Let’s start a business

Judging from the local classifieds, it seems like a lot of folks who have lost their jobs have decided to start their own businesses. After all, they have years of experience in their industry developing strong and valuable skills. No doubt, some will discover they've always had a successful entrepreneur waiting to get out, but based on the returns I’ve done for clients who “oh by the way, I started a business last year,” I’m concerned that many more will discover that running a business requires a broad skill set that employment doesn’t always develop.

Planning: Many small businesses don’t create a business plan until they’re looking for investors. There’s an adage that “not planning to succeed means you’re planning to fail.” You many not need a formal, written plan, but you probably shouldn’t start a business without being able to answer the following:

What services or products will you offer? For how much? And how much will it cost to produce? It probably seems silly to think that someone would try to make money by providing something at less than their own cost, but it happens. Some new business owners just don’t have the cost/benefit mindset. And even with the right mindset, a new business owner, without a history to draw on, may not anticipate all the costs of a project (mileage seems to get overlooked a lot). Without good record keeping, they may not even realize that they’re losing money until they pull the numbers together for their first year's taxes. And often, (and I dare you to find someone who hasn’t done this at least once:-), they underestimate how much time (or other costs) a project will demand.

While not all franchises and multi-level marketing plans are scams, in general, they tend to emphasize the huge amount of potential revenues (not net income after costs) compared to the “modest” start up costs. This is probably not the best predictor of how much money you’ll be putting in the bank.

Marketing: Once you’ve developed a product or service that you can provide at a profit, you still need to get people to buy it. A marketing plan should answer the following:

Who will you offer your services or product to? Why will someone want to buy it from you? Are you offering something that no one else does? If so, how will you reach and convince people that they need a new product or service? How much will it cost to do so? If you’ll be competing with other business, what makes you special and more appealing than them? Also, research how your industry is doing in this economy – is anyone buying?

Doing it all: Unlike many large companies, small business owners don’t have coworkers to help (or dump stuff on – you know it happens). There’s no production, maintenance, sales, accounting, or delivery staff to handle the aspects of running a business that you aren’t the best at (or just plain don’t like), until you hire them.

Until then, guess who will have to answer the phone, fix the computer, track down the missing delivery, calm the disgruntled customer, write the copy for your new ad, and balance your checkbook. If you don’t have the skills to do any of these things, guess who will find (and pay for) a company to do it for you?

Time management: If you spend all day tracking down a delivery, you won’t get any other work done. Will you be better off paying someone to write your newsletter while you make sales calls or doing it yourself? Until you have staff that can handle crises for you, if you want to take a holiday or vacation (or a long lunch), bring your cell or plan to shut your doors until you get back.
Compliance: Larger companies have people who keep their licenses current (and know which ones they need). Ideally they have people who keep them current on their payroll, sales, property, and income tax filings. It’s up to you to learn the regulations that apply to your business and comply with them (or find someone who can). Fines for failing to obtain a required license can be hefty, and few late payments will cost you more than blowing a tax deadline.

BTW, it’s my understanding (I’m not an attorney) that failing to comply with certain regulations (doing construction contracts over $500 without a general contractors’ license or failing to register a foreign corporation doing business in California are the first two I think of) can cost you your standing to sue. Without standing to sue, you could be denied access to the courts to go after a client who doesn’t pay - or defend yourself against a lawsuit.

After you have a plan, you may find the following steps helpful for your new business:

1) Create a budget, calculate your startup costs, double or triple them, and find the funds. Make sure you have enough funds to cover operational expenses (leases, inventory, etc.) until the business is paying for itself. The last thing you want is to close your doors after investing your time and energy because you run out of cash. I’ve seen it happen – a local boutique recently came and went that had budgeted enough to lease the space and buy inventory, but didn’t have enough left for advertising. Also figure out how you will cover your personal living expenses until your business is making a profit (in some industries, that can be well over a year).

2) Find out what licenses or registration you will need and figure out how to get them (if you don’t have them already). You may find you need:
* A business license from your city, county, and/or state
* A resellers permit (for sales tax)
* A home occupancy permit (if you plan to work from home)
* Occupational licenses, like a commercial drivers license, brokers or contractors license, etc.

3) Cover your assets. Depending on your industry and personal financial situation, you may want to form an entity like a corporation or LLC. There is a lot of information available on the web about the asset protection and tax implications of various entity types, but an attorney and/or tax advisor can advise you about how they will affect your personal situation. You can also consider different types of insurance available to protect your assets from claims and damages.

4) Sell your product or service. Create the tools you will use to let potential clients find and appreciate you (website, flyers, brochures, business cards, print or other media advertising).

5) Provide your product or service. It’s generally cheaper to keep a client than to find one. Once you find clients, make sure you provide products and services that will keep them coming back (unless you’re selling something like funeral services J) and recommending you to their family and friends.

6) Get paid, pay your bills, and keep good records of both. The importance of the first is obvious, but a lot of small business owners hate doing collections – I think because they hate getting collection calls, so they don’t want to be the one making them. The second one, buy keeping your vendors happy and building good credit, will help you have everything you need available when you need it to take care of your clients. The last one will give you good information about how your business is really doing (and can pay off big come tax time).

7) Repeat steps 4-6.

Tax Strategies that Don’t Work

‘Tis the season for talking about taxes. I thought I’d repeat some tax strategies that don’t avoid taxes, they evade them (the first is legal, a great American pastime, and one of the things I love about what I do; the second can lead to penalties, interest, and if you try hard enough, jail).

Before we get started, I’d like to address a common misconception – money doesn’t always equal income. Some sources of money (the principal part of loan payments, for example) aren’t income. Some sources of income (debt forgiveness, for example) don’t show up as money coming in. One of the more common ways that this misconception plays out is with my clients who insist that their dividends aren’t taxable because they were reinvested rather than paid out.

As a rule of thumb, any transaction that increases your assets (net of liabilities) is probably income. Principal repaid on loans isn’t income because the money coming in is offset by the decrease in the amount owed to you (an asset). Cancellation of debt is income because it decreases a liability (increasing your assets net of liabilities). Dividends are income because (barring our recent stock market insanity) they increase the stock that you own (another asset)*.

Also, not all income is taxable. Certain types of income (gifts, for example) are exempted from taxation. The IRS’s take is that if it’s income, and it doesn’t meet any criteria to be excluded from income, it’s taxable.

Cash:
Some businesses will offer hefty discounts if they are paid in cash instead of checks or credit cards. Some of these discounts may reflect lower processing cost for cash versions payments like credit cards. But I suspect that at least some of these businesses are offering discounts because they don’t intend to report or pay income tax on payments received in cash. Because cash that isn’t deposited doesn’t show up on their bank statements, they assume that they won’t get caught. The IRS can and does do life-style audits – comparing what they calculate you must spend to maintain your lifestyle to all sources of income (including nontaxable) that you report.

Bartering:
I’ve heard bartering suggested as a way to avoid taxes. Unless otherwise excepted, the fair market value of goods and services you receive in exchange for your services (or goods) is taxable income. While bartering won’t increase your bank account or cash assets, it does increase other assets (the ones that you receive) or provide you with services that you would otherwise have to pay for, which would decrease your bank account or cash.

Tax Free Internet:
It’s generally true that if you buy from an out of state company, they won’t collect sales tax (unless they are also operating in your state). What is not true is that purchases over the internet are exempt from tax. California, like many states, has a requirement to report and pay use tax (equal to the sales tax) on purchases that would be subject to sales tax if made from a California vendor. Since I’ve received mailings for the past two years from the state reminding me to ask my clients about use tax, use tax made it to the first page of this January Franchise Tax Board’s Tax News, and California recently concluded a use tax amnesty program, I expect this to be an audit focus in coming years.

Nevada Corporations:
Many Californian’s like the idea of forming a corporation across the border in Nevada to take advantage of the fact that Nevada has no state income tax. No doubt, one of the reasons that Nevada doesn’t have a state income tax is to encourage businesses to operate in Nevada. However, even if you’re incorporated in Nevada, California can still tax you on the income that you make in California (and the California Franchise Tax Board has an entire department dedicated to making that happen).

You may have heard that Nevada (like some offshore jurisdictions) allow “bearer” shares (stock certificates) – where the owner of the stock on the certificate is listed as “bearer” (basically, it’s owned by whomever holds the certificates), and the owner is not recorded on the company books. This is sometimes promoted as a way to hide assets, hide from lawsuits, or hide from controlled group taxation. Hiding is nothing more than a way of trying not to get caught. Bearer shares have been around for a long time, and the IRS is halfway decent at catching folks who don’t want to be caught.

Another downside is the nonneglible possibility of ownership being lost by misplacing a piece of paper (and passing the piece of paper, because it’s worth part of a company, can quickly trigger some hefty gift tax implications). BTW, on June 18, 2007 the Nevada passed a law requiring that companies maintain a “record of a beneficial ownership[that must be] available on request by the Secretary of State during the course of a legitimate criminal investigation).

This is the first few bogus strategies that came to mind, and I make no claim that this is a comprehensive (or even prioritized) list. There are lots more (check out the IRS’ Dirty Dozen for some leading contenders). The truth is, in taxes, like investments, mortgages, and plastic surgery, if it sounds too good to be true, it probably is.

* Most taxpayers cannot recognize their losses in the stock market until they sell the stocks, and selling the stock and they buying it back within 30 days will subject you to wash sale rules, where the losses are suspended (you generally can’t take them until you sell the replacement stock). Taxpayers who qualify (not many do, but some bonafide daytraders may) to and make the mark to market election can generally recognize losses based on the fair market value of equities at year, and are exempt from the wash sale rules.