Flipping that calendar to December seems to trigger a single question in the minds of many entrepreneurs.
How can I lower my end of year tax bill?
Often the second thought is on the first one’s heels.
I know! I’ll buy something!
If you have this thought, then congratulations! You must have had a great year. But before you look for ways to spend away your tax bill, there are some things to consider.
Needs vs. wants
The temptation to go out and get that shiny new widget is hard to resist, but you must really need it to make your business grow.
Let’s look at an example.
A general contractor has an aging piece of equipment he needs to be efficient, complete jobs on time, and make customers happy. Unfortunately, it is beginning to break down and cost money in downtime.
This might be an excellent place to spend money to try and reduce the tax bill. It will shorten project times, reduce downtime, and create the opportunity to complete even more jobs.
But if the equipment is working and purchasing a new one would not really improve business, then buying a replacement could be a waste of money.
The actual cost of needs vs. wants
Let’s say our contractor is in the 25% tax bracket. That means for every $100 spent on new equipment, his tax bill will be lowered by $25.
If the purchase is $50,000, he saves about $12,500 in taxes. So the difference in the purchase cost and the tax savings is $37,500.
Suppose he can determine that the purchase will compensate for downtime, lost opportunities, and customer referrals. In that case, he can justify the expense.
If not, he would be better off paying the taxes.
Because that purchase won’t make money, and his $37,500 is gone. All of it.
Our contractor just spent $50,000 to save $12,500.
Alternative ways to save
There are other ways to lessen your tax bill that might be more beneficial than buying something. One of the easiest is to save for retirement. Opening a traditional or Roth IRA can lower your tax bill right away or later when you retire.
You can contribute up to $6,000 per year to an IRA before age 50 and $7,000 after the half-century mark.
Many business owners have high deductible health plans that allow them to start a Health Savings Account. These vehicles are like personal saving accounts that can be used for health-related expenses. Individuals can contribute $3,650 per year tax-free, and families can contribute $7,300.
You may even look into making your business an S-corporation. This incorporation tool allows your business to have up to 100 shareholders or as few as one. Paying dividends to yourself instead of having your full business salary taxed may be a way to save some money on taxes.
Saving on business taxes is a complex issue. So, it’s best to get some help.
For now, pat yourself on the back for doing a great job. Then head down to your accountant and business advisor for the best way to lower your tax bill.
Those two things will go a long way in giving you time to think before you buy.