This is a question that clients frequently ask their tax preparer. It is both easy and difficult to answer depending on who asks it and when they ask it. Unfortunately, all too often it is asked just before the April 15th tax filing deadline. While there may be an option or two at this point to save some income tax, most of the savings have passed. There are many choices taxpayers have to reduce their tax liability, and with a little forethought and planning, these choices pay off.
Unless it is absolutely necessary, buying a new truck on December 30th isn’t usually the best option for saving on income taxes in April. Actually, it is usually the worst option, but this has been a “tax savings” scenario used by many in the past. Here’s why it’s usually a false savings purchase: when you think about spending money on your business, think of that money as an investment and how that investment is going to repay you in the future. Yes, a new truck can be an investment, but if we are honest with ourselves, it is usually more of an indulgence.
Let’s say your business needs a new truck. The old one just died, or business is growing and you need another truck. This is good news! This truck will enable you to hire a second crew and work twice as hard. This can be a good investment or at least a necessary one. In our professional experience, this isn’t the scenario that usually plays out. The reality is that a business owner wants to pay less tax and wants a new truck. Win-win right?
Not so fast. Let’s say the new truck has a $40,000 price tag. Assuming you can expense the whole vehicle in one year you would save $10,000 in taxes (assuming a federal tax bracket of 25%). Who wouldn’t want to pay $10,000 less in taxes?
There are two options for purchasing the vehicle that potentially cut into those tax savings. Option 1 is to take out a loan to pay for the truck. For the next five years you need to make monthly loan payments that aren’t deductible and reduce your cash flow. In option 2 you pay cash for the truck and deplete your reserves. In either case you have limited your future options in regard to cash flow.
Business owners should be asking themselves this question before every major business purchase, “How will spending this money now help me make more money in the future?” Whether that is buying assets that can increase your production or hiring employees to do the same – there always needs to be an ROI – or we need to ask ourselves why we are working so hard.
If we use our example above, we had $40,000 in cash to spend on a truck. The business must be doing some good things to have an extra $40,000 in the bank. So why waste that effort on a frivolous purchase? Wouldn’t it just be better to pay the $10,000 in tax and take the remaining $30,000 for yourself? Or have the $30,000 to reinvest in your business in the future? With just a little forethought and some planning we can help you grow your business the right way and who knows – maybe you can treat yourself to a new truck as a reward.