If you own two or more companies that buy from or sell to each other, there is a single number on your books that acts like a dial. Turning it shifts profit between your own companies without changing a thing operationally — without any new revenue, without any cost cuts, without a customer or a vendor even noticing. Most multi-entity business owners don't know the dial exists. The ones who do usually set it once, forget about it, and wake up years later surprised that one of their companies looks broken.

Key Takeaway: The intercompany markup — the rate one of your companies charges another for internal sales — is a policy lever, not an accounting fact. Moving it from 10% to 20% transfers roughly $48K of gross profit per $1M of intercompany flow between entities, leaving the group consolidated result unchanged. Bankers, buyers, and tax returns all see very different stories at different settings, and the right answer depends on which story you're trying to tell this year.

What the Markup Actually Does (Profit Transfer Mechanics)

Here's what happens on both sides of the books when Company A sells $1 million of inventory to Company B at cost + 10% markup:

Company A (the selling entity):

• Revenue: $1,000,000
• Cost of Goods Sold (its landed cost): $909,091
• Gross Profit: $90,909 (9.09% margin)

Company B (the buying entity):

• This $1,000,000 becomes part of Company B's Cost of Goods Sold
• Company B's own gross margin is whatever it sells the finished work for, minus this $1,000,000 minus any other direct costs

Now dial the markup up to 20% on the same underlying inventory (landed cost $909,091 — the real economic cost hasn't changed):

Company A sells the same inventory for $1,090,909 instead of $1,000,000. Its gross profit on the transaction jumps from $90,909 to $181,818. Company B's COGS also jumps by $90,909 — which, if Company B's revenue to the outside world is unchanged, drops its gross profit by the same $90,909.

The group consolidated profit is identical. Not a dollar different. But Company A now looks ten points more profitable, and Company B looks ten points less profitable, and every outside party reading either company's financials independently forms a completely different opinion about which one is the "good" business.

This is the dial.

The Sensitivity — 10% vs 15% vs 20% in Real Dollars

Let's put numbers on it with a real example. A multi-entity marine services group runs about $1.06 million of intercompany flow per year — one entity selling parts and inventory to its sister entity for installation on customer jobs. At the current 10% intercompany markup:

Two observations matter. First, every 5-point move in the markup shifts about $42,000 of gross profit per year per $1M of intercompany flow. That's meaningful money for an SMB — meaningful enough to change a loan decision, a partner equity conversation, or a buyer's valuation multiple. Second, the effect is completely symmetric: whatever one entity gains, the other loses. The group is exactly as profitable at 25% markup as it is at 5%. Anyone who tells you "raising the intercompany markup makes the group more profitable" is wrong.

What it does change is which entity the profit lands in, and by extension which entity every outside reader of the financials thinks is the star of the show.

Three Reasons to Adjust the Dial

There are three legitimate strategic reasons to consciously move the intercompany markup. Any of them is enough.

1. Bank presentation. If one of your entities is applying for a loan or line of credit, the banker is evaluating that entity's standalone financials. They want to see a healthy gross margin, a stable EBITDA, and a DSCR above 1.25x. If the intercompany markup is currently dragging the borrowing entity's margin down, raising the markup temporarily (or restructuring the intercompany flow entirely) can materially change the loan decision. This is not accounting fraud. It is a conscious reallocation of profit between entities you own, done transparently and documented in board minutes or a partner resolution.

2. Tax optimization. If your entities operate in different tax jurisdictions, have different owner splits, or one is an S-Corp while another is a partnership, the markup determines which entity's partners pay tax on which slice of the group's profit. In some cases — a loss in one entity, different owner tax brackets, different state tax rates — there's a meaningfully cheaper place for a given dollar of profit to land. The IRS cares that the markup is within arm's-length range under IRC Section 482, but "arm's-length" for simple parts transfers between related parties is a reasonably wide band.

3. Buyer / sale readiness. If you are preparing one of the entities for sale within the next two to three years, a buyer will normalize the intercompany markup as part of due diligence. They will often set it at a market-neutral rate — usually somewhere between 15% and 25% for simple parts transfers — and recalculate the target entity's standalone EBITDA accordingly. Presenting the entity already normalized at a defensible markup is cleaner than asking the buyer to make the adjustment themselves. It also eliminates an excuse for them to reduce the offer price.

Three Reasons Not to Adjust Blindly

The dial is powerful precisely because it is mechanical. That same power makes it dangerous if you turn it without understanding what else it touches.

1. IRS Section 482 arm's-length requirement. The IRS requires that transactions between related parties be priced as if they were between unrelated parties. For simple parts transfers, "arm's-length" means any markup that a third-party distributor would reasonably charge a customer for the same volume, payment terms, and service level. Cost + 5% is defensible for long-standing distribution relationships with favorable terms. Cost + 30% is defensible for specialized or low-volume orders. Cost + 50% with no documentation and no business rationale is not defensible. The rule of thumb: stay inside the 5–30% band, document why you chose the specific number, and revisit it formally every 1–2 years. The Treasury Regulations at Treas. Reg. § 1.482-1 define the standard.

2. Partner equity implications. If your entities have different partner ownership percentages — and many multi-entity SMBs do, especially when partners contributed different capital or skills — shifting profit between entities also shifts economic value between those partners. A markup change that looks like a simple accounting adjustment can quietly transfer real dollars from one partner's future distributions to another. This needs to be an explicit partner-level conversation, documented in writing, with everyone aware of the economic consequences. The worst intercompany disputes we see in our practice start here.

3. Downstream entity impact. Raising the markup means the buying entity absorbs a higher cost of goods. If that entity was already running thin margins, a 10-point markup increase can tip it into a loss. That loss is still your money — the group is still net-neutral — but it changes how the buying entity looks to its own bankers, its own vendors, and its own employees (who may have profit-sharing arrangements). You do not want to fix one entity's loan application at the cost of breaking another entity's supplier relationship.

How to Set the Policy

Here is the process we walk multi-entity clients through when the intercompany markup has never had a conscious decision behind it:

1. Document the current rate and when it was set. In most SMBs the answer is "sometime years ago, we think 10% or so." Get it in writing.

2. Calculate the current intercompany flow — the dollar volume moving between entities annually — and the current profit transfer at the current rate.

3. Model three scenarios — current rate, +5 points, +10 points — for each entity's standalone gross margin, operating margin, and any ratio that matters (DSCR, net margin, EBITDA margin). Build this as a side-by-side comparison, not as a narrative.

4. Identify the binding constraint this year. Is one of the entities applying for credit? Is there a sale conversation on the horizon? Is there a tax planning opportunity? Different constraints lead to different optimal rates. Usually only one matters at a time.

5. Convene the partners and present the scenarios in a single meeting. Get a decision in writing — a partner resolution or board minute. This is the documentation the IRS will eventually ask for if anyone ever looks.

6. Implement the change at the start of a new fiscal period, not mid-quarter. Changing the rate mid-month creates reconciliation headaches and makes year-over-year comparisons noisy.

7. Revisit every 12–24 months. The binding constraint changes. The entities' relative scale changes. The dial should not be permanent.

The Monday Morning Decision

The marine services group we mentioned at the start of this series had been running at a 10% intercompany markup for as long as anyone could remember. When we presented the partners with the divisional P&L showing that the internal division was structurally unprofitable at 10%, and the sensitivity table showing what 15% and 20% would do to both entities, it was the first time anyone had put a conscious decision in front of them.

They took a week. They ran the numbers against their upcoming banking conversation. They checked the effect on the partner equity balance. They documented the rationale. Then they raised the rate to 15%, effective next quarter, with a commitment to revisit it after 12 months. The group's total profit didn't change by a dollar — but the selling entity's standalone numbers, the ones the banker was about to see, moved from "structurally unprofitable" to "defensibly healthy." The loan conversation went differently than it otherwise would have. The partners slept better knowing the rate was now a deliberate choice instead of an accident of history. Your accountant has this data. The question is whether anyone is using it as a lever. Read how accounting becomes an ROI center — and if you haven't yet, start with the divisional analysis that makes the markup question visible in the first place.

Frequently Asked Questions

Is changing my intercompany markup considered tax avoidance? No, when done within the arm's-length range and documented. The IRS explicitly permits related parties to set transfer prices, subject to the requirement under IRC Section 482 that the price fall within a range a third party would accept for a comparable transaction. Tax avoidance would be setting a markup outside that range specifically to shift income to a lower-tax jurisdiction without a business rationale. A move from 10% to 15% for simple parts transfers, documented as a banking or buyer-readiness response, is a normal business decision.

What if my entities are in the same tax jurisdiction with identical partner splits? The tax-optimization rationale largely disappears, but the bank presentation and buyer readiness rationales remain. Even if the group tax bill is identical at every markup level, the standalone financials of each entity still change — and every outside party that reads those financials individually still forms a different opinion based on which setting you chose. That's enough reason to set the dial consciously.

How do I know if my current intercompany markup is inside the arm's-length range? For simple parts transfers, 5–30% is generally defensible. For service transfers (labor, management time), the range is wider and more fact-specific. The test is: would an unrelated third-party distributor or service provider, without a long-standing relationship, charge something in this range for this specific transaction, at this specific volume, with these specific payment terms? If yes, you're inside the range. If no, you need either a different rate or documented business reasons (such as volume discounts or long-term contracts) that justify the deviation.

Can my accountant just change the markup without a formal partner decision? Technically yes, procedurally no. A change to intercompany pricing is a policy change, not a bookkeeping correction. It should be documented in a partner resolution or board minute, with the rationale stated. This protects you if the IRS ever asks, protects the partners from disputes about the economic consequences, and creates a paper trail that supports the decision in a banking or sale context. Accountants who make this change silently are creating risk for everyone involved.

How often should I revisit the rate? Every 12 to 24 months, or whenever a specific event — an upcoming loan application, a sale conversation, a major shift in entity scale, a new partner — creates a reason to re-evaluate. The binding constraint changes over time. A rate that was optimal three years ago is rarely still optimal today.

Disclaimer: This article is for informational purposes only and does not constitute tax, legal, or financial advice. Tax situations vary — consult a qualified tax professional for advice specific to your circumstances. Practice examples are anonymized composites based on real client data; identifying details have been changed.