Why Your Tax Return Undervalues Your Business

Are My Business Tax Returns Public? Advice for Small BusinessesWhy Your Tax Return Undervalues Your Business (And How to Fix It)

When you look at your tax return, the number at the bottom—Net Income—rarely tells the whole story of your business’s financial health. In fact, if you have a strategic accountant, that number is likely minimized to legally reduce your tax bill.

However, when you decide to sell your business, we need to reverse that engineering.

Most businesses are not valued based on the taxable income shown to the IRS. Instead, buyers and lenders look at a multiple of SDE (Seller’s Discretionary Earnings) or EBITDA. To get the highest valuation, you must shift focus from tax minimization to profit maximization.

The Strategy: “Recasting” and Add-Backs

To maximize your sale price, M&A professionals use a process called “recasting.” We identify “add-backs”—legitimate expenses that a new owner would not necessarily incur, or non-cash expenses that reduce your tax burden but not your actual cash flow.

Common add-backs that increase your valuation include:

  • Officer’s Compensation: Your salary, bonuses, and associated payroll taxes.

  • Personal Expenses: Company vehicles, travel, meals, or memberships used for personal reasons.

  • One-time Expenses: Non-recurring costs such as legal fees for a settled lawsuit, a website overhaul, or major facility renovations.

  • Depreciation & Amortization: Non-cash accounting measures that lower taxable income but don’t impact cash in the bank.

  • Interest Expenses: Financing costs related to your current debt, which won’t transfer to the buyer.

The Math: A Real-World Valuation Example

Let’s look at how recasting financials impacts your final sale price.

Imagine your tax return shows $400,000 in Net Profit. If you apply a solid 4x industry multiple to that number, your business appears to be worth $1.6 Million.

However, once we dig into the Profit & Loss (P&L) statement, we identify $725,000 in valid add-backs (including your salary, a large one-time repair, depreciation, and interest).

Here is the calculation for your True Earnings (SDE/Adjusted EBITDA):

$400,000 (Net Profit) + $725,000 (Add-Backs) = $1,125,000 (True Earnings)

Now, apply that same 4x multiple to the real number:

$1,125,000 (SDE) x 4 = $4,500,000 Valuation

By properly recasting your financials, the value of the business increased by $2.9 Million.

The Takeaway

Do not rely on your tax returns to tell you what your company is worth. The gap between “Taxable Income” and “Market Value” can be millions of dollars.

Before you consider selling, let a professional Business Broker or M&A Advisor perform a valuation based on your true earnings to reveal the real number.