Top 20 Destroyers of Business Value # 11 – Sometimes It’s Ok to Pay Taxes!

Posted on October 10, 2012 · Posted in Blog

One of the biggest problems we see with privately held companies is a lack of verifiable net income.   Many businesses owners get in the habit of reducing taxable net income as much as possible. In some cases deductions blatantly cross the line – and we’ve seen it all – from deducting the family dog for “security” to trips to Greece to check out potential vendors.

In most cases deductions, while pushing the line do not cross it. These typically include family members on payroll, client entertainment, personal benefits and timing issues like pushing revenue into the next tax year and accelerating expenses.

While these may be benefits to ownership, when the time comes to sell or value a business, they often cannot be recognized as valid income.  Post financial crisis lenders, investors and valuators have a whole new standard of due diligence and income verification requirements.

Non verifiable income that is not on a tax return or GAP prepared financial statements is typically not counted as net income. Without getting into valuation theory, let’s look at an example:

If a business is valued at 4x net cash flow and the company has $250,000 in taxable income, the valuation would be $1,000,000.  If the business owner decides to run miscellaneous expenses and deductions of $50,000 to save on taxes, he would save about $17,500 at a 35% tax rate. However, he could lose 4x $50,000 or $200,000 in valuation.

In addition to losing potential value, business owners who push the limits on tax deductions also risk losing credibility with lenders, investors and valuators. While pushing the limits may be fine when running a business, there are risks when the time comes to sell or transfer ownership.

Are you destroying value by pushing the limits on tax deductions?

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