What is one way to get the attention of a small business owner? Talking about taxes! Every year, businesses go through several rounds of reporting taxes to various entities. From sales taxes, income taxes to property taxes and employment taxes, the “T” word is a sensitive topic for small business owners. While transparent and legitimate reporting of taxes is certainly sustainable business practice, passive financial management can lead small businesses to pay more taxes than necessary. Hear me out.
Here is a simple example. Tom, a brewmaster and microbrewery owner in upstate New York, recognized that part of his brewing system was aging and needed to immediately replace several storage tanks and expand his capacity by purchasing other equipment, which would roughly cost him $50,000. With the new equipment, he expects to grow his business further.
Because of his propensity for staying out of debt, Tom pays for the equipment with cash, and feels pretty good. Yet, things don’t work out as planned, and Tom eventually finds himself short on working capital (tightened cash flow) leading to much stress, which leads to less than optimal management decisions, and reliance on credit cards for his business and personal expenses; in addition, at tax season, Tom realizes that his $50,000 out of pocket expense gave him zero deductions on taxes, because it was a capital expense. Equipment with a life of more than a year is considered an asset, and cannot be deducted from taxes. His decision to pay the equipment in cash turned out to be more painful and less profitable.
It’s unfortunate, but Tom’s story is not uncommon. An alternative, savvier decision he could have made, was to seek out for small business loans and/or alternative financing for his purchases. By financing his capital expense with a loan, Tom can have more flexibility in choosing his equipment while considering his cash flow, and achieve the cash cushion he may need for bumps along his pathway to growth. Even more, use that cash to deliver even better returns for the company.
Lastly, interest expenses incurred from the loan is tax deductible (Hooray!), in addition to the depreciation expense from the assets. Although the amount of tax saved will vary accordingly, a little bit of research on loans, the bottom-line, and taxes will help small business owners to make a better decision.
Disclaimer: LVRG, LLC. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.