Business reserve account: How to save for taxes and payroll

Managing cash flow is a matter of timing. Getting that timing wrong can cost you money — or even your business.

Business taxes create a regular demand for cash flow. That requires meeting frequent deadlines for quarterly estimated taxes and payroll taxes. Building a business tax reserve account is one way of making sure you have the cash on hand to meet those deadlines.

The challenge is to make sure you have enough cash available when you need it, without having money sitting idle any longer than is necessary. This article will discuss how to build up the appropriate reserves for taxes while keeping those reserves separate from other operating funds.

This process can help you find the most efficient way to have the money necessary for tax obligations available when you need it.

What is a business reserve account?

A business reserve account is money that’s put aside for anticipated cash flow needs. In business, you can’t expect the timing and amounts of your cash inflows and outflows to match exactly. Often, it’s necessary to build up cash over time to meet a significant expense you know is coming in the near future.

These cash needs may include things like payroll, rent and inventory. One need that occurs regularly is the necessity of paying taxes.

To help make sure the necessary cash is available for these various needs, it might help to keep some of your cash reserves segregated into separate accounts for these specific needs. One of these business cash buckets could be earmarked for covering tax payments.

Businesses need to have cash available to cover both taxes on the profitability of their operations and payroll taxes. You can use a business tax reserve account for these tax obligations. Those obligations should be determined in coordination with accounting and recordkeeping procedures that meet IRS requirements. The business tax reserve account can be used to make sure you have the cash on hand to meet the tax obligations your organization is accumulating.

What business tax reserves should cover

It makes sense to keep tax reserves separate from cash for routine operating expenses or long-term investments. That way you can be sure you don’t miss a deadline when a tax obligation comes due. Here are some examples of things business savings for taxes can cover.

Quarterly estimated taxes

In most cases, a business must pay federal taxes on its earnings. Those earnings can be variable, so you don’t always know in advance how much tax you’ll have to pay. However, the IRS doesn’t want to wait till the end of the year to start collecting those taxes from you. That’s why they have a pay-as-you-go system known as estimated taxes.

Federal estimated tax payments are due four times a year. You can adjust these payments based on earnings during the quarter. There is a tax penalty if your estimated tax payments turn out to be significantly lower than your actual tax liability at the end of the year. Building up tax reserves throughout the quarter can help you have enough money to meet each quarterly deadline and avoid a penalty.

You should check IRS regulations to see if you are required to make estimated tax payments based on the structure and earnings of your business.

Payroll tax deposits

Besides income taxes on earnings, your business may also owe payroll taxes, also known as employment taxes. These include both taxes withheld from employee wages as well as employer contributions to Social Security, Medicare and unemployment taxes.

These taxes are paid continuously throughout the year. A payroll tax reserve account can help you maintain sufficient cash on hand to meet these ongoing obligations.

State and local tax reserves

Depending on where your business is headquartered and operates, it may also have to pay state and local taxes. Consult state and local tax regulations and your tax advisor to see what those tax obligations are and when they are due. You can use a business reserve account to build up the money needed to make these state and local tax payments when the time comes.

How much to put in a business tax reserve account

Once you’ve set up your business tax reserve account, how much money should you keep in it?

The answer will be a constantly moving target, based on tax liabilities accrued and payments made. You should work with your company’s internal or external tax expert to maintain the right amount in the account. Below are some general guidelines.

Estimate based on taxes owed

Your estimated tax payments will depend on the revenues and expenses of the business, and on the applicable tax rate. Since revenues and expenses aren’t always predictable, the funding of your estimated tax reserves should be closely coordinated with the accounting function of your firm.

This is important because you will face a tax penalty if your estimated payments aren’t at least 90% of your actual tax liability. If it’s too difficult to determine your tax liability throughout the year, you can avoid a penalty by making what are known as “safe harbor” estimated tax payments based on your prior year’s tax obligations.

Note that making safe harbor tax payments may not completely fulfill your tax obligations. Since those payments are based on the prior year’s taxes, they may turn out to be substantially above or below your actual tax liability.

Review after payroll or revenue changes

The amount in your business tax reserve account should be regularly adjusted depending on the activities of your business. Variations in revenues and expenses can affect your income tax liabilities. Variations in payroll can affect what you owe in payroll taxes.

You should review tax liabilities throughout the year, and make appropriate changes to your reserves. In particular, you should revisit this if there have been significant changes to earnings, expenses or payroll. In addition, you should also keep abreast of changes to federal, state and local tax laws and adjust your reserves accordingly.

Quarterly estimated tax payment timing

Federal estimated tax payments are generally due four times a year, according to the following schedule:

• April 15th
• June 15th
• September 15th
• January 15th of the following year

If your organization has a fiscal year that is not based on the calendar year, your schedule may differ. If the due date falls on a weekend or national holiday, your tax payment will be due on the next business day following the normal due date.

In any case, you should check the payment schedule at least annually to make sure it hasn’t changed. If you have to make estimated payments for state and local taxes, you should check with the relevant tax authority to see if their schedule conforms with the federal schedule.

Payroll tax reserves for employers

As many variables go into determining estimated taxes, payroll tax payments are even more complicated.

Part of this is because they include both employee tax withholding and the employer contributions to Social Security, Medicare and unemployment taxes. Since these are based on the size and composition of your payroll, they can change every time you add or subtract an employee or grant raises and bonuses.

Payroll tax payments may have to be made monthly, semi-weekly or even daily. You should check to see which schedule applies to your business. These payroll deposits must be made by electronic funds transfers (EFTs), so you should make sure your business tax reserve account is set up with the appropriate instructions.

Note that in addition to the payments you have to make, there are IRS reporting requirements to meet. These include details on employee compensation and tax payments. Filing these reports should be integrated with the payroll function of your organization to make sure everything flows smoothly.

All of the above pertains to federal payroll tax requirements. You should also check to see whether you have similar state and local requirements to meet.

Where to keep a business reserve account

As you build up reserves to pay business taxes, you should make sure those reserves are kept somewhere that can provide safety and liquidity.

For many small businesses, a deposit account at an FDIC-insured bank can be a good place to house a tax reserve account. The federal deposit insurance available from these accounts provides absolute safety for amounts up to $250,000 at each institution.

The $250,000 limit applies to all deposits any one person or entity has at a bank. So, if your total deposits exceed $250,000, you may want to spread them among multiple banks or use other instruments such as short-term government securities for cash management. If your business is a sole proprietorship, any personal accounts you have at a bank will count towards that limit in addition to any of your business accounts at that bank.

There are more than 4,000 FDIC member banks, so you’ll have plenty of choice. To find one that best suits your needs, consider the following:

• Any fees your accounts will incur
• The interest rate offered on deposits
• Operational efficiency for handling frequent transfers in and out of a business reserve account
• Mobile apps and online tools that will help you manage your organization’s cash flow

Be advised that not all products offered by FDIC-member banks are eligible for deposit insurance. Below are some examples of accounts that are covered, and some of the key characteristics of each type of account.

Business savings account

Business savings accounts are not designed for frequent transactions, but they may be well suited for more periodic needs such as quarterly estimated tax payments.

There are plenty of savings accounts that don’t charge monthly maintenance fees, which can save you money. On the other side of the ledger, savings accounts offer interest rates that allow you to earn some money on your reserves while you’re waiting to put them to use. Savings account interest rates vary greatly from one institution to the next, so be sure to shop around for a bank that will give you a competitive return on your money.

Business money market account

Money market accounts operate much the way that savings accounts do. They aren’t meant for frequent transactions, but they can offer competitive interest rates on money you won’t need to draw from more than a few times a month.

As with savings accounts, monthly maintenance fees can be avoided when choosing a money market account, so this is an important consideration. Interest rates on money market accounts are generally comparable with those on savings accounts and they can vary a great deal from one bank to another. So, you might want to consider both savings and money market accounts when shopping around for the best rate.

Be advised that money market accounts are different from money market mutual funds. Though they are backed by similar types of investments, the key distinction is that money market bank accounts are covered by FDIC insurance, while money market funds are not.

Separate business checking account

While a savings or money market account can help you earn a competitive interest rate on business tax reserves that you tap into less often, a checking account may be a better choice for more frequent transactions like paying payroll taxes.

Checking accounts are more likely than savings accounts to charge a monthly fee, but these can be avoided. There are several free checking accounts, and many banks will waive the fee if you have a sufficient amount on deposit. When choosing a business checking account, consider whether there is a monthly fee and if there is, whether your account is likely to qualify for a fee waiver.

Other fees, including transaction and overdraft fees, may also be relevant. If your account is being set up to handle frequent transactions, making sure electronic transfers can be handled efficiently and cost-effectively is key.

Note that checking account interest rates are generally negligible when compared to savings and money market rates. So, this should be a secondary consideration when choosing a business checking account.

How to set up a tax reserve system

Here are some tips to keep in mind when setting up a process for handling business tax reserves:

• Keep money for tax payments separate from funds for other business purposes
• Set up a schedule for transfers out of the account, based on the relevant tax deadlines
• Base your funding of the reserve account on staying ahead of the schedule of transfers out of the account
• Implement recordkeeping procedures that meet IRS guidelines
• Use an app or software system to track the details of each transaction, including date, amount and reason for each transaction
• Regularly reconcile your records with the bank ledger for the account
• Work closely with your tax advisor to make sure the account keeps up with changes in your tax liabilities

Common business reserve account mistakes

Experience may be the best teacher, but it can also be an expensive way to learn. The following list of common mistakes people make when handling business reserves can help you learn from the experiences of other businesses rather than having to make these mistakes yourself:

• Mixing tax reserves with daily operating cash. This can increase the risk of not having sufficient cash to meet your tax obligations.
• Using payroll tax reserves for other purposes. Payroll tax payments occur frequently, so resist the temptation to tap into these reserves for other needs.
• Missing relevant estimated tax payment or payroll tax deposit deadlines. Missed tax deadlines can result in costly penalties.
• Not accounting for state or local tax obligations. These may be smaller than federal taxes, but they still represent significant payments that have to be made on time.
• Ignoring the cost of fees in your reserve accounts. Besides being an additional expense, fees can jeopardize the availability of sufficient funds when the time comes.
• Failing to recognize FDIC deposit limits. The $250,000 limit applies to all deposits you have at a bank, including personal assets if you’re a sole proprietor.
• Not optimizing return on reserves while they are waiting to be used. Choose the appropriate type of account for your needs, and then shop for competitive interest rates for that type of account.

Next steps for building a business reserve account

Here are some steps to take to set up a business tax reserve account:

• Work with your tax advisor to identify upcoming estimated tax and payroll tax payment amounts and deadlines
• Choose the right kind of business account (or multiple accounts) for these needs
• Shop for the most cost-effective account for each type of reserves
• Set up an accounting system that will allow you to accumulate sufficient reserves in advance of each deadline and keep track of meeting those deadlines
• Periodically review your choices based on the performance of the accounts and changing needs

Managing tax reserves may not seem like a primary business priority, but it’s a detail that can either cost or save your organization money. That impact on your profit margin makes it a detail not to be overlooked.

Frequently asked questions