Guest Column: Planning to Save Taxes
Good tax planning is an art that few seem to be able to master. Unfortunately, we live in an unstable tax environment. Our government seeks to create economic growth, stability and enhanced income but constantly changing tax policy works against all of these goals. Effective tax planning is essential for anyone wishing to build wealth and every business owner must have a good understanding of general tax laws. Making decisions solely based on the tax consequences is not intelligent.
Many people do make decisions based on how some action will immediately impact their annual taxes. The tax consequences of an investment, expenditure or other decision should be taken into account but deciding based on how much you might save in taxes may not lead to a very good choice.
I overheard a father say to his son one year at tax time, “You pay too much in taxes, so you should get a bigger mortgage on your home to deduct the interest and cut your tax bill.”
Presumably, the money received from the mortgage would be invested at a rate of return greater than the mortgage interest rate. If not, such advice would be a net loss for the son’s total income. A mortgage at 3% interest under a 30% tax rate could create up to a $300 tax savings for every $1,000 in interest cost, to make up the $700 lost cash ($1,000 interest paid less $300 tax savings). The investment would only need to earn a rate of return equal to the mortgage.
Earning $1,000 cash return would cost $300 in taxes netting $700, which creates a break-even. Such advice seems sensible, and in a way, a possible money-making opportunity, but to be successful the mortgage money needs to be invested and not spent, otherwise it’s a losing proposition.
Businesses can fall victim to the same faulty reasoning. Towards the end of the year, savvy sales pitches include assumed tax savings in an asset purchase cost. If an asset makes sense to purchase, the special tax breaks should be an added savings or a way to make the investment return more favorable. Tax breaks alone should not be the motivation behind buying an asset.
A friend of mine runs a very successful family farm. Near the end of a tax year a while back, he decided to purchase a piece of equipment based on his need and by determining the equipment would help his operation prosper. His tax professional informed him the equipment qualified for bonus tax depreciation, saving the farmer taxes.
My farmer friend was ecstatic; he made the decision based on a complete understanding of his needs and the tax benefit became an unexpected windfall. He is a great agri-business man and knows his operation well. He purposely does what is best for his operation and is not driven only by saving taxes. Conversely, he will check the tax aspects of a decision to determine if there will be any impact to his taxes, good or bad, which could change his course of action.
Tax policy does affect decision-making. Smart businesses take taxes into account but don’t always act based on what a tax impact may or may not be.