One of the many advantages of small business ownership is mitigating tax liability. You can take full advantage of the tax code to reduce the tax burden. Deductions have been established to allow business owners the chance to pay only their share of tax on actual income.
When preparing taxes there is a scale from non-aggressive to very aggressive when it comes to deciding what deductions to take. The more aggressive approach will lead to more tax savings which is a good thing, right? Not necessarily.
When you decide to sell your small business, the most common method of arriving at the value of your business is by using a multiple of your annual earnings. The lower your earnings, the lower the sales price. For example, let’s say you own a small business, are paying 35% in taxes and know you want to sell in the near future. In addition to your normal business deductions, you have an additional $30,000 in deductions that could be taken but are a step removed from the actual business. These items could include personal expenditures, cell phones, non-business auto expenses, etc. In a 35% bracket taking those deductions would save you $10,500 in tax payments.
If you decided to sell your business your broker would run all of the comps to help determine the value of your business. If it’s determined that your business would sell at a 3.5 multiple, or 3.5 X your annual EBITDA, how valuable would that same tax write-off be worth? If you chose not to take the $30,000 in deductions and paid the additional $10,500 in taxes, your EBITDA would increase by the $30,000. Multiply the $30,000 by 3.5 and you have an extra $105,000 in the value of your business. You get ten-times the tax savings in your sales price.
Of course, this is a simple example, every business is different, and you should consult with your CPA for tax advice.
The bottom line is that when it comes to selling your business you need to think long term. It may seem counterintuitive, but by avoiding some deductions and paying more in taxes you may end up ahead!