Good Expenses Versus Bad Expenses

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A few weeks ago I wrote about the concept of good income versus bad income. Just because money is coming in the door doesn’t mean it’s “good” income. The same concept applies to expenses. Just because money is going out the door, doesn’t mean it’s necessarily a bad thing.

An expense is a good expense if it is for something useful to your business. This includes things that save your sanity, such as outsourcing bookkeeping or payroll.

Here’s an example. One time I worked with a client who had 35 employees. The owners were a husband and wife, and the wife had, in a prior job, helped with part of the internal processing of payroll for her employer. So of course, she knew all about it.

Only she didn’t know all about it.

She spaced off making payroll deposits and filing 941s, and eventually the IRS caught up to the company and assessed $10,000 in penalties for late deposits and late filing.

Now, one could argue that a $10,000 penalty is excessive. This was a small business (don’t let the “35 employee” part fool you, almost all most of the employees were part-time and some only earned a few-hundred dollars over the course of the year).

The client expected me to save them. So I wrote a letter to the IRS arguing reasonable cause because it was a small, growing business that the client had lost control of. This was true … but I knew the IRS would reject the argument. (Side note: I am batting .000 in my career on getting payroll penalties waived for reasonable cause; the only thing that ever works is first-time penalty abatement, and when multiple quarters are involved, it would only apply to the earliest quarter.)

And the IRS did reject that argument.

I told the client they should let me handle payroll. Her response was “that’s a waste of money when I can do it myself.” I replied that at most my fee would be $2,000 per year for payroll services for a payroll with 35 employees. It would take 5 years of my service to total $10,000 spent, whereas she was racking up $10,000 in IRS penalties by doing it all herself.

She said she was confident that “once we get past this issue with the IRS I’ll be able to handle it going forward.”

We ended up parting ways and no longer working together. The last I knew, she had engaged a tax attorney, no doubt dropping thousands more dollars on attorney fees in what will almost certainly be a futile attempt at fighting the penalties.

This is an example where outsourcing payroll and paying a fee to a service provider would be a good expense. Clearly this client couldn’t handle payroll themselves. Yet they clung to the notion that paying a professional is a “waste of money.”

I actually agree with the DIY thing, in the early stages of a business. For the typical tiny startup (which is mostly what I deal with) it probably is true that the business can’t legitimately afford to outsource things such as bookkeeping. It probably does make sense for a typical tiny startup to have the owner keep the books himself or herself.

Some service provider type of businesses probably never need to outsource anything because there may not be enough transactions to worry about. For example, some of my service providers have a small number of clients and only a few basic office expenses. They make a lot of money, but they don’t need anything from me outside of tax preparation because there’s nothing for me to do.

But other businesses will reach a point where the number of transactions will grow beyond the owner’s ability to do it all themselves. And that’s when it might be a “good expense” to pay for some help.