What is a tax reserve?

A tax reserve is money set aside specifically to pay future tax obligations, ensuring funds are available when taxes are due. For professional service firm owners receiving pass-through income without withholding, tax reserves prevent cash crunches at payment deadlines.

Key characteristics

• Funds designated for taxes

• Set aside from income

• Available for quarterly payments

• Prevents payment problems

• Should match expected liability

• Separate account recommended

Why it matters for professional service firms

Without tax reserves, estimated payments, and year-end taxes, cash crunches can occur. Pass-through income is not subject to withholding, making reserves essential. Professional service firm owners should reserve 25% to 35% of profits for taxes, kept in a separate account.

Real-world example

Tom earned $320,000 through his S corporation with minimal withholding. Tax reserve practice: transferred 30% of distributions ($96,000) to a separate savings account. Quarterly estimated payments came from the reserve. When taxes totaled $94,000, funds were available without impacting operations. Reserve account prevented tax payment stress.