4 Tips for Managing Startup Taxes from Day One
Any high-tech entrepreneur who plans to postpone thinking about taxes until their startup is profitable needs to think again.
Taxes are part of doing business from day one, whether the company collects a dollar of revenue or not. Following are tips for making the process more successful and less painful.
1. Draw a distinct line between business and personal finances. It’s black and white. Entirely separate all business and personal revenue and expenses. Develop this mindset and discipline from day one.
- Open a business checking account. Make this your first step in developing a personal, long-term relationship with a bank. Compare two to three banks that have full-service locations that are convenient. See who wants your business. Sometimes banks offer incentives or favorable perks for business accounts. Considerations: Customer service, convenience, ATM availability and fees, account fees, personal banker availability, credit and debit card options, a future line of credit possibilities.
- Get a business credit card. Use it for all business expenses, and do not use it for anything personal. If you have multiple employees who incur expenses, including a spouse, set up a master account for the business with sub-accounts for each employee. Communicate verbally and in writing how and when employees can use the card, and which expenses are eligible, and which are not.
- Create a process for allocating personal assets and services that are shared between personal and business use. Your car, cellphone, laptop, iPad, and even a portion of your residence maybe be used for business as well as personal. You can allocate a portion of the expense to the business as long as you keep accurate and timely records and documentation.
Entrepreneurs who have co-mingled personal and business financials will end up incurring an additional cost from the tax preparer who has to do the separating at tax time.
Worse, if the Internal Revenue Service (IRS) observes that owners are using the business checking account or credit cards as personal assets (it’s commonly referred to as ‘piercing the veil’) the status of the corporation is called into question.
2. Track income and expenses from day 1. Successful entrepreneurs track every dollar—who spends it, where, and on what. You can’t run a business based on how much cash is in the bank.
- Subscribe to a business accounting software system, either desktop or online. Here are links to 2023 rankings by Business News Daily, NerdWallet, and PC Magazine. QuickBooks has become an industry standard for small businesses; if you want to go in a different direction, ask the advice of an accounting professional; this is not the occasion to pioneer. Considerations: Ease-of-use, training and support, automatic charts and reports, integration with other online packages, flexibility, proven reputation, project accounting functionality.
- Make it a habit to review expenses every day. In the beginning, this will be quick and easy, but the minute you sign a lease, engage an outside service provider, or buy a laptop, managing expenses becomes more complex—and it never gets simpler.
- Avoid using cash whenever possible; set up a process to keep track of any cash that you do spend. Taking $5.00 a day out of petty cash to buy a caramel macchiato adds up.
- Learn which expenses are deductible and which are not. Expenses must be described in the Internal Revenue code to be deductible and must be reasonable and necessary.
3. Yes, entrepreneurs do need to understand more than they likely want to know about federal, state, and local taxes. Taxes are complicated. Tax code and FASB guidelines change. Entrepreneurs must regularly seek the advice of both an attorney and a CPA. The following will be topics for ongoing discussion and education.
- The U.S. federal income tax code that applies to a business entity is based on the legal structure of that entity. (See Company Formation). C corporations, S corporations, limited liability companies, and partnerships may be taxed differently. C corporations are required by law to file a federal return for any year the corporation is in legal existence. Individuals are required to report earnings from LLCs and S corporations annually.
- State and local taxes impact the business. These taxes, which differ from state to state and by county and locality, may include but aren’t limited to state/country/city income tax, sales tax, franchise tax, or use tax. Taxes may be determined based on the business entity’s headquarters and other locations, and also may be determined by a company’s products, services, and industry, as well as who the company sells to.
- If the company has established nexus (a legal term that refers to sufficient physical presence) the firm is obligated to collect and remit sales tax (and possibly state income tax). States define nexus differently, and with the expansion of Internet sales, definitions have become broader and the issue more complex. Engage a qualified accountant or tax attorney to help the company navigate.
- Two IRS provisions, Section 179 of the Internal Revenue Code (26 U.S.C. § 179) and the permanent R&D Tax Credit may benefit advanced technology startups. Section 179 defines deduction and bonus depreciation on research and experimental expenses. The R&D tax credit permits qualified research expenses to be used to offset up to $250,000 of an employer’s payroll taxes.
4. Wages and Salaries have tax considerations. Facts and circumstances are the basis for determining whether someone working for the business is defined as an employee or an independent contractor; agreement alone is not sufficient.
- Facts and circumstances test considers behavior, financial remuneration, and the type of relationship between worker and company. Does the company have the right to control what the worker does and how she does her job? Are the business aspects of the worker’s job controlled by the payer? Are there written contracts, or employee-type benefits? Will the relationship continue and is the work performed a key aspect of the business?
- If the worker is an employee, the company must withhold and pay taxes. The company is also required to report employee wages on IRS Form W-2 and pay state and federal payroll taxes.
- If the worker is an independent contractor, the worker’s earning must be reported on Form 1099-MISC, but the business does not need to withhold and pay taxes. The worker can deduct their own business expenses and contribute to their own retirement fund.
No one expects an entrepreneur to be a tax expert. However, entrepreneurs who ask the right questions are better positioned to engage the right accounting and legal experts who can then put tools and processes in place to ensure that the company accurately and efficiently calculates, reports, and pays all taxes as required.