My boss went to the CPA and said that he was going to owe a lot more in taxes because the company credit card was mostly paid off by a large payment and that it was going to raise his tax liability. From what I was always taught, a credit card only affects a P&L from the interest and the rest would either be a cash flow/balance sheet. Am I missing something, was something recently changed in tax code, or is the CPA full of it?
How is paying off a company credit card considered profit?
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Posted by OtherAd2537
16 Comments
Something was lost in translation.
It’s more likely that your boss thought they could deduct the dollars used to pay off the debt. So they thought they could profit 50k, pay off 50k of debt, have 0 taxable profits. They found out though that that’s still 50k of profit. Paying off debt doesn’t reduce profit.
This makes no sense, something is missing or the question wasn’t clear at all.
Okay, here’s one stretch of a possibility:
***Cash basis taxpayer, cash basis business***: the “company” is a Schedule C business doing cash method so the CPA is only considering the item an expense once it is paid off on the credit card.
(This requires some gymnastics of reconciling and is not likely)
***Cash basis taxpayer, accrual basis business***: kind of the same idea as above but even less likely because if you’re accruing the expense then it’s considered an expense and is lowering profit subject to tax to pass through to owner.
OP…you are correct. Paying the principal balance on a debt is not a business expense.
I suspect your boss misinterpreted something the CPA said. The large payment is income and has increased taxes. The fact that he’s using the revenue to pay off the debt is unrelated to taxes.
2 guesses. One, he deducted purchases and then thought he could deduct payment as well. Two, they were personal expenses and not deductible at all.
You need profits to pay debt
Perhaps the company paid off his personal credit card balance and the company was not a passthrough entity in which he was an owner?
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Actually, I think he’s talking about a classic case of income without the cash to pay the taxes.
Let’s say you buy a machine for $1 million and borrow the whole amount. You earn $1 million elsewhere and pay off the debt. You have $1 million income, but no cash. At a 30% tax rate, you owe $300k in taxes—so you borrow $300k.
Next year you make $300k income and use all the money to pay the loan. At a 30% tax rate, you borrow $90k to pay the tax.
And so on.
Your boss made income through his business, but all the money went to pay the debt. He’s cash poor to pay the tax.
Some CPAs call this income from paying off debt. It takes income to be able to pay off debt, but paying it is not income in itself. What got lost in translation is paying off debt converts cash income to non cash income. It creates a serious cash problem to pay the tax.
I actually had a client who had a $1 million windfall from a contract in his Sub S and blew every bit on a plane and vehicles for his business, but didn’t think about keeping $300k to pay the tax. He went bankrupt 3 years later.
Possibly a bad explanation or more likely misunderstood. A reduction in liabilities ends up as the same effect as an increase in cash on the balance sheet. It probably went more like this:
Client: If I have that much profit, where is the cash?
CPA: You used to pay off the credit card.
If for some reason the creditor was cancelling some of the debt, then that debt cancellation is income but from the way you described the situation I don’t think this is what happened.
Ahh. Phantom income. If you use profit to pay down debt instead of putting it in your pocket you have to pay taxes on your profit but don’t feel like it is income. Hated that.
I mean if his credit card interest was costing him enough. The charges themselves would affect the p&l but once you record the expense for the charge it doesn’t matter if you pay it off now or over ten years, besides interest obviously.
Yeah, that’s like the business clients who use accelerated depreciation to write off equipment or vehicles, and then can’t seem to understand why the full amount of the loan payment isn’t a tax deduction. The boss would have needed to spend the money on a new asset for the business to get the write off he was expecting.
there might be some outside debt basis recapture issues at the personal level.