Tax Write-Offs, Deductions & Depreciable Expenses: What’s the Difference?
Grooming Business Basics
By Khris Berry
Gina attends her favorite trade show each year. She eagerly anticipates seeing new products; she makes lists that include supplies such as shampoos, bows and brushes. She needs a new pair of shears but has paused on the purchase until she could make the rounds of each vendor—she likes to hold her shears in her hand before she buys them. The week before she leaves for the trade show, she has a dryer fail so she adds a dryer purchase to her list.
Fast forward, and Gina is driving home with her new purchases packed into her van. She will be adding some spa services utilizing her new specialty shampoos and her newfound education in skin and coat health. She has the greatly needed replacement dryer packed safely behind her and those sweet shears she waited to purchase are in her purse. She made a few impulse purchases including a new grooming table to ease the burden of lifting dogs—although expensive, she knows that this particular purchase will extend her grooming career a bit longer. It’s not Gina’s first time buying equipment or shears or supplies, so she dutifully collects her receipts and files them away—anticipating that she will need them later.
For most of us, this story ends here. We bring our new tools and supplies home—some of them become staples in our salons and some of them become frivolous purchases. Regardless, we repeat the cycle each year and keep our equipment and product uses up to date with the modern advances of the industry. But what about that nagging little part of the story with the receipts? What happens to the collection of receipts we tuck away for later use?
Most groomers know that it’s important to save them for later to provide to their tax professional or accountant upon request. But do you know how to MAXIMIZE their use and ensure that the tool purchases you make actually make you the most money afterwards? Do you know the difference between a tool and supply? Do you know the difference between a tax write–off and a tax deduction and a depreciable expense?
Like you, my knowledge surrounding my business often stays focused on the pets, managing employees and clients, ensuring safety for all and typical daily operations. When it comes to Tools and Taxes—I needed a little direction from my tax professional team. Here’s some advice I received that may benefit every groomer and business owner:
First, let’s make sure we know the difference between a tool and a supply—Gina bought both at the trade show. While a simple concept, this is business expensing ABC and worth revisiting. A supply is a consumable item used in your business. Depending on your accounting preferences, it can be categorized as an expense under Supplies, or possibly even Cost of Goods.
Operating expenses and Cost of Goods measure different ways in which resources are spent in the process of running your business. So, your shampoo purchase can be viewed by your tax professional as a regular expense or it can be viewed as the Cost of Goods to create a product within your organization. Visit with your tax professional about how choosing one, the other, or a combination of both can impact your income statements—they are deducted in different places!
Now, back to that stack of receipts and van packed full of purchases from the trade show. Gina bought shears, a dryer and a table. All of these are items are non-consumable so they will be determined as tools. She will use them repeatedly (hopefully for years) in the course of her business. But the story of the receipts doesn’t end there. Understanding the impact of how to record these tools into your business financial story is critical as those decisions can make financial impacts on your business finances down the road.
If Gina purchased any tool which has a life period of over one year AND it cost over $500, then she will probably be advised to choose to depreciate that tool over the course of five years. She gets to choose if she depreciates the entire purchase and how long she wishes to stretch the depreciation schedule. This is where most groomers get foggy, and check out. Making the correct choices are valuable to the long–term financial health of your business.
If Gina chooses to take the expense and NOT depreciate the tool, she gets credit for the entire expense in the year she purchases it. That seems like a great idea, but this is where it gets sticky. Even if she takes the deduction in one lump (same year), the tool should remain on her financial record until it has been sold, disposed of or removed from service. She gets the immediate gratification of a deduction but has to carry the VALUE of the tool in her proverbial financial purse for many years to come without getting a deduction for it.
For example: if Gina’s grooming table cost her $2,000 and she elected to expense the entire purchase the year she buys it, but then decides to sell it the next year, she will have to ADD back the depreciation she took early. This means she got credit for an expense of $2,000 in year one. In year two, no matter what she sells the table for, she has to add back $1,600 in depreciation expenses. Remember the five years? That’s $2,000 divided by five, so she could have opted to take $400 per year instead.) Now she’s being assessed for the extra depreciation she didn’t use because she sold the table. If she sells the table for $1,500, originally purchased for $2,000, she may think she has a loss to report on her taxes of $500. In reality, she has to report a loss of $500 but a GAIN of $1,600 in depreciation so she has a negative impact of a POSITIVE gain to her business of $1,100. OK, take a deep breath and reread that paragraph.
Understanding how you record your tools and the long–term effect it has on your business is part of savvy business ownership. It seems like a game of chance to most business owners; we are enticed by taking the expense of equipment immediately to reduce our income, but are disappointed when we realize that the tool continues to work for or against us in our financial picture for much longer.
Predicting the lifespan of your tools will help you navigate this puzzle. Determining how long a tool should actually be in service and attempting to match your depreciation schedule to its lifespan helps keep things more simple. Housecleaning of your depreciable items year to year can have a drastic impact on your year–end results. Most items that you depreciate should be kept until they are removed from use to help make sure you do not get assessed added depreciation costs—and of course, ensuring that your tools last their natural life span is always helpful!
Many people hear about reducing their income before year–end and will rush to purchase new tools or fixtures. This is the double–edged sword; the purchase can help reduce your reported income instantly, but choosing how to address that tool purchase on your actual bookkeeping is critical. That tool can end up not providing you with a benefit if it gets removed too early.
So, if you are still reading, you are a super trooper. Tools and Taxes are not exciting to most of us; the housecleaning that we need to do financially can be burdensome as well as completely confusing. Learning which questions to ask and following the paper trail for every tool you purchase will help you determine how to make sure that you are maximizing every benefit of those shears, dryers, tubs, tables, cages and everything else you purchase to operate your business.
I relied on several tax professionals to help me navigate this article—thank you Tom Strohmeier, Strohmeier Accounting and Kris Leitz, E.A KML Business Solutions for deciphering a few of my questions.