The first tax seminar I attended as a young financial professional was held by a Big Four CPA firm.
The speaker, an expert in taxation, explained his objective when consulting with clients:
“I want my clients to pay the most taxes possible after taking every legal deduction to which they are entitled.”
Every attendee in the room let out an audible gasp. The most taxes?
The speaker continued:
“Let me make it clear that if a client pays a large tax bill after taking all his legal deductions, he must have made a very large amount of income.”
“Making a large income should be my client’s objective, not having a small income tax bill.”
I meet business owners on a regular basis who are very proud that they pay no income taxes year after year.
While I am not affiliated with the Internal Revenue Service and do not act as anyone’s conscience in this matter, I can think of at least three reasons not to artificially manage a company’s income down for tax purposes:
- By managing income down, the business owner is avoiding reinvesting in the business.
Reinvesting should enhance future income by building the company’s capabilities, enhancing or increasing products and improving efficiency. And, some reinvestment is tax deductible anyway, either in the current year or in later years.
- Minimizing taxable earnings results in reduced business value.
The sales price of a business is usually developed by multiplying the reported business income by a multiple of income depending on the type of business. The higher the income, the higher the sales price of the business.
- The egregious act of illegally avoiding payment of taxes is fraud.
Tax fraud is a major violation and will land an aggressive owner in the federal penitentiary with a large tax bill including penalties and interest. A business owner who has no taxable income usually manages his income down by pushing personal expenses through his business, such as:
Auto expenses for himself and his family;
Salaries paid to family members who do not materially participate in the business;
Family travel expenses;
Personal club memberships and other deductions.
A potential buyer of the business who sees these expenses reported to decrease income will not trust any of the financial reporting of the business.
You should talk to your tax CPA about what is legally deductible.
To plan the strategic direction of your business and optimization of income and expense and to get your business ready to sell for the best price and terms, you should consult with a financial professional, such as a Chief Financial Officer consultant. If you would like to reach out to me, please call (949) 300-0958 or firstname.lastname@example.org.