We have done ourselves a disservice as business owners. Too often we have justified an expenditure to non-owner friends as “tax deductible” to show how clever we are.
In doing so, we have confused the public. They see the Federal Government throw billions at favored projects, and they think it is the same money that we are discussing.
Tax credits are not tax deductions. Tax credits are for companies that make a profit, and are then forgiven from paying the taxes on that profit. As many small business owners have painfully realized in the last few years, if you don’t make a profit, a tax credit is useless to you.
The past few years have also seen accelerated depreciation as a regular “tax incentive” (as opposed to a “credit”). Unfortunately, that did nothing to help the struggling companies who weren’t profitable enough to buy new equipment.
Tax deductions are expenses in your business that you pay. They involve real cash outlays. They are merely among the list of things that the IRS says you can include as part of the cost of doing business.
A few months ago I was discussing an event with a politician. He is a local part-time elected official, who has been employed for his entire career. He wanted to hold an event for the town.
I suggested we hire a nearby small business to provide refreshments, in the interest of supporting our own local economy. He said (with a wink), “Tell them to just donate everything. After all, it’s tax deductible!”
Let’s say a small business provides income in to its owner in the 30% tax bracket. That means he gets to pay 100% of the food cost, 100% of the employee’s wages, and 100% of the gas out of his own pocket for his “tax deductible” donation. A year later he can put that cost down as an expense, and get 30% of it taken off his taxes. I’m certain the official had no idea that it costs the businessman $1,000 out-of-pocket and $700 net to “earn” his $300 tax deduction.
Tax credits are a zero-sum game. With a government that borrows daily to meet its obligations, every dollar of tax credits reduces the pie of revenues. While tax deductible expenses might have the same effect, they cost business owners about $3 in expenses for every $1 recouped. That makes them self-limiting.
Spending too much money on tax-deductible expenses will put you out of business just as quickly as any other kind. Tax credits, on the other hand, are dollar for dollar gifts from the government.
So the next time you are going to wink at someone about your trip to a conference or tickets to a sporting event, make sure he understands what you are saying. “This is deductible from my profits, just like rent, salaries, employee benefits, and the hundreds of other expenses that I pay to run my company. Compared to them, it is negligible, and I still have to pay 70% of the cost myself.”