You Could End Up Paying More Taxes

Stimulus Money: The Good and The Bad

You Could be Falling Behind on Taxes
The world was pretty optimistic about 2020, it was dubbed the year of wealth and new beginnings. How ironic it all seems now.

In the second quarter of this taxable year, the unimaginable happened — businesses shutdown, practices forced under, in the face of what is the worst financial disaster since ‘07-‘08. In an attempt to mitigate these events, the government started offering aid, packages, stimulus money for businesses.

It’s supposed to be a good thing, right? Financial Aid, like giving CPR to the dying. But, in an end-of-the-world scenario, nothing is always what it seems and plans don’t always go smoothly. It might be a good time to run your numbers by your financial advisor, because these stimulus packages maybe creating higher taxable income, the bulk of which, is not coming from your operations, and the year’s decreased deductible expenses could result in higher tax payable than last year.

What influences this trend?
There are a number of reasons this could be happening and here are a few:
• The PPP stimulus money is offset to your payroll expense, it is NOT deductible expense for the tax year.
• Some stimulus funds from the government such as the Health and Human Service will be considered taxable income.
• Decrease in expenses, such as supplies and rent, during the lockdown, resulting in fewer tax deductions.
• The temporary stop in paying payroll and tax withholding during the lockdown
• Because the collection stopped during Apr-May, the sudden spike of collections in June could mean that the tax payable for the second quarter is higher than the previous quarter or even higher than last year’s second quarter.

Let’s look at the numbers
Based on the hypothetical figures below, let’s analyze the effects of the factors listed above.

1) First, because of the lockdown of the second quarter from April to June, it is reasonable to infer that your collections will be down since there was no business.

2) Second, any HHS Stimulus will cause an increase in Taxable Income as provided by the IRS.

3) Third, Direct Costs decrease due to the months of shutdown when there was no payment of payroll and lab fees, and no purchase of supplies. It further decreased because of the PPP Loan you availed of, which was offset to your Payroll Expense, basically canceling it out, resulting to an overall decrease of direct costs. Less direct costs mean more profit. More profit means higher taxes.

In the figures below, the Year 2019 had direct costs of 30,000. In the Year 2020, a direct cost of $25,000 is deducted by PPP Loan $15,000, leaving you with $10,000 direct cost. That’s 20,000 less direct costs than last year. (See item (3)(a))

4) Fourth, the Fixed Costs overall, will decrease because of the deferred rent of two months. But the other fixed costs will remain the same and will still be incurred despite the lockdown.

5) Net Profit overall will Increase, despite the decreased Collection. Don’t be surprised that the Profit is up despite the shutdown. Remember, you had that stimulus money in item (2) treated as taxable income, technically, you “earned” despite not having done business.

6) By year-end, your tax liability will have increased due to the increase of net profit in item (5).

7) At the beginning of the year, we normally plan out our tax payments. We determine an amount and spread it out through the quarters. Based on our figures, last year’s taxes was $18,000 (see line 6). In the Year 2020, you would expect about the same figure, so we spread it by 4, each quarter you expect to withhold $4,500. However, because you stopped withholding during the second quarter’s lockdown, you are $4,500 behind in taxes.

8) At the end of the year, you have an overall Tax Shortage of $12,000. From that figure, you have $4,500 as discussed in item (7) and a $7,500 increase in Tax liability as shown in item (9) as a result of the increase in profit, as discussed above. Essentially, you expected to pay $18,000 in taxes and withheld accordingly, but because of the circumstances discussed above, your payable taxes should be $25,500.

Basically, in 2020, the Collection decreased and the Costs decreased, accounting principles tell us that profit should decrease too, right? Well, because of the stimulus money treated as taxable income, there could be an increase in profit and consequently, an increase in tax liability. This shortage, if unnoticed, will follow you into the Year 2021 where you have to deal with not only the remnants of 2020’s financial struggle but also surcharge. That’s 2021’s money paying for the mess 2020 made.

When you are drowning, it’s easy to forget everything and cling on to whatever life vest is thrown your way. You are put in a position where you either take it or die. But when the waters calm down, you regain your senses and realize a significant tax debt could be chasing you down years to come.

As businesses are starting to open up again, it’s important to mitigate any imbalance created by the economic dip of the pandemic. Remember, net profit is up, but without proper planning, you run the risk of spending it elsewhere and overlooking this potential threat to your financial stability — because you don’t see these numbers until you work them out. So, don’t spend money on anything not absolutely necessary for the survival of the business and don’t get blindsided! Go by the numbers with your accountant now, and prevent this tax shortage from happening.