You have a killer idea, or you’re really good at something, and you want to start a business. Did you know that according to the Small Business Administration (SBA), approximately 543,000 businesses are started every month, and more businesses shut down each month than start up?
Many people start their own business because they determined they were good at something and could make a living doing it. However, I’d like you to consider the two primary options you have here:
- Be good at something, start a business and make a living doing it, or
- Be good at something and have an employer pay you for being good at it
Both are viable options and can lead to a fulfilling career in something you enjoy. The Grand Canyon-sized chasm separating the two paths is one important skill; Are you good at business?
“The person looking back at you gives you that look; you know the one, where you seem to be the one ruining their day, as if you’ve inconvenienced them.”
Some people believe if they have the very best product their business will succeed. In reality, Walmart is one of the world’s largest retailers, with $485 billion in revenue in 2017, and their products aren’t exactly top-shelf. If you’re like me, you’ve stood in a Walmart at the one open line for 25 minutes while the other 16 registers are unmanned. Maybe you have a child with you, tugging at your clothes asking to go home. When you finally have a chance to pay for your sub-par products, you load them onto the conveyer belt and approach the cashier. The employee looking back at you gives you that look; you know the one, where you seem to be the one ruining their day, as if you’ve inconvenienced them.
Would you run a business this way? My guess is you wouldn’t. At least, that’s not how you’d begin. Walmart is a perfect example of someone who has an inferior product, but an incredibly profitable business model. The owners of Walmart, the Walton family, are not just good at something, or offering the best product. They’re good at business.
You may have a fantastic idea, or be incredibly talented in one area, and hope to make a living working for yourself. However, your business shouldn’t start because of those things; it should start because you want to run a business. Running a business includes many things that aren’t part of your fantastic idea, such as record keeping, checks and balances, AP/AR, hiring, firing, etc. Can you recognize what drives the profitability of your product? I see many small business owners who can’t tell me basic things like what their mark-up is or how much their gross sales were for the tax year. How can you know what your profit margins are, and which choices to make when selling your services, when you don’t know these things?
You don’t track this information just for tax purposes; you do it because you want to be successful in business. Having your records perfectly kept is a nice bonus come tax time.
If you are going into business for yourself, or know anyone who is, you desperately need competent advice from tax, financial and legal professionals. Ask yourself this: “How many businesses will I start in my lifetime?”
How to organize my new business?
One of the most common questions I get when I meet with my clients for our one hour tax preparation session each year is “I want to start a business, a friend told me I needed an LLC. How do I set one up?”
Ah… the “friend”. The “friend” is to tax preparers what WebMD is to doctors. Friends can be a very broad, shallow source of information. I encourage you to listen to your friends and glean what information you can from them and their experiences. However, you should always use your tax professional as a sounding board for information you hear in your social encounters with others and from the internet. Your tax preparer’s job is the interpretation and application of tax laws based on your facts and circumstances.
So the friend told you to set up an LLC. What is an LLC? When I ask most people, their answer is “Limited Liability Corporation”. In reality, LLC stands for Limited Liability Company. You are not incorporated when you become an LLC. An LLC for tax purposes is considered a “Disregarded Entity”. The IRS doesn’t recognize an LLC as any type of corporation. Unless you file election paperwork with your LLC, you’re considered what’s called a “Sole Proprietor”. This means you’re in business with, and for, yourself.
An LLC in and of itself offers you no tax benefits and depending on the state, may not even provide you with much limited liability. If you’re concerned about liability in your new small business, for example if you sell custom firearms, you need to educate yourself on something called piercing the veil of the corporation. (Cornell Law) “’Piercing the corporate veil’ refers to a situation in which courts put aside limited liability and hold a corporation’s shareholders or directors personally liable for the corporation’s actions or debts.”
This means you could find yourself in a position where you did everything you thought you needed to do, and you still didn’t have the liability protection you sought. Please consult with a competent attorney when determining how best to protect yourself and your small business.
Start Smart
Often times my advice to new business owners is begin with a DBA, set up a bank account in the business’ name and go from there. Keep your tax preparer involved, especially in the early stages, because there are many reasons to change to an LLC and incorporate based on the profitability of the business. Being incorporated is where the real tax benefits start to come into play.
Conclusion
If you are going into business for yourself, or know anyone who is, you desperately need competent advice from tax, financial and legal professionals. Ask yourself this: “How many businesses will I start in my lifetime?”
You have one chance to start off on the right foot. We would love to sit down with you and show you the tax benefits for different types of entities and how it will affect your business. Call me at (281) 440-6279 for a free 10-minute consultation and we’ll talk about how to set you up for success!
Kevin Molen
Senior Tax Professional and Department Head