Economic Reality – Selling Your Business Is Tricky Business
June 8th, 2009 Filed under: Uncategorized — Economic Author
Saving on income taxes has become a popular pursuit of many business owners and their advisers. Nobody should pay more taxes than they legally owe. But, sometimes folks tend to “push the envelope” to maximize tax savings. That is just smart business, right?
You might be surprised to learn that “pushing the envelope” to reduce your income tax bill can be one of the most costly mistakes you will ever make. In fact, every dollar of additional tax savings may actually cost you ten dollars! How is this possible?
Let’s look at this very common scenario. Assume that at year end, Joe Biz, Inc. had an inventory with an actual cost basis of $250,000. But, Joe Biz, Inc. decided to report only $200,000 as inventory cost, because doing so reduces annual profit by $50,000. Assuming a combined 40% income tax rate, Joe Biz saves $20,000 in income taxes ($50,000 x 40%). Is this a smart move?
Joe Biz decides to try and sell the business. Joe hires a business intermediary and subsequently learns that his business should sell for approximately 4 times recent earnings. In this example, Joe’s tax savings of $20,000 cost him $200.000! How? Simply multiply the under reported $50,000 inventory (would have added to profit, had it been reported) by the multiple of 4. The indication of value is $200,000 short.
What would Joe Biz rather have, the $20,000 in tax savings, or an extra $200,000 in additional sales price? Which would you rather have? The key is to keep from tricking yourself into costly income tax gaffs. Inventory is just one area where business owners “trim” their tax bills. Other areas include:
- Padding payroll expenses for non-employee family members
- Expensing non necessary recreational items as business expenses
- Expensing personal expenses as business expenses
- Under reporting income >When you are beginning to plan for the sale of your company, it would be wise to sit down with your bookkeeper and accountant to “verify” that all expenses and income items are properly reported, without pushing the envelope.
Keep in mind that buyers and lenders will rely heavily on filed tax returns of your business. Don’t even begin to think about trying to “explain” the short comings of your tax returns. First, buyers and lenders must rely on tax returns as they have been filed, not the way they should have been filed. Second, trying to explain about how you may have been less than honest…sends a very bad message about you and your business. Most buyers will walk away.
If you are interested in valuing and/or selling your business, Grove has provided many additional short articles that can be found at http://www.gruttercpas.com
For professional and confidential guidance, call on Grover Rutter at 419-427-1564 or email him at grutter@gruttercpas.com
