Hi, everyone. This is the How to Lower Your Tax
Bill podcast. I'm your host, Terrence Hutchins.
I'm a financial and tax advisor in the Dallas
-Fort Worth area. And the goal of this podcast
is to help you listeners get educated on different
tax strategies that you can implement to improve
your tax situation immediately. Each episode
will break down useful tax tips you can use to
save money. no matter what your personal or business
income situation. Because our motto is, keep
more of what you earn. So let's get into today's
episode. All right, so welcome back to the How
to Low Your Taxable podcast. We are doing a series
around what to do with your profits as a business
owner. And we'll talk about making smart business
decisions and then how that impacts your taxes.
So we have talked about how taxes are an expense
of the business and your business needs to be
able to make enough money to pay that expense.
And now we're going to talk about debt today
as it relates to how do you manage that from
the profits that you have. So welcome back our
lovely co -host Tamiya. Say hi to the people.
Hey good people. Hey good people. And so we will
try to keep this practical. for people as a lot
of people have small businesses and oftentimes
people get generic advice without really factoring
in the ramifications of how that impacts them
in the long run. So one of the things I hear
is, you know, you got to spend money to make
money. And that could be true. Okay. Depending
on your business model. But we also want to think,
all right, in the case of debt, if I'm going
to take on debt, I have to acknowledge that that
comes with a level of risk. And as a result,
I need to be able to assume a certain rate of
return that can compensate me for the risk I'm
taking plus the actual debt payment. So let's
kind of dive into high level on the debt side.
So first, before I get into that, tell me, what's
your experience with debt, maybe on the personal
or business side or lessons you've learned? So
y 'all remember last time I was on, you talked
about me being on the couch and it seems like,
you know, once again, Terrence just put my business
out there. So, but basically my experience was
that is, you know, trying to start my own insurance
agency. I, for me, you really had to, because
I heard it too, right? You got to spend money
to make money. Starting an insurance agency.
That's one of the things people do is actually
go out, get huge loans to buy a book of business
or to, you know, get an office storefront or
whatever is necessary. Systems, if you need computers,
like all the things. And for me, I actually initially
was. Really thinking about it, I was like, oh
yeah, that makes perfectly good sense. But when
you really think about it, I was like, what's
the likelihood of me being able to pay this back?
So my relationship with debt, I would say, is
not healthy in the sense of I'm low risk. So
I'm like, I want to steer clear of debt as much
as possible, also without hurting my business,
if that makes really sense. Yeah. So Kyle, a
simple example I think about is a seesaw. sort
of mirrors a balance sheet. You have assets and
then you have liabilities. When you take out
debt, you get cash, that would be your asset,
but then you get the loan itself, which is your
liability, that's on the opposite end. So they
start off even. Now you might have a loan fee,
so you might have a little disproportionate,
but generally the seesaw is even. So in reality,
you think, all right, if the asset I'm buying
should be able to increase more than the debt
that I have. Oftentimes, if you have an imbalance
where you have more debt than the assets generated,
then that's not a good use of debt, all right?
So we'll talk about three main concepts when
it comes to debt. So number one is debt to save
on taxes. So this is what I get a lot of times.
So many times when I first start working with
a business owner, they tell me, you know, my
accountant doesn't really talk to me about strategy
and how I could save on taxes, other than, hey,
go out and buy some equipment or go buy a vehicle,
all right? And I get a lot of the people who
have the list of, you know, those cars that are
6 ,000 pounds or more where, hey, I can go buy
that model X or that big, you know, Yukon or
whatever it is. And with bonus depreciation with
the one big visual bill, I can actually write
a hundred percent of my car off. So just picture
this. I go to the car dealership. I signed for
this hundred thousand dollar vehicle. All right.
I go back to my tax person and say, hey, I bought
a hundred thousand dollar car. He says great,
or she says great. they write off $100 ,000 in
your taxes. So if you had $100 ,000 in profit,
all of a sudden, your profit is gone. Now, you
drove off the lot and you didn't pay anything,
right? You could have literally left the parking
lot with just a signature, all right? Now you
have a loan, which is what we're talking about,
the debt, and for that tax year anyway, you're
high -fiving because you're like, look, I made
$100 ,000 and I paid zero taxes. But fast forward
into year two, that loan is going to now kick
in for you to start paying. And so the math will
suggest, Hey, if I have a hundred thousand debt,
the only deductible expense that I have from
that point forward, if I've already written the
entire car off is the interest. Yeah. Which is
just a cost. That interest is tied to though,
the monthly payment. So every month, let's just
say for easy math, the interest is 10 % of the
payment. So let's say my payment is $1 ,500 a
month. I have a hundred dollars of interest.
I have $1 ,400 in principal. Now. I pay $1 ,500
every month, but only $100 is deductible. So
if you're doing the math at home, you think at
the end of the year, I've paid $16 ,000 of principal
payments that aren't tax deductible. So that
actually was cash that came out of my account.
So if I have another $100 ,000 of profit, I pay
tax of $100 ,000 minus the $1 ,200 of interest.
So I pay tactical 98 ,000 and you know, $800,
but I only have cash of like $84 ,000 because
the principal payments didn't count. So the second
year, third year, fourth year, I'm actually shelling
out more cash to compensate for not paying the
taxes in year one. All right. So that makes sense.
Basically what I, what I hear you saying is.
don't take on debt without a clear plan for repayment
and return on investment. That's what I hear
you say. What I hear you say it is, I think you
said it on the tab, don't spend a dollar to make
40 cents. To save 40 cents, yeah. To save 40
cents. And what you're saying is kind of what
I took on when I was thinking about taking debt
is simple. You really need to think, does it
make sense, right? Does it make sense? I have
this money, I have this profit. Does it make
sense to go buy a $100 ,000 card? Does it make
sense, financial sense, tax sense to do this?
And I think a lot of us, even though we've been
with our tax people for a while or whoever it
is, but just ask them, I want to challenge you
all who's listening that you're not using us
for your services, but you're using someone else.
I want to challenge you to really do the math
because in the long run, it could really cost
you. And then you still have this debt you got
to pay. Definitely. And generally when it comes
to assets that aren't going to provide a return
like that, like a car. Yes, you can buy a car.
Yes, that car might have a business purpose,
but that generally that car is not going to help
you make more money. So you want to only buy
things that don't make you more money that are
things you would have bought anyway. All right.
So, Hey, maybe the tax savings allows me to buy
a car that would equal out another car. Maybe
you could justify that, but just buying the car
just to save on taxes isn't a good strategy.
Now, if you could identify that $100 ,000 of
profit that I was going to have, I was going
to pay $30 ,000 of taxes on. Well, hey, let me
take that $30 ,000 and can I reinvest that $30
,000 that can pay for the car? And oftentimes,
depending on the amount of debt and interest
and whatnot, it's going to take a pretty good
amount of return to be able to compensate you
for the debt that you took on on a short -term
asset like that. All right. Now the other thing
that people normally use that on is for projects.
So this is for people who are normally in like
construction or they bid on some type of job.
So a lot of times let's just say, Hey, you're
in construction or you have a project that you're
trying to complete for a customer where you normally
don't get all your money upfront. Ideally, you
like to get as much of it as possible, but maybe
that's not just feasible. All right. If as if
you are working with a big company. They're not
going to pay you upfront, right? They're going
to pay you over a period of time. So they put
down a deposit and really that deposit, you want
to have that cover whatever cost of your job.
So for example, if I have a job that is going
to pay me $10 ,000, but it costs me $3 ,000 to
do the job. So I got to pay people. I got to
buy materials. My deposit, I want to have enough
money that I collect upfront to cover my cost
of goods sold or whatever it costs to do the
job. So I can effectively say, I'm not going
to have to come out of pocket to finance the
difference because if it costs me 4 ,000 to do
the job and I only cut it off at 3 ,000, I'm
going to dip into my cash reserves to finance
it. Or what happens is you dip into your line
of credit and many times people take on jobs,
but they don't evaluate, okay, how profitable
is this job? And this is essentially how companies
will actually grow. themselves out of business.
So wait, wait, wait before you get into that,
because you're making really good sense. So,
you know, I like to say, I tell my son all the
time, don't count your eggs before they hatch.
How do you then, I mean, I'm sure you have an
experience with a lot of different companies.
What do you, and I won't say it lies because
listen, you need to seek help from someone else.
This is not, you know, we're just giving you
strategies, different things, right? When you
mention that, because a lot of people do believe
that you have to spend to get, you know, and
so your example of, you know, needing to have
this money up front for this project, what would
you tell a person of how to balance it, how to
manage that? Because to your point, most people
don't want to pay you 100 % upfront. They're
just not going to do it, right? And so, and then
you do have those flaky people who just kind
of bail on you or whatever, don't pay. So how
do you balance that? Or what experience do you
have? What have you seen before to help people
kind of keep some things in mind before you start
this project or borrow money for a project? So
you essentially need to, number one, forecast.
So in the same way that if I was going on a trip,
I'm going to check the weather to see, okay,
hey, I live in Texas, but if I'm going to the
Caribbean or wherever, I'm going to check the
weather. so that I can prepare to dress for the
weather that I'm going. And many times you have
to say, hey, when am I projected to get paid?
Because that's the other part. What are the terms
of when you get paid? I collect money up front
and then I collect it at the end. Well, how long
is that project going to take? So sometimes it's,
hey, people take on all these projects and then
they have all these kind of unfinished projects
that are going on to where they actually can't
collect. So I have to be strategic with my schedule.
So I can now map out, all right, I got project
A starting. Project A should be completed here.
Here's when I should get paid. And then do I
have a process to make sure I get paid on time?
All right. Because when you're in business, remember,
this is a two -way relationship. Granted, you
want to provide the customer certain benefit,
maybe terms and whatnot. But ultimately, if you
feel like you have to bend over backwards for
the customer, you need to assess the work product.
Is what I'm offering really valuable? and compared
to their competitors, because if what I'm offering
is that valuable, then people will make adjustments.
You know, I was talking about, we won't go down
this rabbit hole, but if you were to go buy a
designer purse, for example, then those high
-end designers don't give you discounts, right?
They don't run specials. You don't see, you don't
see, you know, when you're at Macy's or JCPenney,
right, you might get a 10%, 50 % off call. Well,
when you go to, you know, Kristin, they're not
running specials, you know? They just say, Hey,
here's the problem. Here's what it costs. And
if you can't afford it, you need to come back
when you can. All right. And, and so as a business
owner, sometimes you have to be willing to take
the risk of not bending over backwards to your
customer. Because like I said, if you take on
bad projects and you haven't forecast it well,
or you take on a bad project that you forecast
it, and you're like, Oh, I'll just make it up.
Well, basically you're just going to eat away
at your profits. And then those, a lot of times
you have what they call as cash trapped in the
balance sheet. Because if I know, if I have money
in the bank, but I know I got to pay for the
next project, I can't really spend that money.
I got to prepare ahead of time. So my cash isn't
really free to use. And then what happens is
I show profit for the prior year. And this happens
also when it comes to, most people are on what
you would call a cash basis. So for example,
I could do a job today, but not get paid for
it until next year. Well, I wouldn't report the
income until I get paid for it. So I've had clients
where, hey, In January, they received $200 ,000,
$300 ,000 for prior work they did. Well, the
IRS says, hey, you received that money in this
year, so you're going to pay tax on it in that
year. But they've already allocated that cash
to something else. So it could be tied up into
a project. So what happens is they get a tax
bill. They're not ready to pay. Or, hey, when
we talked to you about the quarterly estimates,
as far as, hey, you need to pay on a schedule
and you don't have the money to pay it, then
the IRS is going to just charge you more. So
part of your plan is I want to pay the IRS more
money. So I had to account for taxes as the expense
when we talked about before. But if I'm managing
debt, that really holds in further on my forecast.
Ultimately, I'm not paying more on money that
I eventually will owe in taxes. Yeah. That's
good. I hope y 'all heard that. Let me tell you
something. First things first, I got a forecast.
I don't know if y 'all heard that, but you got
to kind of temper yourself, learn some contentment
in the position that you're in before you all
pursue these projects. Because it is a lot of
pressure, especially out here in these social
media streets and the TikTok and all the places
where you, so like you gotta go, go, go, not
really sitting down and seeing where your money
is at. And you mentioned something there, Terrence,
about it being tied up. So basically, you don't
have it. You don't have it. If they have not
paid you, you don't have it, right? So... doing
another project, taking on debt. It doesn't seem
to be wise or beneficial in this regard. Now,
what is something to take on debt for? What does
a good debt look like? I guess it's a good question.
Well, ideally, when you take on debt, you should
act to be excited because whatever you're buying
is going to produce enough money to pay for it.
So if I bought a house and I was like, hey, this
house is going to pay me $5 ,000. And the debt
is $2 ,000. Well, I'm excited. All right. I just
made $3 ,000 a month, right? Minus whatever expenses
I might have that are maybe unexpected. But truly
debt should buy assets. Those assets should produce
enough money to pay for the debt plus some. All
right. And so that kind of leads to your third
part is when you use debt to buy long -term assets.
You have to factor in. the value of the assets.
So I have to think about, okay, when I actually
get paid, what's the spread between what I'm
receiving from the asset and the cost of the
debt itself? So generally we take on debt in
a business, they call that your cost of capital.
And the cost of capital, whatever the return
I am desiring should be more than the cost of
the capital itself. So that seesaw example, right?
The asset should be higher as far as what it
produces than the debt is costing. And because
when you take on debt, you are at risk. Like
we talked about before the podcast, when I spend
my money and I lose it, I go back to zero. When
I spend someone else's money and I don't make
money, I'm in the negative. So you have more
risk when you take on debt, which means you have
to be compensated for that risk. That's really
how it works. Right? For example, hey, lend me
20 bucks. If I pay you back today, You may not
want interest, or you may not desire much interest.
If I were to hold the money for five years, you'd
be like, well, hold on, you gotta pay me like
$30 back or $4 back, right? I'm not gonna just,
so the longer it takes to pay it back, the more
you should be compensated for it. So that's the
same concept when you take on debt, right? If
you're the quote unquote investor, which is what
you are, when you take on debt, you're the investor,
you need to be compensated. for the debt that
you're taking on as the investor to say, hey,
the money I get as a result should be more than
what I'm paying for this. And if you can predict
that and forecast it ahead of time, then a lot
of times debt can help you accelerate where you
are and the smart use of debt will help you get
there faster. But if you don't do it smartly,
you might say less of taxes in the year one,
you might even see your revenues grow. But if
you don't do proper forecasting, your cash will
probably start to dwindle. And then like I said,
you can literally grow yourself out of this.
Wow, that sounds so terrible. Grow yourself out
of business. And I remember one of the podcasts
we did is that you really got to know your business.
You really got to know what you're doing and
see it taken on debt is even worth it at the
end of the day. Cause like you said, you can
get some interest from it. You can, it's some
tax things that you can do, but at the end of
the day, if the debt still outweighs the benefits,
it may not be worth it. Definitely. So hopefully
you took away some practical ideas around how
you manage debt. And as Tamia said, this is not
advice to you. So work with a qualified professional
that can help you make decisions. And just because
your accountant said, hey, you need to go buy
a car or go buy some equipment to reduce your
taxes. They are normally historic figures. They're
only looking to help you from a historic standpoint,
right? They look at what happened last year.
How can I help you not pay taxes on what happened
last year versus a forecast says, here's what
you're anticipating to happen. What can we do
to put you in a better position? for what we
anticipate to happen. If you're always looking
in the rearview mirror, you're probably going
to crash at some point. We will talk next time
about the actual reinvestment of your cash back
into the business and how you want to treat that.
So once again, keep more of what you earn and
we will talk to you next week. Peace.