behind because you weren't paying quarterlies for what was that year's current taxes. So how do we fix this? One of two ways.

The first option is to aggressively pay down the back tax first by putting all discretionary funds toward the tax debt. The second option is focusing on saving for quarterly taxes now while paying off the back tax incrementally with doable monthly payments. Also consider that this is not a text on personal finance. You should independently consider these options within the broader context of your savings, bills, and any other debt you may have.

Option 1 - Go with an aggressive plan to pay down back tax first and move to quarterly taxes. Figure out the maximum amount you can reasonably pay each month. Consider whether you can at least pay more than the amount you already should be saving for quarterly taxes.

For example, you may know that you must save 15% of your gross income for quarterly taxes. Maybe you take a look at your budget and decide you can afford to set aside 22% of all income to pay towards taxes.

With option one, you set aside 22% of all your income and make monthly tax payments towards your tax debt until it's fully paid. You continue to save 22% until you're caught up on the amount you should have set aside for quarterly taxes.

This option works well if you can pay off both the past debt and get caught up on past taxes within the span of 1 year. If that's not feasible, you'll look towards option two.

Option 2 - Start at the same point. Figure the maximum amount you can contribute each month towards taxes. Let's use the same 22% figure. If you have a larger tax debt, paying the full debt while saving for taxes may be a struggle.

Instead, the focus on saving for current quarterly taxes to stop the oh-shit cycle. Then pay whatever is left towards monthly payments on the back tax.

For example, assume you owe $10,000 in taxes. You gross about $80,000 a year. Your quarterly tax savings percentage is 17%, thus $13,600 needs to be set aside for taxes. You determine that, at most, you can pay $1,500 towards taxes each month. $1,134 is what will be set aside for quarterly taxes ($13,600/12). Thus, you pay about $360 each month towards back taxes.

If you continue making those monthly back tax payments, you’ll have the back tax paid off in 28 months (2 years and 4 months). Happy news? Probably not, but if you tackle it with that plan in mind, you can look forward to no longer being behind on your taxes. You’re cutting off the oh-shit-cycle by placing a focus on current taxes in addition to the debt.

So how do you know which option is going to work best for you? You gotta do the math. If you want some help getting started on the math, check out the UFYB Book as a starting point.