Getting your small businesses taxes right so that buyers will love you
September 23, 2023 ⋅ 5 min read
You know that feeling when February, that sneeze of a month, is ending and the reality of your small business tax preparation — however it’s looking for you — settles in? Now, imagine you’re exploring selling your small business. You’re taking that hard, necessary look back through taxes past, and you can easily multiply that February feeling X10.
The fact is, whether you’re doing your business tax preparation yourself or with a bookkeeper, doing them right will not just impact this year or next. Smart tax prep will pay off in spades when buyers are combing through your financials and determining the next chapter of your life.
We wanted to know what some of the common issues were for small businesses in doing their taxes and how they could avoid them, so we leaned on expert and Baton partner Patrick Dichter, owner of Appletree Business Services. Thank you, Patrick!
"For every dollar not on your tax return, it could cost you $2-5 when you exit”
- Patrick Dichter, Owner, Business Development Officer, Appletree Business Services
Tax implications of different business structures
Before we get to the tips, let’s address what might be on your mind: taxes vary depending on your business structure. They break out like this (links to forms throughout):
Income from your business is typically reported on your personal tax return (Form 1040) using Schedule C.
Tax Rate: You pay individual income tax rates on your business profits.
Self-Employment Tax: As a sole proprietor, you’re subject to self-employment taxes, covering Social Security and Medicare contributions.
The partnership itself doesn't pay income tax. Instead, profits and losses pass through to you and your partner(s) individually, and you report them on your personal tax returns (Form 1065 and Schedule K-1).
Tax Rate: You and your partner(s) are taxed at their individual income tax rates.
Self-Employment Tax: Partners may be subject to self-employment tax on their share of partnership income.
LLC (Limited Liability Company)
Taxation: By default, your LLC is taxed as a pass-through entity, similar to a partnership. Members report their share of income on their personal tax returns.
Tax Rate: Members are taxed at their individual tax rates.
Self-Employment Tax: Members may be subject to self-employment tax. Alternatively, an LLC can choose to be taxed as a corporation by filing IRS Form 8832.
Taxation: Your C-Corp is a separate legal entity and as such, pays corporate income tax on your profits. Shareholders report dividends received on their personal returns (double taxation).
Tax Rate: Corporate tax rates apply to your C-Corp, and dividends are taxed at the individual level.
Self-Employment Tax: Shareholders typically do not pay self-employment tax on corporate income.
Tax Rate: Shareholders are taxed at their individual rates.
Self-Employment Tax: Shareholders who actively participate in the business may be subject to self-employment tax on their wages but not on profits. The choice of business structure can significantly impact tax obligations, liability, and other aspects of your business. It's crucial to consult with a tax advisor or attorney to determine the most suitable structure based on your business goals and financial situation. Tax laws can change, so it's essential to stay updated on current regulations that may affect your business's tax situation.
Now that we’ve covered the big picture, let’s zoom in for Patrick’s tips on getting your taxes right now and with one eye on the future.
Don’t maximize small business tax write-offs 2-3 years before you sell
If you’re thinking of selling your business within the next 2-3 years, being too aggressive with your taxes now will hurt you. You'll likely sell for 2-5X the EBITDA/SDE. But that number needs to be supported by a tax return. For every dollar not on your tax return, it could cost you $2-5 when you exit. Be legit with your write-offs, and don't try to expense everything.
Have solid bookkeeping
Messy financials are the #1 thing that'll scare a buyer away. Make sure you have good bookkeeping done by an accountant or outside firm, and make sure that your bookkeeping financials match your tax return. We see a lot of Quickbooks files that don't match a tax return, unfortunately.
To find out more, read our article about clean financial records.
Track and clearly mark employees vs. subcontractors
Keep records of your W9s, 1099s, and payroll. If a potential buyer is doing due diligence and sees a lot of team members paid like subs who act like employees, it might become a roadblock.
Pay attention to sales tax liabilities
Buyers don't want to inherit a sales tax liability where the previous owner claimed they didn't think they owed sales tax.
Get your taxes done ASAP
Banks often want the most recent business tax return before closing, so try not to delay your taxes or be on an extension the year that you're trying to close.
The bottom line
The best time to get your small business’s financial ship in shape is now so that you control your timeline to sell and the ease of your exit. Even if you’re working with a reliable bookkeeper or tax preparer, be sure you’re aware of the things future buyers will be looking for, and work backward from there when preparing your taxes this year.