If Your CPA Says One of These 5 Things, BEWARE

If your CPA says one of these five things, you may need to find a new CPA.

(1) “You need more write-offs.”

(2) “You don’t need to write a check to the IRS.”

(3) “Don’t worry, you’re going to get a refund.”

(4) “Just borrow the money.”

(5) “You should take advantage of the new payroll tax deferral executive order.”

Talking with a prospective client recently, I received an all too familiar response to my question, “Do you currently obtain annual tax planning advice?” The almost universal answer is: “My tax person tells me how much I need to spend on new equipment to pay no tax each year.”

In the last two years, the owner had spent $200,000 on equipment to avoid paying current income tax. Fast forward a few months, in the middle of a global health pandemic, due to a government ordered shut down, he had to close his doors. He’s laid off his entire team and has been struggling to pay reduced rent and other essential costs in an attempt not to lose his business.

What he really needed was $50,000 in new machinery. He bought the rest in advance of his needs, to avoid paying income tax. If he had simply bought what he needed, his cash account would be $150,000 higher, less the tax cost. So how much would he have paid in tax? During 2018 and 2019 his tax combined rate, federal and state, was only 18%. So not spending the $150,000 would have cost him exactly $27,000. The bank account boost possible without unnecessary spending? $123,000! Enough to save his business.

This kind of nonsense drives me crazy.

So why is this kind of bad advice so universal?

It’s all about what questions we ask. The CPA and the business owner are caught in a trap that says the best outcome is not to write a check. CPA’s and business owners are focused on one question, how big of a check must I write?

But how can this lead to a great outcome? No check to the IRS means no income. No income means no wealth creation. No wealth creation means short- and long-term goals are on hold, maybe never to happen. In addition, it leaves your business cash poor, unable to weather the winds of change that come with hard times. By asking the wrong question, you jeopardize your most precious and valuable asset, your business.

The question you need to ask is, how do I create the most wealth?

From this question, the financial health of the business and the owner are paramount. Of course, your goal is to pay the least tax possible, over your lifetime. We are in one of the lowest tax environments of my 37-year career as a CPA. The deficits created pre-2020 where already approaching insanity. Now add the increase in the deficit from Covid spending. What direction do you think taxes are heading?

So how do you know you are getting bad advice? One way is to ask more questions if you hear one of the 5 statements listed above.

Let’s dissect each one.

“You need more write-offs.”

This statement tells you the CPA is focused on one number, your taxable income. Before you take their advice, consider that write-offs cost you precious cash.

As a business owner, your business is likely one of your largest assets. The financial health and wellbeing of your business is essential to your and your family’s short- and long-term future. For your business to be healthy, cash is job #1. With it, you are in business. Without it, your business is toast.

A cash buffer day is how long the business could run on its current cash reserves without new inflows. 25% of surveyed small businesses have less than 13 cash buffer days.

Before arbitrarily spending cash to get more write-offs, do a deep dive into your liquidity and working capital. Know what you need to be stable and secure.

Second, the long game always beats the short game when it comes to taxes. Tax rates are currently at historic lows. For a married couple filing a joint return, the first $19,750 of taxable income is taxed at 10%. The next $60,500 at 12%. This means until your taxable income exceeds $80,250, your tax rate is 12% or less.

In 2000, for a married couple filing jointly, taxable income over $43,850 was taxed at 28%. Think about that. 28% vs 12%, a 16% savings. Taxes are on sale. In the long-term game of building wealth, you must pay taxes. Why not pay them at historic lows?

Wait, there is a second way taxes are on sale now. Most qualify for the QBI, Qualified Business Income Deduction. This allows small-business owners to deduct up to 20% of their qualified business income on their taxes. Not all businesses qualify and there are limits. Check with your tax preparer to determine if you qualify before accelerating deductions. QBI is new and is scheduled to expire in 12/31/2025.

“You don’t need to write a check to the IRS.”

Not writing a check is different than not paying taxes. If you or your spouse are receiving a W-2, you automatically have tax withheld from your paycheck. Instead of focusing on whether you are writing a check, focus on your marginal tax rate over time. As noted above, rates are very low now and in the long-term game of building wealth, it is a great time to pay income tax.

“Don’t worry, you’re going to get a refund.”

Yes, in many ways an unexpected cash inflow is nice. But where do tax refunds come from? Your tax payments! A tax refund is your own money coming back to you. This statement, rather than being a reason for excitement, means you made a tax-free loan to the government.

“Just borrow the money.”

If you borrow money today to increase your tax deductions in 2020, you’ll likely be paying this money back in future years. While that might be a good strategy, I have seen it backfire time and time again.

Many a business owner calls me for a second opinion on their taxes. They are in shock at the amount of tax they are paying based on their cash on hand. Looking deeply into their finances, I most often find that they borrowed money to purchase new equipment and took a tax code Section 179 deduction. They call me when they are in the process of paying off the loan. In the later years of the loan, they have large, nondeductible, outflows going to pay the principle on the loan. This is when the shock sets in. They have no cash and a large tax obligation.

“You should take advantage of the new payroll tax deferral executive order.”

Beware, beware, beware. When you withhold taxes from an employee’s check, you hold those monies in trust. These are not your funds. It is your obligation to remit these taxes promptly to the appropriate government agency.

If you allow your employees to use the payroll tax deferral plan, they get more money today. But you are still on the hook for their tax withholdings. If your employee quits or is unable to pay, guess who pays? You do. Don’t put yourself at this type of risk. For more information on the payroll tax deferral executive order click here.

Because it is impossible to build wealth without paying income tax, paying income taxes is a welcome problem. Focus your time and energy on making your business as profitable as possible. Then engage a CPA who looks at your tax expense through a wealth creation lens and enjoy watching your wealth grow. Remember, when it comes to taxes, the long game always beats the short game.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Mackey McNeill is CEO and President of MACKEY, a Cincinnati-based firm offering family-owned businesses an invaluable and innovative combination of coaching and CFO-level financial expertise to increase their chances of a successful succession. Mackey is the author of several books including The Intersection of Joy and Money: A Workbook for Changing Your Relationship With Money and The Dynamics of Money, in addition to her latest book, The Prosperity Playbook.