Involve Your Banker in Year-End Tax Planning

Do you expect to meet with your accountant in the next few days to discuss year-end tax planning?

If so, call your banker before you head into this meeting. Better yet, ask your banker to come along--because what you do to avoid taxes this year can affect your ability to borrow next year.

Indeed, in a worst-case scenario, what you do can make it impossible to borrow next year.

How?

As the year ends, business owners commonly ask their accountants what they can do to lower income taxes--an understandable effort, given the burden.

In response, accountants, plumbing the complexity of tax law, suggest a variety of techniques by which the company, as distinct from the business owner, may avoid taxes, among them:

* Bonusing out profit to the company’s shareholders.

* Placing the highest possible value on inventory.

* Classifying certain assets as inventory, not as plant or equipment--for example, items such as trucks leased to others.

* Deducting the entire cost of certain items as expenses, rather than depreciating their value over more than one year--for example, the cost of adding component machinery to a printing press to enhance its efficiency.

Within limits, each of these techniques is perfectly legal, and using them aggressively can cut your tax bill significantly. When you bonus income to yourself, for example, you strip your company of retained earnings and transfer the burden of income tax to yourself--the payoff being that you pay taxes once, not twice, on the same income.

Similarly, you reduce profits and hence your tax bill when you place the highest possible value on inventory, or classify certain assets as inventory rather than as plant or equipment, or expense the purchase of an item.

But if these techniques cut your tax bill, they also make your business look less profitable on paper if not in fact--and the less profitable your operations this year, the more difficult it becomes for you to get a bank loan for, say, a marketing blitz in the first quarter of next year.

“There’s always a trade-off,” says Fred B. Denitz, a senior vice president with Imperial Bank in Beverly Hills who specializes in lending to small and mid-size businesses.

“If you want to minimize your taxes, you can lower your operating profit on your income statement and therefore your tax liability.

“But at the same time, if you leave your company with no earnings, you may also leave your equity on your balance sheet unchanged, and this can make it more difficult for your banker to approve a loan.”

Sole proprietors and the principals of family-owned businesses often think only of minimizing their tax burden at the end of the year, Denitz says, and don’t realize that their success in doing so can leave their companies in a poor position to secure bank financing to grow.

“The effect of good tax planning on the balance sheet and income statement can be significant,” Denitz says, “and this in turn affects your ability to borrow.

“If you take all your earnings out of the company, you don’t increase your equity in the business. The lower your equity, the less you can leverage it in borrowing power.”

Similarly, in the eyes of a lender, if your tax planning cuts into cash flow, it may also undermine your ability to service debt, Denitz says.

But if there are hidden dangers in good tax planning, there are also opportunities to maximize your ability to borrow capital.

For example, you can give yourself a year-end bonus so as to leave your company with no tax burden on retained earnings, but then inject the same money right back to your company in the form of a long-term loan.

The loan shows up on your balance sheet as a debt, but if you offer to subordinate the debt to any bank loan, your banker may treat it as an addition to equity, increasing your ability to borrow.

Similarly, your accountant may suggest other ways to value inventory, classify assets and expense costs without damaging your borrowing power.

Whatever your strategy, Denitz says, you should keep your banker informed of your tax planning--and maybe get him or her in on your discussions with your accountant before you settle on a plan.

“Your banker should be a member of the team,” Denitz says.

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Freelance writer Juan Hovey can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.