Do you run your own unincorporated business?

If so, you may be a candidate for cash damming, a tax reduction technique that could potentially save you lots of money.  This technique allows you to convert your personal debt, which is not tax deductible, into business debt.

Who Is This Best Suited For?

• Business owners who are not incorporated
• Rental property owners
• Self-employed workers

The Requirements

This works best if you have high business expenses and significant personal debts (mortgage, car loans, etc.).  You’ll also need some form of flexible borrowing, ideally a line of credit (personal or business, doesn’t matter either way).

If you’re in a high tax bracket, you’ll see a bigger impact from doing this, but those in lower brackets can benefit as well.

So How Does It Work?

Right now, you may be using the revenue generated from your business to pay your business expenses; whatever is left you keep for your own personal needs.

With this technique however, you will change that; instead, you will start using your business revenue (gross income) to pay down your personal debts.  All of your business expenses will be put on your line of credit.

The End Result

The effect of all this will be to start building business debt, while accelerating paying down your personal debt.

Your total combined debt (business and personal) will remain the same, but you will now be building an ever-growing tax deduction from the interest on the business debt.  Those tax savings can be used to further pay down your personal debt or for any other purpose you choose.

A Real Time Example

Mike has a $200,000 mortgage, a business that generates $10k per month in sales, and has $5k per month in business expenses.

He wants to save money on taxes, so he decides to implement this technique.  First he sets up a line of credit (maybe against his home, so he can get a higher limit and a lower rate).  He then starts putting $5k of his monthly business revenues (he needs the other $5k for living expenses, just as he did before) as an extra payment against his personal mortgage and pays his $5k of monthly business expenses with his line of credit.

After one year, he now has a mortgage with a balance that is $60k lower and a line of credit with a $60k balance.  It’s the same net worth situation as before, but now the interest on the $60k line of credit is a business expense and therefore tax deductible.

If that interest in the first year was $2k and Mike is in the 40% tax bracket, he’s just saved $800 in taxes! His savings will go up in future years, as he converts more debt from personal to business.

Once all of his personal debt is cleared, he can then start paying down the business debt, if he chooses.

Some Pitfalls To Watch Out For

• Make sure you keep business and personal debts separate!  The line of credit must be used only for business expenses.

• Ensure that you are able to make large additional payments against your debt without penalty.

• Your interest rate on your business debt must be reasonably close to your rate on your old personal debt.

Questions? Feel free to ask in the form of a comment below.

All advice given here should be used as a starting point only. You should consult with a tax professional before engaging in any tax strategy discussed here.