"You can only build wealth with "after tax" income."
- Craig Crabtree
Every business owner knows the drill; we made a profit this year so we need to spend our cash to save on taxes. I want to challenge you to think differently this year to "save cash" not "save taxes."
The inherent flaw in spending your cash is that you have to spend a dollar to save 40 cents in tax. Last time I checked, that just seems like a bad idea. Every year, you come up with every excuse to go ahead and spend money that you think you would have spent anyway. You buy new computers, you buy some extra supplies that you always use, buy a new vehicle because you heard you can "write it off."
My argument is that if you did without all of those costs up to December, maybe you did not need to spend it after all! My most successful entrepreneurs spend a dollar at the last possible moment it is needed.
Build Wealth or Save Taxes?
You can only build wealth from "after-tax" income, so every attempt to lower your taxes lowers your ability to create wealth. The number one key performance indicator of wealth creation is "how big of a check did your write to the IRS." If you did not write a big check, you either cheated or you did not make any money, both are bad. Do not pay more taxes than you should, but you should be focused on building wealth above savings taxes.
What if I am Cash Basis? For those of you who are cash basis businesses, you can easily fall into the trap of draining your cash paying off vendors at year end. While this seems enticing, you eventually take it to the illogical extreme and have such a huge amount pushed forward it causes you to make sloppy decisions at year end. Here are just a few of the issues that you could encounter:
- Bank financing - Your year-end financials are more important than ever
these days. By focusing on taxes instead of good business fundamentals,
you distort your balance sheet at year end and spend the next year explaining
why your balance sheet looks bad at December so you can get your line of
credit or bonding renewed.
- Missed Opportunities - Because you dumped all of your cash in
December, it takes longer than you think to build it back in January and
February. By not having cash available to start new projects, you delay or
miss out on new opportunities. To delay acting on an opportunity wastes a
day of potential productivity that can never be recovered.
- "Deferring Taxes" versus "Saving Taxes" -
Did you really save taxes or did you just defer them? Be
honest with your language when you spend your year-end cash. It is not
saving taxes unless you are saving at a high rate this year and you pay a
lower rate in the future. Not likely to happen. Most entrepreneurs defer
taxes at year end and push their rates down into the lower brackets to end
up paying at a much higher rate in the future when they have kicked the
can as far down the road as they can.
- Borrowing money to finance that year end equipment purchase - This is
the ultimate tax trap. You borrow $100,000 to buy that new piece of
equipment (that could have been delayed) and you end up taking the
expensing election on the equipment. Inevitably, this purchase pushes you
down into the 20% or lower bracket. The only way to repay debt is to make
after-tax profit. To make enough profit to repay the loan, it pushes you
into the higher brackets and you end up paying close to 40% tax to
generate enough cash flow to get out of debt (if you are lucky). The
politicians (and most tax advisors) are not doing you a favor to trap you
into this bad decision by calling this a tax break.
Please heed Mr. Crabtree's advice -
especially the part about kicking the can down the road. Saving on taxes this
year by buying non-essential things or incurring non-essential expenses only
costs you more and pushes the inevitable down the road.
Don't make financial decisions about your
business or your personal finance based on avoiding taxes. You can't build
wealth unless you pay taxes.
All the best,
Rick Wallace
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