Is the Tail Wagging the Dog When It Comes to Your Taxes?
The U.S. Tax Code is overwhelming and a bit disorienting, causing misconceptions that leave most people clinging to a single number—the amount they pay or receive back from the IRS at the end of the year. Out of this comes the mother of all misconceptions—the myth of spending more to save more.
The IRS allows business owners to subtract large equipment and other big purchases from their taxable income through deductions and expenses—quick-hit ways to reduce their tax bills. So when business owners purchase assets like equipment and other property in order to reduce their tax bill, they think they’re making a smart move.
Maybe it is a smart move, but only if they need that equipment. While these purchases certainly reduce a tax bill, the reduction is not a dollar saved for every dollar spent. Usually it’s closer to spending a dollar to save 40 or 50 cents. You may save 40 or 50 cents, but you could save the whole dollar if you don’t buy equipment you don’t need.
It’s like going to the grocery store with a book of coupons to save money but ending up with extra items that aren’t on your list. If you’d have stuck to your list, you’d have saved even more money. Truly, a penny saved is a penny earned.
Expenses and deductions are meant to help small businesses and stimulate the economy, of course, but they’re not Santa Claus. If you have a plan to purchase necessary equipment that will expand or benefit the business long term, then purchasing the equipment in a year when you need increased tax relief is a fine idea.
But notice, in this situation as with the grocery list analogy, what’s guiding things is a plan. Your grocery list has items that you would buy whether or not they’re on sale, because you need them.
While the Treasury is not out to pick a fight with you or out to “get” you, its deductions, benefits, exemptions, etc., are never free or foolproof. There is always an exchange that benefits the Treasury. It’s up to you to discern whether this or that provision can be of use to you, too.
So many clients come to Addicus having previously channeled hundreds of thousands of dollars into environments or plans where the money is highly restricted for the sake of saving taxes.
It may not be worth it. Often times clients may be saving taxes, but they’re locking up too many dollars that can’t be utilized to fulfill and support the main operating business of objectives. They are missing out on tremendous economic opportunity out of fear of their tax bill.
Making frivolous purchases for the sake of a tax break is letting the tax tail wag the dog. In fact, so is any short-term move that doesn’t fit into an overall tax strategy, and so is any overall tax strategy that isn’t considered within the context of your total PFE. Tax and tax mitigation planning should be woven around your PFE—your plans for your life, your family, your business—not the other way around.
Too often, tax advisors who seek to mitigate taxation accidently work against the objectives of your PFE. Again, this usually isn’t their fault. They’re doing what they can without having the total picture. It’s your responsibility to make sure your tax plan, the goal of which is to reduce taxes as much as possible, gives the right of way to the big-picture objectives of your PFE—whether those goals are economic or otherwise.
By implementing a complete plan, you can accomplish all of your goals and desires, and mitigated taxes will be a natural byproduct of a well-run PFE.