As tax season looms again for small business owners, it’s time to think about those deductions.
Though common sense may tell you to take as many as you can, that could be a bad strategy long term.
That’s especially the case if you plan to sell your business.
Because experts say too many deductions may make your company look less profitable to prospective buyers.
“As long as there appears to be profit, and you have successfully taken every business deduction over the years, there is a sense of contentment,” explains Kevin Busch, president of CFOToday in an email interview with Small Business Trends.
CFOToday is a national accounting franchise specializing in small business finance and taxes.
“But truth be told, when you take every tax deduction, your financials don’t leave a trail of smart accounting — they leave a trail of one dimensional financial management,” Busch adds. “In most cases, years of tax returns form the basis of your assessment of the value of your business.”
Too Many Tax Deductions Can Affect Valuation
Unfortunately, Busch says taking those deductions could have an unanticipated side effect.
“The dirty little secret is that every dollar in taxes you save today could cost you two to five times that in lost value when you sell your business,” he adds.
In the end, Busch says too many years of breakeven profits — or, worse yet, losses — on your books will lower the net worth of your company. And that, of course, affects what you may be able to get for it in a sale.
Hence, trying to take every deduction you’re permitted year after year is short-sighted when what you need is a long term strategy.
“Preparing to sell your business is a marathon–not a sprint!” Busch insists.
So it may be better to pay a few more dollars in taxes now. Otherwise, you could lose out in the long run, Busch says. In the end, buyers may only be willing to offer a fraction of what you believe your business should be worth.
That’s not to say you can’t take steps to minimize your tax exposure, of course.
Smarter Tax Strategies for Small Business Sellers
For a smarter tax strategy, Busch recommends adopting a net worth versus net loss tax strategy focused on a long-term period of perhaps 5 to 10 years.
That means shifting away from a strategy of minimizing tax liability. Instead, focus on what Busch calls “smart” deductions — those that are specific, measurable, attainable, realistic and time-based.
Here are two examples Busch shares:
- First, evaluate investing in a depreciating asset or tax deferred retirement plan. (But look for a plan other than a traditional 401K, Busch suggests.)
- Second, if your business is large enough, consider an Employee Stock Ownership Plan, one that allows you to “cash out” at a favorable price, and perhaps even tax free (but at a rate no worse than tax deferred.)
“It may seem counter-intuitive to look at maybe paying a little more in taxes today and next year and so on … to save a lot of taxes when you sell what may be or should be your most valuable asset- your business,” Busch adds.
But the alternative, he says, could be ending up selling your business many years down the road for substantially less than you believe it should be worth.
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