Don’t Let The Tax Tail Wag The Dog!

Let me ask you a question. Have you ever seen a dog’s tail actually wag the dog? As funny as that might be to see this happen, we all know that the tail is wagged by the dog…sometimes with an excess of excitement and vigor…and not the other way around.

I have been in the accounting profession now for 17 years, where I have worked with a number of small business owners across a wide range industries. During this time, I have come to witness a very dangerous mindset and approach to making business decisions I like to call “The Tax Tail Wagging the Dog”.  

The Tax Tail Wagging the Dog Mindset

What do I mean by “The Tax Tail Wagging the Dog”? Think of your business as the dog and think of the tax implications of your business activity as the tail. When you as the business owner makes a business decision “solely” based upon what the tax implications of that decision may be, then you are guilty of letting the tax tail wag the dog. The implication is that the whole focus and reason for making your decision is based on the tax impact.

Business owners who have this narrow minded and “tax” only focus, generally make poor decisions, and fail to consider how their decisions will improve their business. Improvements could include increasing revenue, lowering costs, improving efficiency, increasing employee retention and morale, or several other important positive outcomes.

Often during meetings with small business owners, I am asked “What do I need to do to not pay any taxes?” This question is an indication to me the business owner is suffering from ‘The Tax Tail Wagging the Dog” mindset and needs some guidance on how taxes work so they can make better business decisions.

My response to this question is always the same. I answer with this question “Did you go into business to make a ton of money or to never pay any taxes”?

Without hesitation most business owners respond by saying “I want to make a ton of Money”. Hopefully that is the same reason you went into business.

With that understanding in mind, I can then begin the process of educating my business owner clients on how taxes work and why their focus (with my help) is to minimize their tax liability rather than to eliminate it.

Taxes, Taxes, Taxes and How they Work

Nobody likes paying taxes. Trust me, I understand that 100 percent!!! However, the unfortunate reality of operating a business in the United States means that if you are intentional about generating a profit in your business you are going to pay taxes. I suspect this is the case in most other countries as well.

You cannot avoid this reality; however, I believe once you understand how your tax liability is calculated, you will begin to adjust your mindset away from only worrying about taxes and start making amazing business decisions that will consider all aspects of your business…resulting in more profit for you as the owner.

Without diving into all the nitty gritty of the tax code (believe me it is better this way), let me walk you through how your tax liability is calculated. Put simply, the following formula shows how your business tax liability (and frankly how your own tax liability) is calculated:

Let’s add some numbers to this formula to bring it to life more. Assume your business has $40,000 of gross revenue, $15,000 in deductible tax expenses, and your combined federal and state tax rate is 30%. Your tax liability would be $7,500.

Okay, I know this example is simple and the tax code is very complex and confusing…trust me I have spent many hours reading through it and the myriad of regulations and court cases interpreting the code.

However, once you peel back the layers of the nasty tax code onion and the confusing tax forms, we use to file our taxes, the above formula is how it all works.

So why is the tax code so big, confusing, and frankly in some instances downright stupid? Well, that is a discussion for another time…

You may be asking, why do I need to understand how my tax liability is calculated? Great question! Let me explain.

Another question I am asked repeatedly by business owners is “What do I need to spend my money on this year, so I don’t pay any taxes”? Maybe you have asked your accountant this question too. This is not a bad question, but it is often a misguided question and suggests the tax tail is about to start wagging the dog.

The truth is you will spend more money trying to save taxes than you will actually paying the tax liability. What? That can’t be true?

Well, it is true! Let me show you.

Going back to our example above, let’s assume your business gross revenue and tax rate are the same. The only difference is you want to spend $15,000 to buy a business vehicle. You don’t need the vehicle and it is not going to improve revenue, lower expenses, or provide any other positive benefit to your business. However, your accountant indicates such an expense is a tax deduction. Great, this increases your deductions to $30,000…let’s see what that does to your tax liability.

Your tax liability dropped from $7,500 to $3,000 saving you $4,500 in taxes. However, let’s think about your cash flow situation for a minute. Remember, purchasing the vehicle did not improve your revenue, lower your expenses, or otherwise improve your business and its cash flow in any way. True, it lowered your taxes by $4,500; however, it cost you cash of $15,000, making your total cash outlay for this decision $19,500. Now, if you would have just paid the tax, your total cash outlay is $7,500, which is $12,000 less.

You got it…the tax tail has wagged the dog in this scenario.

Strategies for Avoiding “The Tax Tail Wagging the Dog” Mindset

Hopefully, this helps you see the importance of not having a “tax” only focus when it comes to making business decisions. I know you don’t want to pay taxes (neither do I), but both of us are more likely to achieve success in our business, improve cash flow, and increase profits by avoiding “The Tax Tail Wagging the Dog” mindset. Isn’t that what we all want in our business?

Here are four strategies you can use to avoid this narrow-focused mindset.

  1. Planning – Work with a tax professional who takes a holistic approach to tax planning. Their focus should be on helping your business grow and succeed, while also insuring you’re paying the minimum tax possible. They are not just telling you to spend money to save taxes, they are providing guidance on how you can make your business improve and your profits grow.
  2. Goals – Create goals for your business. What are you hoping to achieve with your business over the next month, year, 3 years, and beyond? Make sure to explain these goals to your tax and other professionals. Often, the tax strategies that can be used are dependent on your goals and what you want to accomplish as an entrepreneur.
  3. Double Impact Decision Making – Make sure every decision to spend money (because that is how tax deductions are created) to lower taxes also has a positive impact on your business. You worked hard to generate that revenue so make sure how you spend it improves your tax situation along with improving your business operations. Consider spending decisions that will increase revenue, lower expenses, improve efficiencies, and/or improve employee retention and morale. Remember, you went into business to make a ton of money! As the example above demonstrated, spending money just to save taxes is a bad idea (check out our blog post “Spending Money To Only Save Taxes is a Bad Idea” for additional examples on why spending money to save taxes is…well a bad idea).
  4. Pay as you Go – This is hard one for many people; however, it is crucial. Take the sting out of tax time by make sure you are regularly setting aside money and paying estimated taxes throughout the year. Combining this strategy with the above three strategies can help you pay the minimum amount of tax possible and enjoy more of the profits of your hard work.

The “The Tax Tail Wagging the Dog” mindset should be avoided when making business decisions. You can avoid this mindset by implementing these four strategies in your business. They are simple; however, their impact on your business can be life changing. Your focus will shift from only worrying about taxes to improving the success of your overall business, which can mean more profit. More profit means more reward for you.

Until next time, I want to wish you all the success possible in your entrepreneurial journey.

Schedule a call with us today to learn about how Procenac, as Profit First Professionals, can help you minimize your tax liability and maximize your profits.

Click here to listen to our podcast episode on “The Tax Tail Wagging the Dog”, where Darin discusses this concept and strategies in more detail.

Don’t Let the Tax Tail Wag The Dog – Fundamental Entrepreneur Podcast – Episode #48

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