Warning Lights On the Dashboard: Spotting a Tax Bill Before It Blows the System

It's early October, and Vernon is meeting with his accountant to discuss what the estimated tax bill will be and what strategies he can take to lower it. Now that he has better systems in place, he's hoping it won't be too high.

"Your company is projected to make $2M in gross profits this year," the accountant says.

"This'll be our best year yet!" Vernon replies. But he grimaces at what the accountant says next.

"Based on this estimation, your tax bill will be $600K."

"What?" Vernon asks. "How is that possible? I've put better strategies in place to better plan for taxes. How is it still so high?"

A $2M Year, and Still an $600K Surprise

Vernon's situation is not uncommon. So often, HVAC business owners have a year where they make more in net profits than they've ever had and think that life's going great…until they get their tax bill. Then they're wondering how it's so high even though they've planned and prepared ahead of time to avoid the anxiety that April brings.

The Warning Signs Nobody Was Watching For

When it comes to spotting a high tax bill before April, there are several warning signs to look for, the first being that your company is having a strong year of high net profits. The more profitable companies will pay more in taxes. Vernon realized that this was not something he'd taken into account.

Another warning sign is if the reporting is not properly set up. If job costing is inaccurate, the timing isn't considered, and/or tax brackets are changed due to income increases, then the financial reports won't be accurate because they'll be reporting based on outdated data.

Busyness is yet another warning sign. Businesses can often change from unprofitable to profitable as the underlying systems improve, but the feeling doesn't change, so the income is a surprise.

The last (but certainly not least) warning sign is tax item expiration. Tax items expire like depreciation. If a piece of equipment has been fully used up, then there are no tax benefits.

What a Quarterly Gauge Check Would Have Shown

A first step to take to make decisions ahead of time that consider the tax impact would be to talk to a tax advisor in Q3 or Q4. A tax advisor can answer questions and help business owners talk through the decisions they need to make.

Another step to take is to have a strategic acquisition of assets. These are things like trucks and equipment that a business owner will need in the next year. Rather than buying it all at once, business owners can assess the trucks and equipment that need to be upgraded and prioritize which ones get upgraded first from most urgent to least urgent. By doing this, their bank account isn't hit with a large decrease, but by smaller decreases over time.

Another step to take is to set aside 15-20% of net profits for taxes. In general, taxes are 15% of the net profits at a minimum. Since many HVAC business owners are self-employed contractors, they are subject to 15.3% self-employment tax. However, unlike regular employees, taxes are not taken out of their paychecks for them. Contractors are responsible for paying taxes out of their own paychecks. Setting aside 15-20% of net profits each month helps ensure that business owners are prepared to pay the tax bill before it arrives. They can and likely should make these payments to the IRS throughout the year, rather than setting them aside, so the IRS does not charge interest. Although depending on the taxpayers personal situation, they may decide the interest charged by the IRS is acceptable and hold on to the money anyway.

I would also add the option of some sort of retirement plan such as a SIMPLE IRA. That way they can offer a benefit to their employees as well as provide themselves with tax savings. If the business is a corporation and Vernon is on the payroll, this is especially useful.

Reading the Dashboard Before Year-End

Let's revisit Vernon's situation from the introduction to this post, but fast forward to a year later: It's early October, and Vernon is on his way to meet with a tax advisor. He's bringing a documents list of things to ask his tax advisor about, including an estimated tax bill and some strategic acquisition decisions. He also plans to ask if there are other things he can do to lower the tax bill.

About an hour later, Vernon is walking back to his office. Now that he's gotten some clarity from his tax advisor, he can make a plan to lower his tax bill in April.

Call to Action

Identify one decision this year that was made without considering the tax impact.

If you need additional assistance, book a complimentary consultation with Joseph.

Disclaimer: The information in this post is intended for general guidance purposes. For advice specific to your business finances or taxes, consult a licensed accountant or financial advisor.