A common question we get here at DMF is: Should I get rid of my cash balance in my business in order to help reduce my tax liability?
While there are many answers to that question, the short answer is: No. You don't pay taxes on cash balances in your business; you pay taxes (at the individual level most likely) on activity that creates that cash balance.
In a perfect cash-basis environment, your year-end cash balance would in fact be your taxable income. However, none of our business clients operate in an environment like that. That's because most businesses enter into transactions that affect cash but don't affect their tax liability. Or transactions that affect taxable income but don't affect cash.
These transactions include (but aren't limited to): incurring or paying off debt, buying or leasing equipment, expenses for meals and entertainment, and inventory purchases.
Bottom line: the differences between cash flow and taxable income are sometimes difficult to explain and even harder to understand. Make sure your tax professional explains or reconciles the difference for you.
