Stop, Look Listen – Three Overlooked Steps When Starting a Business

  • Posted by Michael Beauchemin on Tue, Oct 02, 2012 @ 08:43 AM

    Stop, Look, Listen – Isn’t that one of the first lessons we learn and pass on to our children?  It is a life lesson we should carry with us in most things we do.  If you are about to start a business follow this simple advice – Stop, Look, Listen.

    There are three, often overlooked steps, by first time business owners, and with good reason.  They have never started a business and the tax laws, regulation and requirements for businesses are constantly changing and increasingly complex.

    Before launching your new business take time to reevaluate and reassess by following these three simple steps.

    1. Speak with a CPA. and a Lawyer. 

    Amazingly many business owners never consider meeting with a CPA or a lawyer until it is time to file taxes, or the business has put themselves into a difficult situation.  Even before you write your business plan, consider sitting down with a CPA to evaluate the information that you should include in the business plan and see if the projected cash flow, income statements and balance sheets make sense.  If you do not know how to do this, consider having a CPA assist you.  Depending on the complexity of the business plan and amount of time required, the fee for assistance with this task can be as little as a few hundred dollars.

    A lawyer will help you work out ownership or partnership agreements, licensing agreements, review franchise agreements, sales agreements, etc.  Too often, spouses, family members and friends start a business with no formal ownership agreement in place.  Owner and partners do not expect the relationship, philosophy or vision to change between them and do not plan for it. Isn’t it better, to enter into a business relationship and understand what your recourse or exit plan is before things fall apart or take an unexpected turn? 

    2. Choose an Entity Appropriate for Your Business.

    A new business can be setup as a Sole Proprietorship, Partnership, S Corporation or C Corporation.  Note, I did not list an LLC.  To the IRS the LLC has no tax meaning.  When a business is setup as an LLC it is up to the owner or partners to let the IRS know how they want to be treated for tax purposes (an LLC can be treated as a sole proprietor, partnership, S corporation or C corporation). 

    The sole proprietorship, partnership and S Corporation  are referred to as flow through entities.  This means, the income of the business flows from the business to your personal tax return and is taxed at your personal income tax rate.  The amount of taxes you pay is dependent on what business entity you choose, your personal federal income tax rate and the state income tax rate where the income is generated. 

    For flow through entities, the income from the business can be subject to taxes as high as 60%.  That’s correct, depending on the business entity chosen, the personal income tax rate, state income tax rate, local tax rate and self employment taxes (if applicable) can total as much as 60% of the business’ net income.  The C Corporation is treated differently and has it’s own separate income tax schedule, along with it’s share of complexities. Each entity has advantages and disadvantages. 

    During your sit down with a CPA, he or she can help estimate the tax consequence of each entity.  There is no worse feeling for a CPA than to tell a business owner they owe tens of thousands of dollars in unexpected taxes because the owner did not seek advice beforehand.  

    3. Establish a Separate Bank Account

    No matter how  convenient you think it is to have just one bank account for both your personal and your business expenses commingling your funds is a big mistake.  The IRS, if they ever audit your business, will look at your business expenses with suspicion. 

    Suppose you setup a business to tutor students after school.   The students, when they arrive at your facility are always hungry. You buy snacks and drinks to have available for them. so they are focused on learning and not their hunger.  You purchase the snacks and drinks using a debit card tied to your personal account, often when you are buying other groceries. 

    This is a red flag to the IRS auditor.  It will cause him to not only challenge these expenses,  but many other business expenses regardless of whether they are legitimate. Needless to say, many of the expenses coming out of your personal account will be treated with suspicion and may be disallowed by the IRS.   This is avoided  by having separate bank accounts and using only your business account for expenses directly related to operating your business.

    You can launch your business with confidence, by taking a little time to stop, look and listen and following the few simple steps listed above.