I talk to a lot of businessowners who, at year end, realize they had a good year and have “extra money” that they will need to pay taxes on. Their accountants, trying to help them save tax, suggest that they go out and buy a large purchase that they can deduct, often with the single year section 179 bonus depreciation deduction, which enables a businessowner to immediately expense (deduct) the cost of qualified business property the year it is put into service. This is a great idea if you REALLY need that new truck or the new piece of equipment. But I have seen a lot of businessowners just go out and buy something like a new SUV or a new truck or piece of equipment even though they really don’t need it, just to save tax.
Looking at this from a business valuation standpoint, it might not be the best idea. These added costs show up on your bottom line as expenses that reduce your net income. Reductions in your net income (and concurrent increases in expense) mean that your business effectively is making less money and is now worth less. This can be significant if you plan to sell in the next three years, or if you need to get a bank loan. Bankers look at the bottom line to see if they can feel confident you can repay the loan. If your bottom line is too low, they don’t have confidence you can pay the money back. Buyers do the same. They are willing to pay less for a company that they perceive is making less money, or may not want to buy it at all.
When we value a business, we can “add back” certain expenses that a new buyer would not incur. So it is possible we can make an argument that this expense was not necessary and could be added back—at least sometimes. But banks and buyers often don’t buy into that argument for something like a piece of equipment or a vehicle. And now the vehicle or equipment, upon sale or even for lending purposes, is depreciating and worth less than what you paid for it.
Of course if your business truly needs that piece of equipment, it makes every sense in the world to buy it if there is excess cash at year end. But if you really don’t “need” it, consider investing more in your 401K, SEP or IRA to save the tax and create long term value for yourself. If your business does not have a retirement plan, we can help you set one up. If you already have one, we can help you determine the amount to contribute and how to best allocate it for maximum diversification.