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

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.

About the Author: Peter Siegel, MBA is the Founder & Lead Advisor at BizBen.com (established 1994 - 8,000+ California small businesses for sale & wanted to buy postings -  with 500 new & refreshed posts daily). BizBen.com offers business buyers, owner sellers, business brokers and advisors free access to online postings, articles, blog posts, discussions, podcast, resource and broker directories, etc. Peter heads up the BizBen.com ProBuy, ProSell, & ProIntermediary Programs. Peter Siegel, MBA can be reached direct at 925-785-3118.

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

Contributor:

Peter Siegel, MBA
Areas Served: Nationwide - All Areas
Phone:  925-785-3118 Cell, 925-785-3118 Text
Peter Siegel, MBA - Founder Of BizBen.com (since 1994), I am the Lead Advisor for the ProSell, ProBuy, & ProIntermediary Programs. I advise/coach buyers, sellers, and brokers daily about buying & selling small to mid-sized businesses throughout the Nation. I can be reached direct at 925-785-3118.

Blog Comments

Posted By: Joe Ranieri, Business Broker: LA, Orange Counties

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.


Posted By: Timothy Cunha JD, Business Broker: San Francisco Bay Area

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."



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