I understand everyone dislikes paying taxes. Some business owners will do almost anything to avoid paying money to the IRS.
For this moment, let's shift our perspective.
What if paying taxes were a good thing?
Well, it actually is a good thing because the higher your tax bill, the better your business is doing.
Don't get me wrong: tax minimization is a good thing, too. But some organizations take it too far and actually end up hurting the business.
The Truth: You can’t create legitimate wealth from an operating business unless you pay taxes on profits.
Resist Spending Money as a Tax-Saving Strategy
Usually when a company goes on a spending spree at the end of the tax year, it often means they are spending money to increase deductions or are engaging in acquiring assets to reduce a tax burden.
Beware of being lured into using this tax-saving strategy because you will pay less in taxes—but you will not build wealth.
True wealth is created only with after-tax profit. If you do not pay taxes you have not created wealth.
Let’s take a closer look at how this money-saving strategy is often misapplied, using round numbers.
Burning Cash. Taking on Debt.
Historically, the average corporate effective tax rate has been about 29 percent due to various tax credits, deductions, exemptions, preferential rates and loopholes that reduced the actual, applicable tax rate and the amount of profit available for taxation.
Using a tax rate of 29 percent for the 2017 tax year, say a business owner has $100,000 in profit that they don’t want to pay taxes on. So, they take that money and spend it on [whatever their company is buying] to increase deductions and lower taxes.
They essentially get rid of $100,000 of profit so they don’t have to pay taxes.
$71,000 of after-tax money was spent, that could have been used to build wealth, so that $29,000 in taxes could be avoided.
Resist the temptation to spend $1 in order to save 29 cents in taxes by rationalizing, “The government pays for 29% of the costs of [whatever we are buying].”
Another scenario is a business owner has $100,000 in profit. To avoid paying taxes they buy a piece of capital equipment, and take on new debt.
Debt is generally not your friend and will enslave your business if not managed properly.
Term debt can be used to spread the cost of long-term assets over their useful life.
But, avoid falling in to the trap of using debt to buy an asset at year’s end to save on taxes unless assets purchased are CRITICAL to improving profitability.
I see this all the time, where business owners spend more money than they should at the end of the year as a tax saving strategy, and they deplete their cash or take on burdensome debt.
Spending money to lower taxes makes sense if done in a smart way.
It Happened to Me
Twenty-five years ago, before I knew better, I used to practice these same tax-saving strategies to lower our company's tax burden.
These actions emptied out our bank account, and it took many months for us to financially recover the cash we needed to easily pay our short-term obligations.
The "kicker" is our CPA strongly encouraged us to spend money to increase our deductions, get tax credits, and lower taxes. I was young, naive, and did what I was told.
I take full responsibility for my ignorance, at that time. This is one of those mistakes and lessons learned that gave me wisdom to pass along to my clients, so they don't make the same mistakes.
If you don’t spend to save taxes you will generate real after-tax wealth that helps pay business owners' salaries, helps the company stay flush with cash, and stay in better financial condition.
This advice is different from what many business owners hear from their CPAs.
But, think about it: CPAs are hired to help plan tax strategy, minimize taxes paid, and prepare tax returns. They're doing what they are hired to do; if they've reduced your tax burden they've done their job.
But in the wake of these "tax saving" actions, some business owners are left having to navigate choppy waters because of cash flow and debt issues, and painfully experience the associated stress and worry that go along with that.
No one "likes" to pay taxes. I don't like to pay taxes.
But I realize that 1) spending money to increase deductions, 2) spending money to make smart investments that are critical to increasing profitability, and 3) preserving profits to increase wealth all must be considered, and balanced, when making decisions about how much money to spend to minimize taxes.
Ultimate responsibility for making money decisions always falls on a company leader's shoulders, and "not knowing" isn't enough to shift the blame or responsibility to CPAs.
However, I do think some CPAs would better-serve business owners if they would emphasize that true wealth is created only with after-tax profit. If you do not pay taxes, you therefore, will not have profit to create wealth.
Minimize taxes to the greatest extent possible that makes sense in a wicked smart way.
To create wealth don’t focus so hard on not paying taxes. Focus on increasing profits.
DISCLAIMER: I AM NOT A CPA OR ACCOUNTING PROFESSIONAL. I AM SHARING INFORMATION LEARNED FROM EXPERIENCE. CHECK WITH YOUR CPA, ACCOUNTANT OR PROFESSIONAL FINANCIAL ADVISER TO DETERMINE THE BEST ACTIONS FOR YOUR SPECIFIC SITUATION OR BEFORE ACTING ON THIS INFORMATION. YOU AGREE THAT OUR COMPANY IS NOT RESPONSIBLE FOR THE SUCCESS OR FAILURE OF YOUR BUSINESS DECISIONS RELATING TO ANY INFORMATION PRESENTED BY OUR COMPANY.