No free lunch

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The Transportation Services Index for freight decreased 0.9 points in January to 119.8 from December’s record high of 120.9, the Bureau of Transportation Statistics reported. The January 2004 index, however, was 2.3 points higher than the January 2003 level. The overall TSI for January reached its highest level in the 14 years covered on the strength of the TSI passenger index.

Internal Revenue Service, following a string of recent convictions and court rulings involving employment tax schemes, alerted business owners last month to be wary of eight types of tax schemes or practices in which federal employment taxes are not properly withheld or paid by employers from their employees’ paychecks. For more information, visit www.irs.gov and search for IR-2004-47.

Congress enacted legislation increasing lending authority for the Small Business Administration’s 7(a) loan program by more than $3 billion and raised the $750,000 cap on 7(a) loans to the previous $2 million. The new law also gives lenders the option to make SBA Express loans of up to $2 million, and it once again allows piggyback loans.

IRS reported that in the past year, the U.S. Tax Court imposed nearly $136,000 in penalties on 23 taxpayers for pursuing frivolous cases in an effort to delay tax collections. Penalties are higher than in the past. From 2001 through March 2003, the court imposed $126,000 in penalties on 38 taxpayers. Taxpayers who misuse their right to a court review face up to $25,000 in fines.


First Quarter Operating Income
ABF Freight System
$8.3 million, down 15.9 percent from the first quarter 2003.

Con-Way Transportation Services
$51.1 million, up 37 percent

Covenant Transport
$3.06 million, down 13 percent from the first quarter 2003.

Heartland Express
$19.8 million, up 22 percent.

J.B. Hunt Transport Services
$58 million, up 144 percent.

Knight Transportation
$15.4 million, up 29.8 percent.

Landstar System
$13.9 million, down 18.7 percent.

Marten Transport
$4.6 million, up 72.8 percent.

Old Dominion Freight Line
$10.9 million, up 25.8 percent.

Swift Transportation
$14.7 million, down 20.1 percent.

Transport Corp. of America
$962,000, up 201.6 percent.

USA Truck
$3.01 million, compared to a
$543,000 loss.

U.S. Xpress Enterprises
$3.6 million, up 13.4 percent.

Werner Enterprises
$24.9 million, up 31 percent.

The annual obsession with taxes has just ended, and as usual, we were bombarded with offers to help us keep more money away from our greedy Uncle Sam. While it’s always smart to consider taxes in the highest levels of your business or personal financial strategy, an overwhelming emphasis on saving every last dime or availing ourselves of every last write-off is more than unwarranted. It’s dangerous.

Some well-meaning CPAs, wanting to avoid informing a client that he owes a big chunk of change to the Internal Revenue Service, often encourage their clients to show little or no income every year. I think this is a big mistake for anyone wishing to build wealth and net worth. The disgust at paying taxes often blinds us into making longer-term mistakes. Here are some of the most common:

Tax-driven purchases
“Let’s buy a Hummer because we can deduct the full cost.” If you believe that, pay your CPA $60,000 extra this year and you’ll get the same $20,000 reduction in your tax bill. Buy one because you want one, or because you think it will impress your friends. But the tax savings alone will never justify the ultimate cost to you. The game of spending money to save taxes is kind of like buying watermelons for $1, selling them for 33 cents, and thinking you’ll make it up in volume. Maybe that $18,000 Hyundai Santa Fe looks a bit better now?

Two sets of books
The ultimate temptation is fraud – hiding income from your CPA or from Uncle Sam. But for every $10,000 you hide, you avoid maybe $3,500 in taxes. Would you rob a bank and risk a prison sentence for $3,500 or even $35,000? Of course, it should be enough that fraud, like armed robbery, is just plain wrong. But even if you don’t buy the moral argument, surely you see that the fruits of a crime must be really big to make it worth the risk.

And the risks are high because the IRS assumes that companies try to hide income. To properly skim funds, you must put that money where no one can find it. But you can’t put it in the bank because the feds will want to see your W-2 receipt or trace the deposit from your business. You can’t pay cash on your home mortgage because the IRS will ask to see your 12 monthly canceled checks. You can’t pay cash for vacations because the IRS will want to see your checks or credit card charges. You can’t even gamble with it because IRS agents can compare your checks written to “cash” with your casino habits and records.

Excessive owner pay and perks
All business owners are tempted to incur unnecessary deductible expenses, including pay for spouses and children who don’t really work in the business; expensive hunting trips; higher-than-market rental rates on properties; membership in pricey country clubs, and so on. You can rationalize some of these moves more easily than others. Aside from the financial drawbacks, loading your payroll up with non-performing family members is especially troublesome. For some operations, the effect on the morale of non-family employees and managers may be more than you bargained for. Do you really want those valuable team members to wonder whether the only people you care about are those with a particular last name?

Finanically speaking, however, overzealous methods of income management can produce some warm and fuzzy feelings in the short run. But there’s no free lunch. There’s a saying common among us financial types: “What’s good for the tax return is point for the banker.” Bankers are concerned about the bottom line, not about your savvy tax management. To the banker, all of these additional costs serve only to reduce net income and, perhaps, disqualify you for a loan. The failure to get financing for growth – or getting it, but at a higher interest rate – may represent an opportunity cost that far exceeds your tax benefit.

What’s good for the tax return is also poison for the business seller. You may spend decades building a company’s worth, but you can throw a significant portion of that worth away through tax-wise, profit-foolish decisions. A buyer may look, for example, at your most recent five years of financials and conclude, based on profits, that he cannot pay close to what you are seeking.

Perhaps you are thinking that this is risk worth taking. After all, it’s just a matter of trading money at the time of sale for money in the form of annual tax savings, right? Not by a long shot! At business sale time, every $100,000 you kept off the bottom line saved you $35,000 in taxes. But businesses typically sell at multiples of profit. So each $35,000 you saved has now cost you three to seven times your hidden income on your selling price, or $300,000 to $700,000. Not much of a bargain.

I’m not suggesting that you ignore the tax benefits when making business decisions. But there are ways to strike a balance between saving taxes and building wealth. Talk with your CPA about them. Don’t let your passion for depriving Uncle Sam of every possible cent drive you into decisions that will hurt you in the long run.

Resources
See “Underreported Income,” Journal of Accountancy, March 2002, by Ronald R. Hiner, CPA, EdD at this site.