Don't Zero Out Profit to Save Taxes

I recently watched a video where a digital marketer shared why he buys so many expensive vehicles and watches. He claimed to have multiple luxury cars. 

His secret is, every month, his accountant tells him how much money he needs to spend to pay zero taxes at the end of the year. He said he claims a tax deduction every time he buys a six-figure car or watch.

As a former tax accountant, the ‘tax advice’ shared in the video made me cringe.

In this article, I’ll share why this is bad business advice, what’s really happening behind the scenes on your tax return and the affect the decision makes on your cashflow.

Before we dive in, I want to address the elephant in the room…yes, I am all for claiming every tax deduction you and your business are entitled to, but I’m not a fan of spending money for the sole purpose of claiming a tax deduction. You must consider the effect on your cashflow.

Why zeroing out profit is bad business advice

1. Drains your cash - The only way to reduce your income taxes is to spend money. When you spend money to save on taxes, you no longer have the money you need to fund your growth plans or pay down your debt. When an opportunity or a problem presents itself, you will not have the cash you need.
2.  Reset your business to zero every year
   When you zero out profit and taxes, you are essentially resetting everything in your business to zero. This is why business owners feel stuck on the hamster wheel.

3.  Bad math
   You’re spending 100% of your cash to save 30% in taxes...that’s bad math.
   
   When you spend money for the sole purpose of saving taxes, it’s like walking up to a slot machine, inserting a $100 bill, and celebrating when you receive $30 back.

4.  Poor financial investment
   Besides the bad math mentioned above, tax advice often relates to buying assets that depreciate in value. Later, if you need the cash, you’ll sell the asset for less than what you paid for it.
   
   A great financial investment is buying assets that serve a business purpose like generating revenue…not just a tax deduction.

5.  Fun money
   Claiming tax deductions is all fun and games until you need to borrow money or sell your company.
   
   Think about it, if your goal is to zero out profit, how will your business show the profit and cashflow that is needed to borrow money or show the value of the company when you are ready to sell.
   
   It’s difficult to normalize your financial statements when you spend money for the purpose of reducing taxes. Loan officers and potential buyers lose trust in financial statements that have a lot of add backs.
   
   You may be thinking…I can explain that wasn’t really a business expense.
   
   This goes beyond IRS rules. Your business needs cash to survive and grow. Stop trying to game the system and be intentional with how you spend the money.

But wait a minute, if it is so bad to zero out profit, then why is my tax accountant encouraging me to spend money?

Think about your relationship with your tax accountant. What do you talk to your tax accountant about? Of course, taxes! You hired them to prepare your tax return and help you save money on taxes.

But, have you shared your growth plans with your tax accountant? Have they created a cashflow projection to make sure you’ll have the money you need to hire a new employee or start a new revenue stream?

This is a classic example of Maslow’s law in action – “If the only tool you have is a hammer, it is tempting to treat everything as if it were a nail.”

It’s natural for your tax accountant to help you save money related to taxes. The problem is there is a disconnect…their viewpoint is limited if they are not involved in other financial matters – setting prices, managing cashflow, and learning about your growth plans.

When your tax accountant advises you to spend money to reduce your taxes, simply ask

• how will this affect my overall cash flow?
• Will I have the money I need to support the business through the slow season?
• Will I have the money I need to fund my growth plans?

Invite your tax accountant into the conversation. This will help you make better financial decisions.

Tax vs Cashflow Viewpoint

When you hear bits and pieces of tax advice, there’s usually more to the story. Numbers need friends to make sense.

First, consider the special rules that apply to company vehicles since they are considered an asset and are depreciated over 5 years. For example, if you buy a car for $100,000, the annual depreciation expense is $20,000 each year for 5 years.

Some vehicles qualify for the Section 179 deduction where you can claim 100% in the first year, but luxury cars have limitations. To keep the example simple, I will use regular depreciation to show what’s happening from a tax and cash flow viewpoint.

Tax viewpoint:

Business claimed a $20,000 tax deduction every year. After 5 years, the car will be fully depreciated. The business claimed $100,000 of depreciation deductions.

Cashflow standpoint:

1^st year

Purchased a vehicle which reduced cash by $100,000

Claimed $20,000 tax deduction x 30% tax rate = $6,000 tax savings

Cash decreased by $94,000

 Years 2 through 5

$6,000 tax savings each year

 After 5 years

Purchased a vehicle which reduced cash by $100,000

Claimed $30,000 tax savings

Cash decreased by $70,000

Notice how you did not save $100,000 in taxes…you only saved $30,000 over a 5-year period.

Instead of spending $100,000 to zero out profit and taxes, what if you paid the $30,000 in taxes and saved the difference of $70,000.

What could you do with an extra $70,000 of cash?

Bottom Line

When you zero our profit to reduce taxes, you’ll get stuck on the hamster wheel.  

One of the ways to shift to a long term, financially strong mindset is to think about taxes the way big companies do.

• They consider taxes to be a cost of doing business…it is not a penalty for being successful.
• They include income taxes in their prices.
• They reserve the money every month so there are no cashflow surprises.
• Big companies list income taxes as an expense on their Profit and Loss Statement so they see true profitability.

Before you spend money to reduce taxes, consider all 3 financial angles - your growth plans, cashflow and tax.

Will the purchase push the company toward our goals?

What will we have to show for the investment five years from now?

You are the financial leader of your company, so invest a little time to make sure you are making the right decision for your business long term.