Essential Tax & Legal Tips for the NEW Business Owner
Starting a business is a process. It is MUCH more than filing the one or two page articles/certificate of formation with the state. At the same time, it doesn’t have to be so complicated and overwhelming that you never start. Further, not only is starting a business a process, it’s a process that is unique to YOU. It is not a cookie-cutter one size fits all proposition. What your business and YOUR situation require may be completely different than anyone else you might know who is self-employed. Having said that, here are 8 tips that apply to all businesses, but how to USE these tips will be different for each business owner:
- Operate out of and properly maintain the appropriate entity formation for YOUR situation. While it is true you can operate your business as a sole proprietorship, I think it’s generally better to operate your business out of an entity such as an LLC or corporation. First, I think it has a positive impact on your mindset as a business owner in that it makes you feel more “legit”and others will see you the same. More importantly, it is always better to operate your business out of an entity such as an LLC or corporation as those companies prevent liability of the business from extending to the owners. Lastly, operating out of an entity can in certain situations produce tax savings such as when operating out of an S-corporation to save self-employment taxes. This is generally recommended for operating businesses who have $30-$40k net annual income.
- Make sure you have a partnership/ownership agreement if there are other owners. If you have somebody that you trust to own and run your business WITH YOU, that’s a great thing, and hopefully you continue to have a great business relationship with that person(s). But don’t let that be a reason to NOT get your relationship in writing through a written agreement that you both/all would sign to memorialize the rights and obligations of each other. If the business fails or one of the owners wants out or isn’t “pulling their weight” and you didn’t address this in writing BEFORE the crisis/event has occurred, that friendly business partner could wind up AGAINST YOU.
- Embrace bookkeeping. Embrace the fact that bookkeeping is one of the keys to maximizing tax write-offs and commit to either obtain the right training to do it yourself OR see the value in outsourcing it to someone who knows what they’re doing. Maybe your strength as an entrepreneur is the marketing/sales side of business, or you have the relationships to be successful, but when it comes to taxes, you must keep good records, and for all your strengths, if you’re not organized, you’re going to get killed in an IRS audit. So either learn to be organized with your records in terms of tracking expenses and use a good bookkeeping software (Mark Kohler offers a great set of videos that train on how to use Quickbooks), or outsource it to someone else who is good at it so you can focus on what you do best. The clients who embrace bookkeeping usually have more write-offs and deductions come tax-time as they rarely miss an opportunity to expense something.
- Have periodic tax and legal consults with your attorney and CPA. Unfortunately, many small business owners don’t use a business attorney ever, and maybe only meet with their CPA once a year, assuming they even use a CPA. I think the cost of meeting with a good business attorney and CPA at least twice a year is worth the cost. Prevention is much less expensive than the cost of getting “sick”, whether “sick” is an unnecessary amount or risk exposure that leads to a lawsuit, or whether “sick” is failure to maximize tax write-offs and you’re paying more than necessary to Uncle Sam, OR, maybe without a good CPA you’re TOO aggressive on your taxes or even worse, you don’t file a return at all and the IRS comes knocking. Not to mention meeting with your attorney and/or CPA is a tax write-off! On the legal side, it is good to get periodic “checkups” on how your business is structured, what has changed, what’s coming up that is new in your business, etc., so that your business attorney can guide you on mitigating your risks and protecting against liabilities. On the tax side, it’s good to also get periodic “checkups” to talk about tax strategies and which ones you aren’t maximizing or implementing, or which ones you’re doing wrong that is going to be a problem in an audit, i.e. health care, paying kids, auto, home office, dining, entertainment, travel, tax deductible contributions to retirement plans, owning real estate, etc.
- Be sure to have adequate insurance for your business. This legal tip is not new or cutting edge by any means, but the failure to follow it could be catastrophic to your business. A good insurance broker can help a great deal to match up the appropriate amount of insurance (in terms of amount and policy types) for YOUR business. You don’t want to spend TOO much of your business income on insurance premiums but if you don’t have any insurance, if/when a liability comes up in your business, and you don’t have an appropriate insurance policy to divert that financial responsibility for that claim/liability to an insurance company, it puts the full force of that claim or liability on potentially ALL of the assets and income of your business.
- Make sure to use contracts in your business and don’t rely on verbal conversations or handshake deals. You may have heard that under the law in most situations verbal contracts are enforceable. That doesn’t mean you should RELY on them, especially with the core aspects of your business i.e. your clients, your vendors, your business partners, etc., you want to properly memorialize the agreement IN WRITING. This will make it SO much easier to prove your case in court if the other party violates/breaches the written contract versus trying to prove they breached/violated a contract that is not in writing and signed by all parties. You should have a good service contract or something applicable that is provided to your customers. This not only helps with enforcing any liabilities or claims you have against them (non-payment for example), but it also is REALLY helpful to clarify the SCOPE of what your business WILL do for them and what your business will NOT do for them. If you don’t clarify that in writing, you have no idea what your customer assumes or expects, so even it doesn’t result in a lawsuit, it can create a rift between your business and that client and result in bad press about your business on social media, etc.
- Make sure you are properly characterizing your workers (independent contractor v. employee). There is a temptation for the small business owner to view/consider ALL of their workers as independent contractors. The small business owner loves to do that because there’s no payroll tax, no added costs for worker’s compensation, unemployment, employee benefits, etc. Unfortunately, the federal and state taxing authorities do not take YOUR word alone that your workers are actually independent contractors. IF you improperly classify workers as independent contractors and the government (state or federal) determines they are employees, you will have fines and penalties. Don’t misunderstand, you can have workers that ARE independent contractors, so long as they are TREATED as independent contractors, and the key word there is “independent”. If you’re going to micro-manage what they wear, when they work, how they work, where they work, etc., that doesn’t sound very “independent” and it sounds at lot like an employee, which it is sometimes necessary to have that much control of your workers, but you can’t have it both ways, if you treat them like employees, you have to accept that it comes with things like payroll taxes, unemployment, worker’s comp, etc.
- Have an exit strategy (including an estate plan). Understandably your primary concern is getting the business STARTED, so you might think it would be unproductive to think about an exit strategy so early in the “game”, but it is so important to have that in your mind. Do you want to grow the business and sell it soon as possible or hold onto it and pass it loved ones, or maybe you want to buy out your partner’s ownership (or vice versa). There are many unknowns that make it difficult to have any certainty about what WILL happen, but it’s very productive to consider the ways in which it COULD happen and form an opinion on what seems most appealing to you. But REGARDLESS of what your exit strategy is, you should make sure your business ownership and estate plan is coordinated. Even if you plan to sell the business as soon as possible, and you have no plans of owning the business for the long-term, the spontaneity of death requires that even in that situation, your business ownership be coordinated with your estate plan. Don’t forget about incapacity either. This could mean you have power of attorney documents in your estate plan that contemplates ownership/operation of your business if you become incapacitated.
In sum, your business needs you as the business owner to make sure your business is healthy from both a tax and legal perspective. These tips are a great starting point to make sure that happens. Our office is available to assist and would love to help you and your business with implementing these and other tips specifically to you and your business.