The Business Owner's Biggest Tax Trap

Talking with a prospective client recently, I received an all too familiar response to my question, “Do you currently obtain annual tax planning advice?” The almost universal answer is…. “My tax person tells me how much I need to spend on new equipment to pay no tax each year.”In the last two years, the client had spent $200,000 on equipment to avoid paying current income tax. That’s $200,000 of cash out the door. Now he finds himself in the middle of a global health pandemic. Due to a government-ordered shutdown, his business had to close its doors. He’s laid off his entire team and has struggled through to pay reduced rent and other essential costs so as not to lose his business.

If instead of $200,000 of new equipment, if he’d only spent the $50,000, he really needed to replace his old machinery, his cash account would be $150,000, less the tax cost, higher. So how much would he have paid in tax? During 2018 and 2019 his tax combined rate, federal and state, was only 18%. So not spending the $150,000 would have cost him exactly $27,000. The bank account boost possible without unnecessary spending? $123,000! Enough to save his business.

This kind of nonsense drives me crazy.

So why is this kind of bad advice so universal?

It’s all about what questions we ask. The CPA and the business owner are caught in a trap, that says, the best outcome is not to write a check. CPAs and business owners are focused on one question, how big a check must I write?

But how can this lead to a great outcome? No check to the IRS means no income. No income means no wealth creation. No wealth creation means short- and long-term goals are on hold, maybe never to happen. In addition, it leaves your business cash-poor, unable to weather the winds of change that come with hard times. By asking the wrong question, you jeopardize your most precious and valuable asset, your business.

The question you need to ask is, how do I create the most wealth?

From this question, the financial health of the business and the owner are paramount. Of course, your goal is to pay the least tax possible, over your lifetime. We are in one of the lowest tax environments of my 37-year career as a CPA. The deficits created pre-2020 were already approaching insanity. Now add the increase in the deficit from COVID spending. What direction do you think taxes are heading?

It is impossible to build wealth without paying taxes. Taxes are on sale, so buy now. Focus your time and energy on making your business as profitable as possible. Then engage a CPA who looks at your tax expense through a wealth creation lens and enjoy watching your wealth grow.