At a certain year end I explained to one of my clients that he was still going to owe $25,000 in income taxes.     About a week later, he called to tell me his solution: “I just purchased a new Vehicle for $59,317 and this will wipe out all that I owe in taxes.” When I later asked him how he came to this conclusion, he told me that first he heard on the radio that the IRS was allowing business vehicles to be written off entirely, all in the current year if the vehicle was purchased before the end of December.

Then, he went into his friendly auto dealer and the salesman explained just how it worked. He would have to pay nothing now (the vehicle would be financed and payments would begin next year) and since it was a business vehicle he could write off the entire $59,317 on his tax return. In other words, the salesman explained, since he was in a 45% tax.bracket (combining Federal, State, and Social Security taxes), he would save $26,692.65 in taxes! WOW! Who could pass this up? Not my client.

Unfortunately, as I later explained to my client, it is not quite this simple. It is true that the IRS allows. certain capital expenses, including vehicles, to be expensed (rather than depreciated). There are some other considerations. First of all, expensing an item now does NOT eliminate the tax liability; it just pushes it into the future. If you expense a purchase such as this, you might get to deduct the entire purchase amount now which might lower your taxes now, however, if you finance the vehicle and have to pay for it over the next five years, then for five years you will have an out of pocket expense without a deduction. (The interest may be deductible, but the principal is not). The effect of this is that you could pay more taxes in the long run if your tax bracket is higher in the payout period than when the item was purchased. So, for five years, you have to earn money to make the payments, pay taxes on it at a higher rate, and then pay off the vehicle with after tax dollars. (This is because you already took the deduction when you expensed the vehicle in the year you bought it). The result, I estimated in this case, is that my client will end up paying between $4,000 and $8,000 in additional taxes during the next five years. This is money he would NOT have had to pay if he did not expense the item in the first year. This gets back to the almost always ignored problem that comes with borrowing money to build a business. You usually borrow the money when your taxes are lowest and you usually have to pay the money back when your taxes are the highest. And you pay the money back with after tax dollars because you got the money tax-free when you borrowed it.

But this is only the beginning of the complications of this case. The vehicle has to qualify as a 100% business vehicle in order for the deduction to be completely expensed. If it falls below 50% business use, than it does not qualify for the expense provision. In addition, whatever percentage that is not business use compounds the tax liability both now and in the future since this (non-business %) portion of the interest payments will not be deductible as a business expense. If the vehicle is 80% business, then this will cost my client an additional $3,500 in taxes over the next 5 years. This and the $4,000 to $8,000 of increased taxes from being in a higher tax bracket when the payments are made is all in addition to the $26,692.65 which was NOT “saved” as my client was told by the salesman---it was POSTPONED. In addition, my client did not realize that he would have to pay some taxes on the vehicle that he traded in when he bought this new one. This is because he had already deducted more than the trade-in value of his existing vehicle.

It amazes me how much misleading information I see, especially in business magazines, on the internet and direct-mail propaganda promising all sorts of “new” and amazing ways to reduce or eliminate taxes. The Federal Register includes over 80,000 pages of rules and regulations for American business and individuals. The Federal Tax code and related tax rulings include another 40,000 plus pages. Many of these rules and regulations are ambiguous and contradictory. NO ONE, no accountant, no attorney, and no government bureaucrat is likely to even read all of this, let alone understand it.
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So, don’t expect anyone to give you clear “answers” when it comes to taxes. Talk to ten accountants about the same thing and you will get ten different answers. On the other hand, many of the car salesman will give you the same simplistic (and wrong) answers. So, watch out where you get your tax advice.

The PROBLEM with dealing with taxes often begins with how we approach taxes:

Some of us are intimidated by the tax collectors. Fearing the Gestapo type powers of the tax collectors, we pay much more in taxes than we should. We fail to seek competent counsel for tax planning; we fail to keep appropriate records; we fail to properly engineer our income and expenses, or we put our profits in government-controlled retirement plans.

Others of us try to “get even” with the tax collectors. Growing angry with the unfairness, incompetence, and ruthlessness of the tax collectors, we try to get even by failing to report all of our income, by counting illegitimate expenses as deductions, by getting involved with complex tax shelters that only attract the attention of the tax-collectors, or by paying laborers in ways that violate the tax laws. Each of these activities can put us in danger of being destroyed by the tax collectors.

BOTH of these approaches are wrong and can be very costly. The truth is, the tax collectors are limited by the law, by the overwhelming task they have, and by their own incompetence. There are many legitimate, legal, and moral ways a small business owner can reduce the amount of taxes owed.

The SOLUTION to dealing with taxes is fourfold:

1.  Find a TAX SPECIALIST who will work for you, not the tax collectors.

2.  Develop a RECORD SYSTEM that exceeds the expectations of the tax collectors. The traditional accounting records and reports provided by many accountants and computer software packages lack the flexibility needed to provide records that will embrace an audit by the tax collectors.

3.  ENGINEER your income and expenses so that they minimize your taxes without wasting your money for things you shouldn’t be spending money for. This involves examining options, timing, and allocation of income and expenses. It also involves proper selection of business structure, method of accounting, treatment of inventory, and payroll structure.

4.  INVEST your profits in places that are protected from the tax collectors. One of the worst places to invest your profits is in an IRA, KEOGH, SEP, ESOP, 401(k), 403(b) or other government controlled “retirement” plans.