No doubt this title sounds a bit sensational to you. You might be thinking: “What do you mean? How will saving money on taxes prevent me from growing?” It sounds illogical. Any savings are good, aren’t they? No, they aren’t! In fact, this kind of thinking could lead you to commit a mistake that’s very costly and common among small businesses. I’ll explain below.
But first, let’s start with some very important assertions:
- Everyone is obligated to declare and pay income taxes to the government.
- Many small businesses will try to save money on taxes any way they can.
- One of the most important things a bank looks at when deciding whether to approve or deny a business loan application is the business’ tax returns.
So where am I going with this?
An open secret: many small businesses do everything they can to save money on taxes, even if it means changing, omitting or concealing certain information. I know this isn’t what you want to hear, but it’s the truth. More people do it more often than you might think. Why bury your head in the sand? It’s better to learn from others’ mistakes. Trying to save money on taxes is a common practice. If you have a business that does most of its transactions in cash, that doesn’t have much paperwork and that allows you to modify certain information in your favor with regard to taxes, well, you probably know what I’m talking about. But be very careful because this can end up costing you much more than you think.
I’ll explain with a fictitious scenario. Let’s suppose you own a store. Every day, you supply numerous restaurants in your area. You have three delivery trucks and nine employees. At the end of the year, someone (perhaps your tax preparer) recommends that you don’t report all of your income so you can save as much as possible on taxes. Luckily, more than 50 percent of your sales are in cash. You follow the advice and only report part of your profits. You’ve saved a lot of money. Everything looks good. Was this good advice or not? Let’s see…
Business is going great. Now, you’re needing a bigger truck. You buy it. A bigger warehouse. You rent it. The monthly rent for the warehouse goes up to $9,500 per month. No problem. You can easily pay that much and more. Your business keeps growing. If only you had the money to buy a warehouse and a couple more trucks… Can you imagine owning your own warehouse?! Wouldn’t that be awesome?!
The owner of the warehouse you’re renting decides to sell it, along with the property next door. Since you’ve been such a good tenant, Mr. Kim offers it to you first. You’re interested and the idea of buying it motivates you. But how are you going to get your hands on 1.2 million dollars? How about a business loan? The monthly loan payments for this amount at 6 percent interest would be around $8,000. Considering that you’re currently paying $9,500 in rent and you could rent out the property next door for $4,000 a month if you owned it, it’s definitely a great option. So you decide to go for it! You’ve always been very responsible: you have great credit, you’ve already been in business for five years and you have an expansion plan. Everything appears to be stable.
The bank initiates the loan application process. They assure you that there’s a very good chance that the loan will be approved. Of course, this is based on your initial meeting when you told the loan officer how much your business makes each year and how much you have left over after expenses. But you know that the bank can’t just take your word for it. They ask you for copies of your federal tax returns to prove your income. Oh, my God! What are you going to do? You only reported $50,000! That won’t even cover half of your monthly loan payment! You tell the loan officer, “But look, I really do have the money. That’s not really how much I make. I make a lot more than that. Believe me! I can easily make that monthly payment and more.” The loan officer thinks it over and answers:
I believe you. This happens all the time. Business seems to be good. I can see that you have money and you make money. You drive a nice car. You’re nicely dressed. I can see you’re wearing a Rolex. But I can only go by the documentation the bank is asking for. The requirements are very strict and there’s no way around them. And besides, how am I supposed to trust someone who lies to the United States government?! I’m afraid we’re going to have to turn you down.
The example above is just for illustrative purposes so you can analyze what your business is doing and what it’s not doing. Saving a few dollars on taxes can often end up being the biggest obstacle preventing your business from growing. In the above example, you’re missing out on a $1.2 million loan just to save a few bucks! What a shame! What you thought were savings ended up being a huge barrier.
In general, for you to get a business loan, the bank requires the following: documented payment capacity, a down payment, your tax returns and your credit history.
The moral of the story is that your income determines whether you can get a loan or not, your tax returns prove your income, and lying on your tax returns stops you from growing. Do you see where I’m coming from? A wise man once cautioned against being penny wise and pound foolish. I’ll leave you with his good advice.