I recently heard a small business owner weighing options for a business related decision. Both options were viable and both offered a clear cost benefit analysis depending on how she planned to expand her business. A fixed cost arrangement made sense if she planned to grow and expand her business while a per unit cost structure worked best if she planned to remain small and wanted to continue the greater flexibility afforded by her part time arrangement.
Cool, I was pleased to hear that she was thinking… AND thinking about the right things.
That is until she explained that she needed to add more overhead to her operation for tax purposes.
Que the rewind… say what? You need more overheard for tax purposes??
No, you really don’t and the reasons become very obvious once you start to dissect the language.
Over a brew with the uninitiated you might sound very business savy by saying something like this lady said. “I need to grow my overhead in order to maximize my tax write-offs.”
Wow, that kinda sounds smart until you apply a basic English translation over the fancy businessman-speak.
Overhead equals costs or expenses. So “I need to grow my overhead” begins to sound like “I wish I made less profit on my current sales”.
It is true that business expenses are deductible, in fact, business expenses are tax deductions. So if overhead equals business expenses and business expenses equal tax deductions, and transitive properties hold true making overhead equal to deductions. The original statement of “I need more overhead so I’ll have more tax deductions” starts to sound like “I need more expenses so I’ll have more expenses”.
And yes, it does net out as ridiculous as that. Here’s why.
Let’s assume you add $1000 in expenses for the sake of a tax deduction or write-off (with little or no expectation that the expense is an investment in the actual growth of the business). And, for the sake of round numbers and illustrative purposes, you were in a 40% tax bracket. You would be entitled to write off your $1000 expense in exchange for a 40% or $400 tax deduction.
…wait for it…. Yep, you just spend $1000 to save $400.
Incur the $1000 expense and save $400 in taxes and watch the remaining $600 pass through your cashflow statements… for whatever the expense actually was.
Pass on the expense and pay $400 in taxes and watch the $600 flow into your pocket.
Hmm, so next time you see a clown – literally or figuratively – blasting around town in a fancy Hummer with advertising graphics emblazed all around the vehicle, feel free to laugh to yourself for identifying a poor business person. Sure, advertising is a legitimate business expense. Feel free to rent a bill board or purchase an ad spot on this blog. But be careful rationalizing a new car for yourself for the sake of the write-off when the likely alternative is a healthier business AND more cash in your pocket.
Your Turn – If you enjoyed this article, I would personally appreciate it if you would consider commenting below and/or subscribing to our Free Updates via email or RSS updates. Thanks!