April 2010 Newsletter

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The Great Tax Debate

It’s April and time for the most feared activity in the world for business owners – filing tax returns. More accurately, filing tax return extensions! Of course corporate returns are due March 15th, but April 15th is more dramatic and common.
It is one of the great dilemmas of all time: Do I under-report my earnings and exaggerate my expenses? For some, this process of NOT paying Uncle Sam is a real art. Without getting into politics or the social values of paying taxes, let’s review the other most obvious reasons to be more honest on your tax returns.

  • It’s much easier to sleep at night knowing you won’t end up losing sleep as someone’s boy or girl toy in the big-house.
  • Your spouse that signed the return without reviewing and understanding how much you are cheating is just as liable, so also ends up being “befriended” in Leavenworth.
  • IRS judgments on your credit bureau leave a lasting impression.
  • AND, if you are a business owner that cheats at tax time, you have reduced the value of your business and personal net worth 100% or 1000%. Who knows, but the impact will be huge.
  • Oh yes, and forget getting that bank loan for working capital.

Very real example: (I have many to choose from, but I will take a simple one)
Bar and Grill owner decides it’s better to pay cash to his employees to avoid his portion of taxes. He doesn’t report all his income because he doesn’t have employee expense to write off and doesn’t want to raise suspicion. His groceries, cars, kid’s phone, and other personal items are expensed through the business. He almost hits break-even. No taxes owed. Job done. Cool.

Bad news. He couldn’t keep all that unreported income, so he spent it. The economy takes a dive and he needs a bank loan to keep going. However, his tax return shows no profit, and he shows no personal salary, so the banks say no to a loan. The next “great idea” he has is to sell his business. After all, who wouldn’t want such a great business that has supported him and his family for 10 or 20 years?

Depressing part. Since his tax return shows no cash flow, his business is worth the used equipment in the building; about $35,000. There is a very limited market for his used equipment so he’ll need to discount it further to sell.

Summary. Had he reported his true cash flow of $110,000, his business would have been worth $200,000 to $250,000 in this case. A qualified buyer would be much easier to find and there would be a bank to fund the acquisition. Multiply the size of this business by 4 or 5 and you will get an idea of the impact on one’s estate with a larger business. Plan ahead when thinking about selling. The example above can be rectified without too much pain and with a little time. Call an Apex Business Advisor to find out how!

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