Profit and Uncle Sam

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This is the tenth article on “profitability”—a guide to help understand and develop the true significance of its impact on a business: revenue growth, peace of mind and freedom to do about whatever you want to do.

 

It’s November and Jimmy has worked hard all year.  He has done everything right and the numbers reflect it.  Profit is the highest it has been in the history of the company.  He is excited and tells his outside CPA the good news and then the next week he gets the call.  His CPA is projecting that he will owe an additional $300,000 in taxes on his profit of $1.1M.  Jim believes in paying his fair share of taxes; but not his and his neighborhood too!  What does he do?

Jimmy’s choices are:

  • Bite the bullet and pay the taxes – painful as it will be
  • Buy some assets he doesn’t necessarily need but may need in the future and maximize the $500,000 accelerated tax deduction.
  • Pay bonuses to his employees and key team members, lowering his profit
  • Do some other tax strategy that lowers profit and takes money out of the company

There is no pat answer – it really depends.  Here are the pros and cons for each one of these

  • Bite the bullet – this hurts but isn’t a bad strategy.  What his key balance sheet ratios are and what he expects to do in growth for the next 12-36 months will pretty much define what he needs to do.
    • $1.1M in profit less $300,000 in taxes (assuming a distribution to do this) will add $800K in equity to the business.  That may be the very correct thing to do.
  • Buy assets – this is a great strategy if you need the assets, then the next decision is will you pay cash for the assets, borrow for them or do some combination?  Do you want to spend 250K-$500K in cash to guy the assets of finance them?  Will the debt service of the new debt impede future revenue growth?
  • Pay bonuses – this is a great way to get rid of profit; but if you pay large bonuses to get rid of profit what will the expectation be next year?  $1.1M in profit less $500K in bonuses lowers taxable profit to $600K, cuts the tax bill about in half and lowers how much your equity increases.
  • Do some other tax strategy to get your profit down.  Answers are same as those above.

The successful businesses I work with will do everything they can to decrease their tax bill; but yet do everything they can to keep the money in the company to support growth.  But overall, the correct answer is – it depends.  It depends on your current balance sheet structure, the future growth of the company and other issues we haven’t even discussed in this article.

Make as much money as you can and then call me about your taxes.

 

Dan Lacy

The Business Growth Coach