Many small business owners inevitably review their financial statements at the end of the year and look for deductions to minimize taxable profit, thereby reducing taxes owed. Taking deductions to legally reduce income, and therefore tax liabilities, probably seems like an ideal strategy, but it may actually limit your company’s ability to grow in the future.
Whereas tax evasion is illegal, tax avoidance is not. A recent poll indicated that many people do not see a moral distinction between the two, but we’re not talking about the mega corporations of the world paying minimal taxes by taking advantage of legal loopholes. For most mainstreet business owners, an optimal tax strategy involves 3 things:
- Reducing taxable income
- Optimizing the business for deductions and credits
- Timing income and expenditures to your benefit
For small businesses, these strategies don’t play out to some sinister end. Rather, tax avoidance can be something as simple as timing the purchase of new equipment to reduce profit—and therefore the taxable income. So if we’re not talking immoral behaviors, then where does the problem come in for your business?
The problem comes when tax avoidance practices don’t take future needs into account. Take the example above. It’s a common scenario we see here at Magnolia Financial that a business owner gets to the end of the year and realizes they’ve got more profit than they had planned. Rather than losing that money to Uncle Sam, they look for deductions to reduce their profit.
Seems simple, but the problem here is that business owners often forget that paying taxes mean you’re making money. We’ve discussed the difference between Cash Flow and Profit before, and stressed the importance of Cash Flow, but profit is just as important to banks. If your company doesn’t show enough historical profit and cash flow, the bank likely will not be able to make the loan you need to grow your business. The little money you save by not paying taxes can mean losing access to that larger bank line of credit you need down the road.
As the year comes to an end, be sure to consult your CPA or Tax Advisor as they may help you realize that paying more taxes may end up helping your business in the long run.