Are End of Year Purchases Always a Good Idea?

Your accountant says you’re making money so you should buy something to reduce your taxes. That’s always appealing, but it’s often wrong-headed advice.

Let’s say you have made $100,000 and that you will pay 30 percent taxes or $30,000. Buy something for $50,000, take the depreciation this year, and you will reduce your taxable income to $50,000 and only have to pay out $15,000. So you’ve saved $15,000, right?

Let’s look at the bank account. Make $100,000 and pay $30,000 taxes and you have $70,000. Make $100,000 and buy something for $50,000 so you only have to pay $15,000 in taxes. What happens to the bank account? $100,000 - $50,000 = $50,000. Subtract another $15,000 in taxes and you have $35,000 in your account.

Would you rather have $70,000 in your bank account or $35,000? Yes, I know you need the $50,000 thing. But do you need it more than cash? Most business owners need the cash more, so being stampeded into a purchase just to reduce taxes isn’t always the best course.

What about the deduction? If you’re spending $50,000 on equipment to reduce your taxes, realize you could spend the same $50,000 on a number of different things and have the same deduction. You could spend it on advertising, wages, or just about any other deductible expense and be in the same place. Either way, you are spending $50,000.

So, my bottom line question to you is: If there were no tax ramifications, would you still spend the $50,000 on equipment?

All too often the answer is no. If it’s no, then don’t do it. You’ll be cash ahead.