It’s amazing when you consult for businesses throughout North America – particularly when you’re intimately involved with their billing software – how many “questionable” things you learn.
- Paying people under the table.
- Canceling cash transactions in the computer and pocketing the money.
- Trade deals to avoid sales and other taxes.
- Running the expenses to remodel a home through the business.
- Paying salaries to family members who don’t even work in the business.
- Buying a company motorcycle.
- Paying country club memberships directly from the business.
- Writing off business trips and meals where business was never discussed.
And if your accountant approves of one or more of the above, get a new accountant because they’re not liable – you are. Those write-offs are only gonna be legit for as long as you can avoid an audit.
So why the overwhelming pressure to “cook-the-books”? The simple answer is, of course, taxes. When someone in America makes more than $100,000 per year about half of his income goes to the government so I can understand how people can get a bit bitter… However, there are a few reasons why not doing things “by the book” or why sneaking unethical transactions through your small business is a bad idea.
- It devalues the business when you go to sell. If you’re ever buying a business NEVER include cash deals that aren’t on the books as part of the value of the business no matter how well documented they are. I can create a fake spreadsheet in about an hour “documenting” the 3 years of over-the-counter cash transactions. If the business hasn’t paid taxes on it, then don’t include it. You have no way to verify. Additionally, when valuing a business based on Seller’s Discretionary Earnings or Cashflow you can only add back so many “owner perks” before the buyer is going to wonder if maybe a great deal of those perks might just be necessary for your type of business. You bet I would certainly use that to negotiate the purchase price down.
- It will catch up with you. And maybe the only way it’ll ever catch up with you is by you not being 100% comfortable every night knowing that the IRS will never find anything out of line. Business is a means to an end. That end being more freedom – particularly of your time. But if that free time is haunted in the back of your mind with, “How do I conceal X if I get audited” then how can you completely enjoy it? CFO magazine from July/August 2008 had an article titled Don’t Mess With the IRS – Tougher Enforcement has Companies Rethinking Tax Strategies. It makes the point that the IRS is better funded, has better legal talent, and for the first time ever, actually wants to take people to court because they’re so confident in their new abilities to win. And they’re making waves. CFO points out that in 2002 corporate tax penalties amounted to $335 million while in 2007 they totaled $939 million. Nearly a three-fold increase in 5 years. Don’t be naive and think “well those big sheister corporations deserve to pay all that money but they’ll never worry about my small business.” You don’t have a full staffed legal team for them to even fight. It’s just a matter of time before small and medium business’ start feeling the repercussions of the “New IRS”.
- There are legit ways to minimize taxes. However they can be a bit challenging and finding a good accountant is even more work…
Don’t get me wrong. It makes me physically ill to think of how many thousands of my dollars are going to wasteful government spending and redistribution of the wealth programs… If it gets bad enough, then I’ll move to another country that’s more tax friendly (more on that later) however for now, the possibility at the American Dream and making millions in America is still alive and well so I’m going to pay my fair taxes and make sure my business’ are legit. With that in mind, here are a few legal tax minimization ideas you may want to consider:
- Rental Real Estate – You can deduct up to $25,000 in losses from passive income against active income if you’re an “active participant” in that real estate and you don’t make more than $100,000 per year. It gets more complicated from there…
- Equipment Leasing – Leasing equipment from one business to another business, or from your person to your business is a great way to get money to your pocket with minimal taxes. More importantly it’s a great way to shield your business from the liability that having employees driving vehicles would present. In other words, if company A owns your trucks and leases them to your primary company B and someone sues the company that owns the trucks because they were in an accident, all they could take would be the trucks… Not the rest of your business. Admittedly its a bit more complicated then that, but you get the idea.
- Multiple Business Entities – If you have a pass-thru entity such as an S-Corp or LLC, you don’t pay any Self-Employment tax or FICA. In essence, any distributions that you take out of those businesses saves you 15.3% on FICA taxes right off the top. You must, however, pay yourself a reasonable salary. You can’t take all of your income in distributions. Also, all corporate expenses (i.e. forming your business entity) plus the formalities necessary to keep it up and running are deductible expenses. Depending on your type of business you could also incorporate in a state without state income taxes such as Nevada, Wyoming, Texas, or Tennessee.
- Personal Loans – Loaning your business money and then taking a reasonable interest rate against that loan is a form of passive income. It’s not taxed the same way as active income (no FICA, I believe).
- Like-kind-exchanges – If you buy and then sell a business, you can defer your tax indefinitely by buying another business with your capital gains. The same is true for similar real estate transactions. Obviously if you can’t completely and legitimately eliminate the tax, your next best option is to defer it for as long as possible.
The list can go on-and-on. Granted, as in all my business dealings, I err on the side of creativity which is why I would never setup any of these programs without my accountant’s and lawyer’s blessing.
Simply put, according to The Millionaire Mind, “Being honest with all people” is the number one trait millionaire’s attribute to success – dealing with the IRS requires that same level of honesty.
For a few more resources on legitimate ways to minimize your exposure while improving your marginal tax rate, check out How to Pay Zero Taxes 2009 (How to Pay Zero Taxes) and The Corporation Manual.
Oh yeah, and don’t forget the purchase of those books can be deductible. 😉
To your success, Bryan