Unreported Income: Should Sellers Disclose Unreported Cash To Potential Buyers?


Unreported Cash

A question that occasionally comes up in our BizBen Business ProSell program is whether a seller can and should reveal to prospective business buyers that the business produces extra income not reported on business tax returns. The purpose, of course is to let the buyer know there is more income to be made from the business than is posted in the business records.

The expectation behind this admission, is that the buyer will be more inclined to make an offer and at a price that will satisfy the seller, if buyers learn there actually is more money collected than is posted.

But many small business owners, particularly business sales intermediaries, think that lying to the government about the actual business income subject to taxation is a mistake. And bragging about it only compounds the error.

Pro Arguments:

A number of business owners systematically under-report their company's income. Perhaps most get away with it. One reason they can avoid being examined by taxing authorities is that there are far fewer agents than there are business owners who don't pay their required share of taxes. One seller told me that some buyers are more inclined to get into a business, perhaps for the first time, when they learn that being a business owner offers ways to reduce their tax exposure-ways not available if they were working chiefly for someone else. A rather surprising reason some sellers feel they should tell all about unreported income is to make the buyer a co-conspirator in the crime of tax avoidance. "It's insurance against being sued," one owner told me. His reasoning was that a buyer who is disappointed with performance of the company after taking over and has an inclination to accuse the seller of misrepresentation, will think twice about that idea. That's because he might have to testify in court that he is aware of the former owner's practice of illegal tax avoidance and is guilty of neglecting to report it to the IRS.

Con Arguments:

But it seems an unnecessary risk for the seller to take. And putting a buyer in that awkward position is not the best way to get a business relationship started. Most buyers don't want to hear about anything that is not documented. They don't want to take your word when it applies to the landlord’s promise of a new lease, your customers' verbal pledges to remain loyal or vendor statements that they won’t raise prices. Why would buyer prospects believe that you really collected $80,000 in discretionary earnings last year rather than the $55,000 stated in the books? As one buyer told me, "If I know the seller is not telling the truth to the tax authorities, what makes me think he'll be honest with me?" And talking to a business sales intermediary about unreported income is not a good strategy if you want his or her trust and cooperation.

An owner who admits his or her tax dodge when offering a business for sale may think the tactic will add appeal to the offering and increase chances of getting a sale at a desirable price. But that usually does not work and it's a plan that is likely to backfire with unintended and unwanted consequences.

Categories: BizBen Blog Contributor, Buying A Business, Selling A Business

Contributor:

Peter Siegel, MBA
Areas Served: All Of California
Phone:  925-785-3118 Cell, 925-785-3118 Text
Founder Of BizBen.com (since 1994). I am the Lead Advisor for the ProSell, ProBuy, & ProIntermediary Programs. I consult daily with buyers, sellers, and brokers daily about buying and selling California small to mid-sized businesses. Call 925-785-3118.

Comments Regarding This Blog Post


I've been a business broker for 25 years, but before that I was a liquor store owner, and so I understand what it's like to operate a mostly all cash business. I've been the broker on many liquor store transactions, but before that I was both a buyer and seller a few times over. While taking a business listing I have the seller fill out a financial disclosure form and sign it, so that I can advertise the figures. I explain to seller what type of information a buyer will want to see, such as, z-tapes from the cash register, tax returns, fillings with the State Board of Equalization, inventory purchases, and any other book and records they might have.

If a seller tells me that they have unreported income, I tell them "that if it's not on paper then to forget about it." The fact that they do have income not reported to the State Board of Equalization should be told to the buyer, so when they buy it and report higher income they do not trigger an audit. When selling a business, the best thing to do is "disclose, disclose, disclose", especially in the litigious times we live in. I do not take into the account the unreported income when setting a purchase price on the business, and I tell the seller that they can't have it both ways. I can only set the price by what is shown on paper, and the buyer should be advised on the risk of the situation if they plan to proceed.


While "cash" income is less common because of the trend toward payment by credit and debit card, in many industries, cash income can be a significant factor. Of course, all cash income should, by law, be reported, even though often enough it is not.

Should sellers reveal the unreported cash income to buyers? My simple answer: "No". As a business broker, I will not make any representations to any prospective buyer about any unreported cash income, and I would prefer not to even know about it; there is no "privileged communication" between broker and client as there may be between attorney and client.

Nor can a business valuation be based on unreported cash income. Generally it is unverifiable. It would need to be discounted by the taxes that would be paid by an honest business owner. It may not be sustainable by a new owner who does report the income because often the customer paying cash doesn't want their possession of cash potentially known to tax authorities. And, in order to take over a business and continue to operate it with unreported cash income, the buyer is effectively saying, "On the day of closing I agree to become a co-conspirator and a felon; maybe we can have adjoining cells."

And, lastly, but very importantly, if a business owner says, "Look I'm a liar, a cheat, and a thief, because I don't report my cash income or pay my fair taxes on that income, "then my reaction is "Why should anyone believe anything else you tell them; you've already established that you're not honest."






  Helpful Resources To Assist In Selling And Buying California Businesses
William F. Ziprick, Attorney: Legal Services For Buyers And Sellers

Through creative problem solving, attention to detail, accessibility, & understanding that unnecessary delay is often a deal killer, I work closely with my clients and other professionals to consistently achieve a high rate of closings. Office: 909-255-8353, Cell: 509-951-7230.

Elizabeth McGovern: Escrow Services - San Francisco Bay Area

McGovern Escrow Services, Inc., is a leading independent escrow company. We are a trusted partner with our clients, assisting them through the tangled bulk sale & liquor license transfer process. We provide attentive, quality & innovative customer service. Phone Elizabeth McGovern at 415-735-3645.

Diane Boudreau-Tschetter: Escrow & Bulk Sale Services - CA

California Business Escrow, Inc. is a full service independent escrow company serving all of California and has expertise in a wide range of escrows. Our team prides itself on providing an exceptional escrow experience. For more info phone Diane Boudreau-Tschetter at 888-383-3331 or 209-838-1100.

Brad Steinberg, Business Broker: Laundromat Specialist

PWS is the leading laundromat broker in California. Since 1968 PWS has brokered over 2,500 laundromat sales. With over 90 employees dedicated to the coin laundry industry, PWS has 18 licensed agents, a 3 person in-house finance department, 10 service technicians and a 20 person parts department.

Janet Carrera: Escrow & Bulk Sale Service - SF Bay Area

Redwood Escrow Services, Inc. is a full service, licensed independent escrow company. We are EAFC Fidelity bonded, fully insured & licensed with the Department of Corporations. Committed to offering our clients the most comprehensive variety of escrow services available. Phone Janet at 510-247-0741.

Shalonda Chappel: Escrow & Bulk Sale Services - Southern California

Escrow services to brokers/agents, sellers, & buyers. Established 43 years. Extraordinary service. Experienced with handling difficult transactions. One stop for all your escrow needs: Bulk sales, lien searches, UCC searches, liquor license transfers, publishing & recording services. 951-808-3972.

Helen Yoo, New Century Escrow - Escrow Services In Southern California

New Century Escrow, Inc. is a fully licensed & bonded independent escrow company. Over 20 years combined experience in handling bulk escrow transactions. Multi-lingual staff that speaks your language, including Korean, Chinese, Vietnamese. Call Helen Yoo direct at 626-890-1151.


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