"I don't get it. You tell me I owe more taxes because I made more last year. So where's my cash?"
I hear this from my clients all the time. And apparently, it's not just my clients who have this issue.
A recent Spark Business OmniPulse Survey conducted by Research Now found that only 41 percent of small business owners feel confident that they are maximizing their tax benefits this year. So this is part of the problem. But there are other explanations for why you don't have as much cash to pay your taxes as you thought you did. And no, it's not President Obama's fault. It's not (entirely) due to rising taxes rates, less available deductions and sales taxes.
So why do you owe taxes when there's no money in the bank? Here are seven all-too-familiar reasons.
1. You took money out of the business.
Oh yes you did. Remember? You took a distribution early in the year to pay for that new kitchen upgrade in your home. You took another distribution in the fall to take care of your kid's college bill. And during the year you sneaked out a few bucks through petty cash for "walking around money." None of this is illegal. We all do it. But know that the cash you took was not recorded as an expense on your income statement. It was just a distribution. So your income stayed up, but cash went down.
2. You bought capital items.
During the year you bought a few pieces of equipment on sale. You got new computers and tablets for the sales people. You put on a new roof. It's all good and necessary. Except these aren't expenses. They're capital items. The payments went on your balance sheet, not your income statement. You get to take depreciation, of course. But that's spread over a few years, so you're only showing a fraction of the payment you made as a deduction. Even so, the money went out.
3. You have too much inventory.
You bought lots of stuff this year. And you intend to sell it. But you haven't yet. It's still sitting there. Not only on your warehouse floor. But on your balance sheet too. So while you wait for the sales to come, the inventory you purchased (and paid for) is a non-deductible expense until it ships.
4. You have too many receivables and too few payables.
You know that you're not going to collect that invoice from the firm in Florida who promised payment months ago. You're pretty sure that there are a few other open invoices that are questionable because there were quality problems with the shipment to one customer and another customer had concerns about the service. This happens. And whether you're right or wrong, you're still owed the money. Meanwhile, you're paying your bills, right? You make it a practice to meet your obligations in under 30 days so that you've got a good relationship with your suppliers. And that's a good way to be. But not if you're trying to conserve cash.
5. You have debt.
You own your building. That's good. You got it for a great price last year, and now you're paying rent to yourself. But now you've noticed something: Rent is deductible. Mortgage and other debt payments are not. Interest expense is showing up on your income statement. But your principal payment is not. So your cash is going down each time you make that payment. The real estate market might be giving you some benefit. But the IRS isn't.
6. You're not putting money away for retirement.
You can take significant deductions if you just make payments into a retirement plan, like an SEP (Single Employer Pension), 4019k) or even an IRA. But you're not doing that. You're concerned that once you make this payment you can't get access to the money until you retire. (That's not entirely true. You can withdraw the money if you're willing to pay a hefty penalty. You may be able to borrow against it too). Making a pension payment not only reduces your income (and your tax bill), but is also akin to paying yourself. You're just moving money from one account to (albeit a more restricted) another account. You need to do more of this in 2014.
7. You mismanaged your estimated tax payments.
Last year your accountant told you the minimum quarterly payments to be made during the year, and you did what she said. But these aren't deductible. You, like most business owners, probably file an S-Corp return, which means you had to withdraw cash from the business (like a distribution to yourself) and then personally pay in your estimates. The cash came out. But your current year's earnings did not go down.
Now what if you did not pay enough in, even if you made your estimates on time? You failed to meet with your accountant during the middle of the year to see if your estimates should be adjusted. You paid a couple of your estimates late, incurring penalties. And your files are mess. You may be one of the 22 percent from the previously mentioned survey who filed for an extension because you needed more time to get everything together. Underpayment, late payments, disorganization ... it all results in more cash outlays than you planned.
See? You did have a good year last year. You showed profits. But showing profits doesn't always mean you've got the cash left over to pay your taxes. And this past year you were short on the money.
Now that you have this explanation don't you feel better? Yeah, me neither.