Business Cash Balance Equal Taxable Income

Does your business cash balance equal taxable income? Will zeroing out the bank account eliminate your business income taxes?


Again today I was asked a question that I am asked at least quarterly “Jeff, I know if I can get rid of all of the cash in my check book by the end of my tax year of 12-31,  my won’t owe any taxes. So, I am going to pay down the loan that my business owes”.
The answer is “NO”.

First, the cash balance does not have anything to do with how much taxable income or income tax you or your business will have to pay.
The taxable income is figured by taking your business revenues less your business tax deductions which include cost of goods sold, payroll, payroll taxes, rent, auto expenses, advertising, yada, yada!  So, you could have a
Second,  if your business is operated for tax purposes as an S corporation or a partnership, your business will not have to pay a tax. The taxable income profit or loss flows down to your personal tax returns where it gets taxed as income or if a loss can be used to reduce other taxable income.
So how do you know if your business operates as an S corporation or partnership?  Go into your computer files or file cabinet and see what tax return form number is on the tax returns If you see the form 1120S then your business files as an S corporation. If you see the form 1065, then your business files as a partnership. If you find that you file as a sole proprietorship through your personal tax return as Schedule C, then you are a sole proprietorship.

So, in the case of filing form 1120S or 1065, the income or loss flows down to your personal tax returns and the business does not pay the tax.
Now that that is settled, how can I prove to you that eliminating the business bank checking account balance will not eliminate taxable income?
Rule: Loans made to your business are not considered taxable income.  Repayments of loan are not considered tax deductible.
Rule:  Capital you put into the business are not considered taxable income. Draws or distributions you take out of the business are not considered taxable deductions.

So, if you started a business on December 31st by receiving a loan from the bank for $300,00 and you did not deposit any income or write any checks for expenses (like rental expense), would you have $300,000 in taxable income?  NO

If you repaid the loan the same day for $300,000 to eliminate cash would you go from $300,000 in income to zero because you zeroed out cash? NO
The world is never perfect.  Let us take an example that might help you understand the concept that taxable income has just a little to do with cash balance but that they are never the same.

Let us say on December 1, your bank account starts out as zero.  You deposit $1,000 in capital and $9,000 in loan so the bank account has $10,000 in it.

For the month of December your business added $8,000 in revenue from cash/check/credit card received from customers/clients/patients.  You paid out $7,000 in payroll expense, rent and other expenses.
Your business cash basis profit is $1,000 and your business bank account is $11,000.
If you turned around and paid expenses for this year and prepaid expenses for early next year for $11,000, your bank account is zero but you now have a loss $10,000.

If at the personal tax level you had no other income but a capital loss from the sale of stock, you should have stayed at $1,000 profit because by spending the cash out to get your cash account to zero, you just wasted a $10,000 loss that you might never get any benefit out of. By not understanding that your business ending cash balance doesn’t have anything to do with taxable income, you paid $10,000 in expenses that you should have deferred to next year.

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009