How to Pay Less in Taxes
I founded Chicago School Supply in 2006, and today the company has about $2 million a year in sales. I'm working hard and running a profitable business, but I'm barely making a living. Every April, we face tax bills that I have trouble paying because we're short on cash. Our accounting firm does our taxes but doesn't provide advice on how to maximize our profit and minimize our tax burden. I'd love to hire a CFO, but we can't afford one. How do I find a financial adviser who understands my needs?
-- Michael Ockrim, CEO, Chicago School Supply
Tax preparation is a chore most business people would rather leave to an outside accounting firm. They turn over their papers at the end of the year and hope for the best. When they wind up with a tax bill that is higher than they expected or can easily afford to pay, they blame the firm. But it's your responsibility and nobody else's to do tax planning for your business. You ignore that responsibility at your peril.
That's more or less what I told Michael Ockrim. He obviously needs tax planning, but it is important that he learn how to do it himself. I asked him how his company was organized. He said it was an LLC operating on cash-basis, rather than accrual, accounting. The question was, How could he defer some of the taxes he owed and give himself extra cash that he could use to build his business?
To begin with, he needs to start his planning process early enough to allow him to end the year with as little cash profit as possible. That's the idea if you have a young company using cash-basis accounting. I gave him a hypothetical -- and oversimplified -- example, just so he'd have a general idea of how it works. Let's suppose that you finished last year with $20,000 in cash. If you end this year with $50,000 (not including new capital you may have added during the year), you'll have a cash profit of $30,000 on which you'll owe taxes -- assuming, that is, you didn't buy depreciable equipment or software.
With planning, however, you can reduce your taxable income by, say, paying in advance bills for expenses you've incurred this year but would normally pay next year. Conversely, you can scale back your efforts to collect receivables for a month or so. You'll wind up with less cash at the end of December but more cash the following month.
In doing your planning, you need to be aware of some important nuances. Let's say, for example, that you bought $25,000 in software or equipment during the year, and it gets amortized over five years. That means only $5,000 of the cost can be deducted this year. The remaining $20,000 is added back to your taxable cash balance, as in the example above. You may be able to offset that amount, however, by borrowing money and using it to prepay expenses you've incurred but not yet paid for. Any new capital you put into the business isn't counted as taxable income.
To be sure, the taxes you defer will eventually have to be paid. But early on, you can usually keep your taxes low. I told Michael that he should look for someone knowledgeable about these matters to review his financial statements and guide him until he gets the hang of it. He should also meet with his outside accountants in September or October each year to get their suggestions about minimizing his tax burden for the year.
Please send all questions to AskNorm@inc.com. Norm Brodsky is a veteran entrepreneur. His co-author is editor-at-large Bo Burlingham. Their book, The Knack, is now available in paperback under the title Street Smarts: An All-Purpose Tool Kit for Entrepreneurs.
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