Don’t let that tax tail wag the (business) dog!

by | Jul 17, 2023 | Business, Taxes

I recently had a very productive conversation with a lender contact of mine as we hone in on service offerings for newly formed T&O Strategic Advisory. This conversation is what inspired this article.

Imagine that you are looking for a new job, and after all the hard work and experiences you have had, you finally get that really nice salary offer, with sign-on bonus and benefits…But you ask your prospective employer to lower the offer because-get this-you don’t want to pay more taxes! Now, deferred compensation plans for high income earners is a legitimate tax planning technique, however, the scenario in which you ask your employer to lower you salary for tax purposes or worse yet-falsify your W-2 to lower it artificially sounds insane-right? When we are employed by someone else we begrudgingly accept that taxes will be taken out of our paycheck, even if it’s tens of thousands of dollars.

However, we see this all the time as tax professionals (and bankers, and mortgage underwriters). When you are a business owner, suddenly, that Schedule C becomes an invite for folks to either write off everything they can think of (whether legitimate or not) or understate their income for the sole purpose of not paying taxes.

As one of my colleagues on LinkedIn aptly noted-a tax deduction that everyone is so hung up on is like a coupon-it lowers your taxable income, but since your taxes are a fraction of the income, so are the savings from the deduction.

The cost of artificially understating your income or overstating your expenses, aside from the obvious fact that it’s illegal and may cost you thousands in back taxes, penalties and fees (tax debt resolution work is not cheap folks!), is that it will have long-lasting ramifications when it comes to obtaining debt financing, a mortgage and yes, it affects your retirement!

Just like income verification allows lenders to ensure that you can afford to borrow the money and pay it back, your Schedule C serves as a verification of how profitable your business is.

For most investors and lenders, your EBITDA (earnings before interest, taxes, depreciation and amortization) is what’s really important. Your tax return is an official way to verify your earnings, just like W-2 is an official way to verify your salary. You can provide all the financials and projections until the cows come home, but it’s the tax return that’s going to make or break a decision for the bank or the mortgage broker a lot of times.

What happens when you consistently understate your income? More often than not, you don’t have enough income to justify getting a line of credit for your business, or a mortgage to purchase a home. Moreover, just like your W-2 salary, your earned income from business determines your social security benefits. The nasty surprise that awaits a lot of business owners who spent years worrying about paying 20-30% of their income in taxes, find themselves in a bind when their social security benefits are so slim, they can’t retire.

Next time you hear someone on Tik Tok tell you that you can write off that proverbial G-wagon, or some other ridiculous way to not pay taxes, ask yourself-does this decision, this purchase, this expense make financial sense?

Start thinking about things like-your pricing, your profit margins, and yes your EBITDA, and then consult a tax professional to see what you can do to minimize your tax burden. Minimize doesn’t mean eliminate. Make your estimated tax payments so that you are not facing a large lump sum of money in April, or at least put it aside, and when you have a large tax bill-congratulations-you have made a lot of money! You are a successful business owner-got get that line of credit, buy that dream home and grow your business!