As 2018 heads to a close, many businesses that have calendar year ends are, or should be, in discussions with their tax advisors about year-end tax planning. Usually, the goal for most small business owners is to pay as little tax as possible. However, this may not always be the best route to the end goal.
If you are considering selling your business within the next three years, or if your strategy is to consistently operate your business so that it is positioned for maximum transferable value, then your outlook on taxes will likely differ from other owners. Below are a few items to consider:
Deferral of Income – A common tax strategy is to defer revenue and accelerate expenses. This strategy may reduce taxes, but it may also decrease the value of the business. The cash flow and profitability of a business are significant drivers of business value. Decreasing the income can reduce the value of the business by multiples of the amount reduced. Additionally, this tax strategy may distort the profitability of the business between years. Both buyers and lenders like consistent earnings and are typically willing to pay / lend more for consistency. When a higher business value is the goal, showing less income and more expenses is not the way to go.
Discretionary Expenses – When looking into a company’s financials, it is not uncommon to discover some aggressive or “undisciplined” expenditures. Commonly, these are found in travel, meals and entertainment, excessive rent (if the operating entity leases space from property owned by the shareholders), and vehicle or cell phone expenses for the shareholders and their family members. Although these expenses will reduce taxes, and some of these expenses may be able to be added back during the recasting of the financial statements, many of the aggressive expenses will be discounted by the buyer and the lender. This may ultimately result in a lower value being attributed to the business, an increased amount of seller financing necessary to close the transaction, or both. As most methods of valuing a business include a capitalization of earnings, the money saved by reducing taxes can be significantly less than the enhanced value of the business that results from showing an accurate profit. If you have a significant amount of these types of expenses, it may be beneficial to have your accountant treat the discretionary expenses as a distribution to the owners.
Equipment Purchases – Even if you are planning a sale or are already on the market, it is wise to run your business as if it were not being sold. You need to concentrate on the continual and profitable operation of the business. So if you need a piece of equipment that will enhance the business, you should acquire the asset. This is different than buying a new vehicle at the end of the year just to take accelerated depreciation. As most businesses are sold “cash-free/debt-free,” a buyer typically will not assume any equipment loans. Also, the increased amount of equipment value will not usually translate to a comparable increase in business value. In lieu of purchasing the asset, it might make more sense to consider leasing the asset, as buyers will sometimes be more willing to assume a lease.
There are many things to consider when developing a year-end tax plan. We strongly suggest that you visit with your tax advisor to address your particular circumstances. There are numerous tax mitigation strategies, such as retirement accounts, that can reduce tax liability, but still leave a paper trail that will justify an add-back to the buyer and the lender, so as not to diminish the value of the business.
Although we are not a substitute for your tax adviser, the FBB team is available to meet with you and your accountant to confidentially discuss strategies to maximize the after-tax value of a potential sale. Our initial consultations are at no cost to you.