Nutritious and Delicious: CPA Tax Conversation

Thank you for the recommendations as to your CPAs. I called and googled several, and decided to go see Ahmed Zaki, the father of a friend of mine from college.

He is the CFO of several small companies, and was very easy to understand on the phone. He's also a certified financial planner, which will come in handy in all of this.

Don't take any of the following as his advice (or mine); it's my imperfect recollections of the things that were most salient to me. I could even have things below absolutely backwards.

We had an hour and a half conversation today encompassing several things:

-The tax treatment/behavior I needed to get be a 1099 contractor for my current client. A C or S corp tax status along with several other behaviors of mine will guarentee I can be a 1099 employee under the IRS 20 questions about W-2/1099 employees. Ironically, the creation of the corporation would probably make me change the last few behaviors that made the 20 questions iffy as a sole-proprietorship

-The way mileage deductions work (to go to the site of my current major client, I have a 39 mi round trip, so this is important).

-How taxes are treated in S-Corps/C-Corps/Disregarded LLC

-How you introduce assets into the company (a fair value, so a used laptop is not going to be valued at the price you bought it at, even if the company still sells it at that price)

-What my hourly costs would be if I didn't ever produce a product but just paid for labor for contracting clients.

-What's a good business expense, and what's a shady, asking-for-an-audit expense. [I was continually amused how "non-aggressive" I was in things I was interested in expensing]



So the public service portion of this post will be a re-explanation by me of the 3 choices you have for your LLC tax treatment.

First off, when its time to do real business (ie, open a bank account), you need to file a SS-4 (with the IRS). The IRS will then give you a EIN, the company version of a social security number. Beware, this starts a clock. Until you do this, the company you form lies dormant. Filing SS-4 puts a timetable on the 8832 and 2553 elections explained below.

1. You can do nothing, and it will be treated as a sole proprietorship/partnership (depending on number of members) for the sake of taxation.

Profits flow through on the 1040 C of the owner's return
All profits that flow through are taken as pay, so you pay Social Security and Medicare and Unemployment on them.

2. You can elect to be treated as a corporation (a c-corp) on form 8832.

Your profits will be taxed at a corporate tax rate by the federal and state gov't. If you release profits to the owners (which you do *not* have to do), they are taxed at the owner's rate.

There are incredible loss retention capabilities in this type of tax treatment. If you lose money in a given year, and you made money in the one or both of the prior two years, you can amend the last two years to get the tax paid on those profits back. You can also retain losses in a C-Corp for up to 15 years.

I didn't note the exact timetable here, but I think I read this was "Before you file a 2553, and before/when you file your first year's taxes".

You can also set your fiscal year to be something other than the calendar year if you're a C-Corp. This is key for government contractors (the US Gov't fiscal year runs from 1 October - 30 September) who have reporting requirements along the government's fiscal year.

3. After electing for a C-Corp with form 8832 (option 2a), you can file a 2553 within 75-days of the SS-4 filing to become an S-Corp.

With an S-Corp, active members need to take a salary. This will be taxed with Social Security and withholding and Medicare and unemployment. However, all profits/losses left in the S-Corp at the end of the year are added to the owner's adjusted gross income. This means as an owner, you're going to get the profits and losses of the S-Corp against your own income. This portion is *not* taxed by social security and its ilk. (See the tax advantage over the disregarded LCC?)

With an S-Corp, you have a couple strictures. Major ones include, you can't have non-US investors, you can't have more than 100 members, you can't have C-Corps as members and you can't have more than 1 type of stock. There are surely more.

You can revoke a S-Corp election with a simple letter to the IRS. Beware though, you can't re-elect to be an S-Corp again for 5 years. There used to be a lot of "perq" restrictions on S-Corp owners. These may or may not have eased recently, especially medical exceptions. The common consensus seems to be that perqs alone aren't enough to offset the double taxation.

Now, what's the thing for me?

Well, 82% of businesses run by first time entrepreneurs (that's me) fail, I should possibly look at the C-Corp long and hard. Also, I'm thinking about making this a lifetime investment vehicle for my job of the moment. In that case, the wealth retention aspect of the C-Corp might be better.

As I can get out of S-Corp status relatively easy (write a letter to the IRS), I should very possibly just go that route until I am sure I at least have the possibility of a big loss.

I'll let you know which of the two options I chose. I'm glad to get the tax questions out of the way so I can cost out rates and figure out other basic financial issues confronting me so I can get back over to the actual business of the business rather than the sideshow of taxes and costs.

--Michael

SCORE: Mini-Business Plans & Startup Cashflow

SCORE is the Service Corps of Retired Executives. I went to their free seminar at the Cobb Chamber of Commerce on Mini-Business Plans and Startup Cashflow Analysis.

In SCORE, retired company executives and former entrepreneurs in retirement mentor those who are just starting business or looking to expand. I've heard their name over and over, and I had been thinking full-blown business plans were overwrought for presentation to a small group over dinner (as I've mentioned before). I was going to learn a format that was only a couple pages.

Turns out the mini-business plan format they were proposing was sufficient, running about 3-5 pages and addressing organization, marketing, legal, financial and other basic needs of a business plans in a couple pages.

The second part of the seminar, which I didn't even really remember was happening until I got there, was more interesting. It was "Startup Cashflow Requirements". This is basically getting that room full of people to correctly model the following variables:

Startup cash
Fixed costs
Profit per unit
Cost per unit
Receivables payment terms
Payables payment terms
Monthly Growth

They did this by showing the cash flow calculator on this page then walked through 4 people's business plans who were in the room.

A revelation to me was the cashflow squeeze put onto the small businessperson by the fact when you're new, you have to pay every supplier immediately, but (for many industries) your customers will demand that they have 30-60 days to pay you (Net-30 and Net-60 in the lingo). That causes many profitable businesses to go under, simply because they must offer credit, but can't get it themselves.

This is the mechanism that allows growth to bankrupt many business: They don't have the cash required to handle all the orders/clients/widgets so run out of it before getting the payoff that will save them. As many costs are merely forecasts, a small error when you're growing quickly can incite bankruptcy quite quickly if your operating cash is low enough (as it is for many small businesspeople).

Other additional tidbits: Business loans right now (for small companies) are going to require about 30% collateral if above 25K. The interest rate will be ~13% if you personally have good credit.

Community loans are available to many people, especially women and racial minorities for amounts up to 50K.

In addition to the seminar itself, I talked to the businesswomen on either side of me. They came to the seminar for the cashflow half. Merissa, is the founder of Cornerstone Tutoring. They serve Henry and Clayton counties, providing tutoring to children after school. Of interest to current tech students: Tutoring in math pays surprisingly well. The second person was Terri Robinson. She has a diverse range of offerings (including a credit card payment system), but the thing that made me talk to her was that she sold one of her products (greeting cards) in supermarkets. This was a trick I wanted to learn, even though the product I wanted to sell in that position has already been made.

(While the lesson can be learned, why not learn it for the future?)

As she explained, there is an office of buying agents at the corporate headquarters that you contact with your product. You send a product and arrange an in-person meeting if at all possible. You provide racks (usually) for the store, and you keep in contact with the stores so when the racks are getting empty, you provide more product to them. This question was on my mind because the Startup Nation's radio show (which is podcasted on their website) has an episode I'm now listening to talks about the selling of product on QVC (Children's Items Don't Sell; Ability to Demonstrate Product is King).

As everyone in the room knew I was a deep tech guy, people asked me questions too. I am amazed how much more fundamentally sound tech businesses are when thought up/started by non-tech people. Most of the people in that room would need a sound technical partner to look out they weren't being snowed at first, but some of those ideas were clearly great business ideas that used technology in a way that would clearly relieve pain yet make money. (I don't know what level of discretion these people expected, so I'll err on the side of caution as far as mentioning their ideas). Some of those ideas will go quite far indeed if they seize them.

--Michael

Atlanta Chapter of SCORE

Why such a weird company to start with?

I'm currently contracting through a recruitment service. I only had an obligation to do this for 6 months, and there are few advantages to me to continue doing so. They're primarily a company that works for other companies to find talent, not to serve talent.

Rowdy Labs is a place where I can:
1. Do consulting/contracting in my field (Embedded Firmware/Systems Programming)
2. Start smaller ventures with liability protection without having all the paperwork in the way as an impediment.
3. Keep money I intend to reinvest in business in the business. Taking the money out as salary/draws then putting it back in has both financial planning and tax issues.
4. Easily spin off ventures "getting too big to share the playhouse" or that need to allow other people to have equity in the company.
5. Deduct real business costs (I buy 600-$1k worth of technical books some years, the laptop I use solely for work is about to fall apart, etc).

--Michael

Deciding the Tax Treatment

I'm calculating my overhead right now (to be able to price out rates).

The chief decision this forces is whether my LLC is going to be treated as a C-Corp or a Sole Proprietor by the IRS. If I elect the first, I file a form 1132 just like every C-corporation does. If I elect the later (which is the default), I will get treated like a Sole Proprietor and fill out a Schedule C on my personal 1040C.

Neither of these should ring out to you right away for this venture. For a services company, the default behavior where I just file 1040C would make sense. There is a very good chance I'll be doing services work right away with one company, but my real goal is more product-oriented. Corporate treatment allows some tax deductions and also changes the way income is disbursed to owners. This can be negative or positive depending on your costs, and what business you actually do (as well as your personal finances).

The form mentions a 60 month freeze period between changing tax treatment, so I'll be stuck with this choice for a good number of years.

The expensive answer is: See a CPA
The cheap now but expensive later answer is: Use the internet
The possibly expensive later answer but probably the one I'm going to do first: Read a couple books on the topic written by a CPA.

If nothing else, the third option will educate me for the meeting with the CPA so I can use that time most effectively.

--Michael

Anyone know a Small Business CPA in Atlanta they like? Right now, I'm about to draw from the BBB and Atlanta Chamber of Commerce to find a good one.