By Greg Crabtree, an EO Atlanta member and CEO of Crabtree, Rowe and Berger, PC.
The old saying “nothing in life is free” couldn’t be more true when it comes to taxes. For every deduction or credit, you give up something. If your goal is to build wealth, not paying your taxes might hinder that plan.
Believe it or not, the size of the check you write to the IRS is the best key performance indicator of true wealth creation. That may be an odd statement coming from a CPA, but I have seen so many wasted dollars spent to save taxes. It prevents business owners from building wealth that will sustain them.
If you, as a small business owner, take every conceivable deduction, you’d have to spend the maximum allowable amounts on retirement contributions, tuition, health insurance premiums, energy-saving measures, and whatever else you can dig up to qualify for all those deductions. Sure, you’d save on taxes, but after all that spending, you wouldn’t have enough to live on. Here are some other tips to consider regarding saving money:
- Hit your profit target, get your consumption under control, and then fund your retirement. I am all for saving for retirement, but if you are in the beginning stages of your business, you can hardly afford to take the maximum allowable contributions out of your business or starve your take-home. Entrepreneurs often have a panic attack after meeting with a financial planner because they realize they do not have any retirement. They take crucial working capital out of their business to start aggressively funding retirement plans. Without fixing the primary problems of not being as profitable as you need to be or overspending, they set themselves up for emergency withdrawals of their retirement contributions. They not only pay tax on the withdrawals, but they also owe a 10 percent penalty if they are not yet age 59½.
- Don’t let the tax saving lure you into a low-value decision. To get the maximum energy credit of US$1,500, you have to spend US$7,500; and to get the maximum lifetime learning credit of US$400, you have to spend US$2,000. You still spent US$6,000 net cash out of your available funds for the energy credit and US$1,600 for the lifetime learning credit. If cash is tight, these expenditures can usually wait.
- Spend only on expenses that help you make money, not cut taxes. You can deduct business expenses from your income, but those entertainment expenses you cleverly run through your business are only 50 percent deductible. Assuming you don’t get them thrown out in an audit, you are only saving 17.5 percent in tax, at best (that’s half of the top tax rate, since the expenses are only 50 percent deductible). So that US$200 bottle of wine that you splurged on to stick it to the IRS saved you a whopping US$35 in tax. If you hadn’t bought the wine, you’d still have the US$200 less your tax rate, which is US$120 if you pay 40 percent taxes.
- If you are not paying any taxes, you either cheated or you did not make any income (this is bad.). Every tax benefit comes with a cost. You must generate income that you will owe taxes on.
When you buy into the fact that paying taxes is necessary, you have to adjust your consumption so you can live on less than your after-tax net income. Don’t pay more in taxes than you should, but those so-called tax benefits can be traps that keep you from reaching your wealth-building goals.