Let’s face it: no one likes paying taxes out of their hard-earned income. Businesses are no different and engage in several tactics to reduce their tax bills. Many reinvest their tax savings in the company. However, businesses also need a favorable valuation for a wide range of purposes. Saved tax money might not be enough to fund their plans or help raise additional capital.
Let’s discuss how business valuation and tax savings impact a business.
Business valuation is a process of determining the fair economic value of a company, including intrinsic value, investment value, and sale value. It might include an assessment of the company’s capital, income, future earnings prospects, management outlook, and the market value of assets. Business evaluators thoroughly analyze its financial statements, cash flow models, and strategies and compare them with similar entities.
A business needs a valuation for a variety of reasons, such as:
- To estimate the selling price of a business
- To help raise additional capital either through an IPO or via a private investor
- To understand the correct value of business assets and allocate the business purchase price among them
- To establish ownership interest of each partner in buy-sell agreements
- To resolve shareholders’ deadlock
- To help in the litigation process of a divorce
- To resolve disputes involving estate and gift taxation.
In some legal cases, attorneys need professionally prepared expert valuation reports to withstand the scrutiny of criticism and cross-examination.
Regardless of the reason, the business owner always gains a professionally prepared business valuation report. It brings the correct value of the business to light and shows the extent of its strength, sustainability, and reliability. An objective valuation helps the owner know the accurate picture of the business’s state in terms of market competition, asset values, and income values.
Basing strategies and plans on a professionally prepared business valuation report helps business owners take advantage in negotiations related to sales, mergers, acquisitions, expansion, etc., and intelligent owners leverage them for steady growth and even exit.
How Tax Savings Impacts Business Valuation
No business owner wants to overpay taxes, and every business owner does his best to reduce his taxes. Regarding income tax, one has to reduce their income to reduce their taxes.
Income or earnings is one of the fundamental elements that impact business valuation. So, when business owners reduce their income to cut taxes, they also decrease the value of their business in terms of earnings.
Let’s look at this argument with the help of a few examples. There are many ways in which business owners try to cut their tax bills. Following are the most popular:
- Reducing the current year’s earnings
- Increasing the current year’s expenses
- Purchase of equipment.
Related: Can You Sell Your Business Tax-Free?
Shift Revenues to Next Year
An effective way to reduce taxes owed is to decrease earnings in the current year. Business owners come up with innovative ways to account for lower revenues. Here’s an example of one such tactic.
Suppose business owner “A” prepares invoices for December. But intentionally sends them out near the end of the month to receive payment in January, which shifts this year’s income to next year. In this way, “A” need not declare the earnings immediately and reduces the taxable income for the current year as well as the resulting tax bill.
Doing that could impact his company’s business valuation if he is on the verge of an important business or legal agreement. While not overpaying taxes is essential, maintaining a healthy business valuation report is also critical.
Professional business evaluators, having profound experience, can advise their clients on ways to legitimately cut tax bills without hampering the performance of their business valuation report.
Shift Expenses to This Year
Accelerating deductions also cut taxes by reducing income. For example, business owner “B” has to pay some bills due in January the next year and opts to pay them in December of the current year. That shifts next year’s expenses to the current year and automatically reduces income which, in turn, cuts the tax bill.
While the tactic works to reduce the taxable revenue or income, it also decreases the business’s profitability, showing the company in a bad light in the business valuation report. Again, the issue of saving on taxes and maintaining cheerful business valuation troubles business owner “B.”
Buying Equipment for Tax Write-offs
Businesses often resort to buying equipment, vehicles, machinery, real estate, etc., that qualifies for a tax deduction to reduce their taxes. While companies must increase their assets from time to time, buying assets just for the sake of cutting tax bills could damage their business valuation.
Let’s do the math: If business owner “C” needs equipment for his business and he purchases it, that’s not a problem. However, issues arise when he buys assets that he does not really need or does not need right now. Suppose business owner “C” spends $1 on equipment and saves 40% in taxes. If he did not need the equipment, then he still spent that $1. That is holding on taxes by wasting money!
Spending hard-earned business income on something irrelevant to business adversely impacts capital and cash flow. It could also result in loss of business opportunities, ultimately hampering business valuation.
Reduce Taxes and Maintain Value
We understand reducing your taxes is essential, and now you know that lowering income for that purpose can harm your business valuation. Quantive works to keep its clients ahead in the competitive marketplace and build a roadmap for growth, greater earnings, and mitigating taxes.
First, determine if you need professional tax preparation services. If your taxes are lower than the professional’s fees, it’s better just to pay the taxes. However, you also need to consider the taxes which you do not pay now but will have to pay in the future as your business grows. Keeping track of such matters and planning well in advance is essential to manage your company’s tax burden.
Something as fundamental as changing the business structure could be the solution. For instance, a sole proprietorship or partnership firm could choose to become a limited liability corporation (LLC), which offers incredible flexibility for the tax treatment of business income.
Should the LLC elect to become an S corporation for taxation purposes, the business owners could draw salaries like other employees. Those salaries would be subject to FICA taxes, and the rest of the company’s income would pass through as a distribution of business income not be subject to FICA taxes. In this manner, business owners could save a lot of tax dollars and avoid owing self-employment tax on a large portion of their income.
Consult legal counsel and tax professionals before finalizing solutions to your tax and business valuation woes. A professional will help you take advantage of legal tax breaks and opportunities to save on taxes, enabling you to save a lot in taxes while maintaining the business valuation of your company.
Don’t follow the crowd concerning industry practices for tax savings: special situations need customized solutions. When saving taxes while maintaining your business’ value, you need original and innovative ideas. Hire the right people to guide you through the complexity of taxes and business valuation while busy running your business.