Is Tax Avoidance Really a Strategy?

I know…I know. Some of you are already raising your eyebrows. Let me be clear about something. I didn’t reference “tax evasion.” I referenced tax avoidance. There is a difference, and it’s not 10-25 years.

Every business owner wants to avoid taxes, but maximize profit at the same time. Sounds easy enough, right? Sure. And we will meet on my private yacht to discuss how to do this.

I recently worked with a client who was interested in selling an expensive business vehicle to a family member who was NOT involved in the business. When we met to discuss the decision, I casually mentioned that the sale was going to result in income to him. 

“But why should I have any income on the sale?  I am planning to pretty much give this truck to him.” (Client, annoyed)

“I think that’s honorable, but you can’t do that.  You can’t just sell this truck that would appraise for $25k to your family member for $10 and avoid the gain.  You’ll record the sale at FMV.  And remember when we fully depreciated the truck a few years ago to avoid taxes?  Yeah, all of that depreciation comes back and guess what?  It’s not capital gain.  It’s ordinary income.”

“But I still owe $20k on the loan.  I won’t have any money after I pay those taxes and the loan balance.” (Client, more annoyed)

“That is absolutely correct.” (Me, hesitant)

“I want my money back.”

He didn’t actually say that last line, but I know he was thinking it.  

The fact is that most clients looked at the accelerated depreciation rules we had in place over the last 13 years as license to buy assets, finance them to the hilt, avoid taxes, and disregard the tax implications of selling them. It’s a pretty good gig, until you realize the idea only works until you sell the assets.

It’s hard to advise a client to pay some tax to avoid more pain later, but I think we are not doing our job if we don’t at least raise the issue. The fact is that while you can certainly avoid taxes in a perfectly legal manner by rapidly depreciating qualifying asset purchases, that decision comes home to roost when you consider selling them. We take for granted that clients can see the future as well as we can, and while we work for some of the smartest clients around, it’s our job to analyze the transaction as it stands now and as it may stand later. As an IRS agent told me the other day, these difficult conversations are why we get paid the big bucks.

Raise your hands if you think your tax rates will be less in 5 years than they are right now. Exactly as I thought…there’s only one of you.  So, those generous depreciation rules we had in place from 2000-2014 were just that. They were generous, for a time. Yes, we used the rules to reduce taxes in the short-term, only to potentially expose the client to a gain they didn't expect on the back-end. Legal tax-avoidance at its best, but swallowing the tax on the gain when those assets are sold is a difficult task.

Don’t let depreciation cause you heartburn. The most powerful antacid can’t cut that pain.