Let's face it, many business owners in cash businesses do not declare all or a substantial portion of their cash revenues to the IRS. Being a business broker from the Philadelphia area, I have seen this circumstance from owners first hand. These owners do this for one purpose; they want to spend significantly less money in taxes. A lot of owners feel as if they pay out enough in taxes and try to keep what they can. Others feel that all business owners do it and that they would not be able to survive otherwise. Whatever the explanation, the fact of the matter is that it is unlawful.

The number one reason that business owners ought to avoid hiding their hard cash is the basic fact that they can be fined hundreds of thousands of dollars and face up to five years in prison. Title 26 USC 7201, "Attempt to evade or defeat tax," states "Any person who willfully attempts to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof: Shall be imprisoned not more than five years, or fined not more than $250,000 for individuals ($500,000 for corporations) or both, together with cost of prosecution. The hard truth, however, is that there is no certainty in prosecution and most owners are willing to roll the dice and hope not to be audited. Truth be told, the IRS has extremely limited resources and the resources they do have are allocated to going after larger businesses where the return on prosecution is much higher. The lack of certainty of prosecution coupled with the instant benefits of keeping money creates an atmosphere in which tax evasion amounts to pandemic proportions.

Business owners wanting to sell their business that have a history of hiding money encounter an uncomfortable quandary. Most owners want to capitalize on the genuine revenues of the business and expect to see a business valuation that contains the concealed cash. These owners want the business broker to market the business based on the legitimate revenues. That is where things get a little precarious, as these owners strive to persuade prospective buyers of the genuine revenues. Sellers try to produce a second set of books or gross sales receipts to prove correct revenues. The Seller is basically airing out their dirty laundry and nothing stops a disgruntled prospective buyer from reporting them to the IRS the moment a transaction falls apart. This is plainly not a risk worth taking.

Sellers that hide their real money who are wanting to sell their business will lose money in the end. Most buyers will not factor in revenues not identified on the tax returns in their offers and rightfully so. Most Sellers do not keep records of the hidden cash as they do not want a paper trail of their illegal actions. Most businesses are valued as some multiple of cash flow or owner's discretionary earnings. Here is a mathematical explanation as to why sellers who hide their cash will lose in the end. For this example we will use a business with a cash flow on the books of $250,000 and where the owner has skimmed off $100,000 cash. This means that cash flow number is reduced from $350,000 to $250,000. The owner saves on taxes at their tax rate. Let's say the owner's tax rate is 35%. The owner for that year essentially saves $35,000 in taxes by skimming the $100,000 off the top. If an owner does that for three years straight they save $105,000. That may seem to be like a fantastic savings, but most business valuations take into consideration the last three years of financials. If we assign a multiple of 3 to the cash flow for a valuation, the Selling Price based on financials would be 3 x $250,000 = $750,000. Had the owner not skimmed money off the top the valuation would be 3 x $350,000 = $1,050,000. That is a $300,000 difference. The owner saved $105,000 only to lose $300,000 in the business valuation. That is a $195,000 loss! The loss is reduced somewhat by the taxes on the sale. If the $300,000 is taxed at the current long term capital gains rate of 15%, then the result is $300,000 x 15% = $45,000 for a total net result of $300,000 - $45,000 = $255,000. The owner still loses $150,000. $255,000 - $105,000 (skimmed money) = $150,000! Even if the $300,000 is taxed at the owner's tax rate of 35% they still lose money. $300,000 x 35% = $105,000 for a total net result of $300,000 - $105,000 = $195,000. The owner still loses $90,000. $195,000 - $105,000 (skimmed money) = $90,000. Keep in mind that we set a multiple of 3 in this scenario. The loss to an owner will lessen and get closer to a wash as the multiple gets closer to a 1 multiple. Most good businesses with a good cash flow will sell greater than a 1 multiple and probably will be closer to 3 than 1.

In conclusion, business owners wanting to sell their business within three years ought to quit hiding their money. The risk associated with fines, penalties and jail, coupled with the reality that an owner will most likely lose money or at least break even with the business valuation, is incentive enough to thoroughly clean up the books and document all revenues, including the hard cash.