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Business Structure and Audit Red Flags

In this article, I would like to discuss audit “red flags” to be aware of in addition to your business structure; should it be something other than a sole proprietorship?

Are you aware of audit “red flags”?

IRS audits are no fun. Being prepared in case of an audit is the best defense. There’s a reason that the IRS audits sole proprietorships (see below for more information) more than other types of business entities by a margin of about 10 to 1. The IRS feels that sole proprietors keep messier books. They comingle their business and personal funds, overstate expenses, undertstate sales, and don’t have records to backup any deductions they take.

Here are a few things to be vigilant about in your business, no matter what kind of business structure you operate under:

1. Keep a separate checking account and credit card for your business. Avoid using personal checks and credit cards for business expenses as much as possible.

2. When you purchase business items in your personal account, keep detailed records. This type of entry can easily be done in QuickBooks. If you don’t have QuickBooks, an excel spreadsheet works well.

3. When you purchase personal items from your business, same rules. Keep records. These are not tax deductible items and are considered draws out of your business funds.

4. Keep files of receipts/bills and sales information that back up all of the income and expenses for your business. You want to take all the business deductions you are allowed on your tax return.

5. Have you hired help? If you are paying people as independent contractors, are they really employees? The IRS has a 20 part test to determine whether a contractor is really an employee. Basically, if you have control over a contractor’s time, where they work, and what they work on….they may be considered an employee by the IRS. If a contractor is later determined by the IRS to be an employee, you could have a large tax bill looming due to unpaid payroll and unemployment taxes.

6. Excessive deductions. Are you having too much fun in your business? For instance, if you just started your business this year, made $10,000 in sales, and are claiming $12,000 as deductible conference and travel expenses; watch out. Take reasonable deductions on your tax return.

7. What NAISB code is your business in? The IRS uses this as a reasonableness factor when looking at your business vs others in your industry. Make sure you pick the right one!

-Pick the Right Business Structure

Many small businesses start out as sole proprietorships. It’s easy; you just say that you’re in business, get a DBA (doing business as), open a business checking account, and start offering your products and services. At the end of the year, you use the Schedule C attached to your 1040 income tax return to list out all of your business income and all of your business expenses. The net income or loss gets added to or subtracted from your other taxable income on your 1040.

There are two reasons you want to be a business structure OTHER than a sole proprietorship:

1. Liability protection

2. Tax savings

I won’t go into a lot of detail here, but when you’re a sole proprietor and something happens in your business that causes a lawsuit, your business AND personal assets are at risk. There are several business structures that provide a barrier between your business and personal assets:

1. LLC

2. Sub S Corporation

3. C Corporation

At least consider becoming an LLC (Limited Liability Company). You’ll get liability protection as well as some tax benefits, depending on how your business chooses to be taxed. A Sub S Corporation and a C Corporation can be beneficial in different ways, depending on your unique situation.

It’s important that you understand what each business structure is about. After you do some research for yourself, I suggest finding a CPA or attorney who specializes in business structures. They will help you determine, for your unique situation, which one would be best for you.

After your business is established as an LLC or Corporation, there will be more restrictive rules for recordkeeping. So, make sure you learn how to properly run your LLC or Corporation after it’s established.

“It’s Not Personal, It’s Strictly Business” – An Ethical Perspective

This famous statement by Michael Corleone (actor Al Pacino ) in the 1972 block buster movie “The Godfather”, has, in a very real way, become a cornerstone of modern competitive business practice. Modern business owners sometimes use this line to justify an action or business decision which is at variance with what they truly know to be right and moral. Put another way, “as an individual, I hold myself to a high standard of ethical behavior, but as a business owner, I do what I must to get ahead”.

This double standard allow us to compartmentalize different aspects of our lives, so we can pretend to uphold high standards of truth, honesty, and ethical behavior as individuals, while we lie, cheat, steal (or as in the case of Don Corleone, kill) our way to business success.

As a practicing Christian and licensed CPA, I encounter moral dilemmas in business transactions all the time. For example, a surprising number of business owners will knowingly under-report income or overstate business expenses for tax purposes (i.e. commit tax fraud), if they think they can get away with it. I have seen business owners misrepresent the truth in order to secure a negotiating advantage and then thank God for granting them success in their venture, as if by some means, God has endorsed their lie.

None of us is immune to the temptation to compromise and adopt double standards. For some of us however, years of practice has made it easy to do so, to the extent that we can no longer distinguish between what is morally right in business and what is not.

Christians believe that the Bible is the inspired word of God and it sets the standard of excellence to which we aspire. The fundamental Biblical principle for our dealing with others, including our business dealings, is that we treat others the same way we would want to be treated ourselves. The principle of “Do unto others as you would have them do unto you” is the moral antithesis to “its not personal its strictly business”. This requirement to treat others as we would want others to treat us, forces us not to lie, cheat and steal, since no-one whats these injustices to be inflicted upon them. If we apply this Biblical principle, then business is always personal, since it is our personal convictions that drive our business dealings.

Even if you are not persuaded by Christian beliefs, there are some very good reasons for adopting a high standard of moral and ethical principle in your business dealings. For one thing, it sets you apart as a business person of integrity and establishes a basis of long term trust with others. Doing the right thing, even at the cost of profit and gain, establishes creditability in the eyes of our customers, employees and peers. People trust us more and want to buy from us, work for us and associate with us. Do not deceive yourself into thinking that the corner you cut with your customer, or the lie you tell your supplier, goes unnoticed. You may get away with it once or twice, but is always catches up with you. In many cases doing business that way becomes a habit and at some point someone will find you out. The Bible cautions us that “Be sure your sin will find you out”. Even if our customers never notice or the IRS never catches you, your employees and your accountant know what kind of business person you are, and word will get out. Incidentally, employees are more likely to steal from business owners who they see cheat their customers, than those who do not.

Lying and cheating your way to success may make you wealthy, but that wealth comes with a price. Though Michael Corleone is a fictional character, there are some truths to be observed in his life story. The bottom line is this; what is the value of money, wealth and influence, if your family, friends and colleagues lose all respect for you?

My advice to every business owner is as follows:

Set a moral compass over your business. Determine that your business is personal and it must reflect the same standard for honesty and integrity that you set for yourself.

Communicate your core values to your employees and especially to family members who work for you. The Biblical military leader Joshua, made a statement for all ages when he said, “as for me and my house, we will serve the Lord”. Put another way, “this is my business and when you work for me, we do things the right way. What you do when you leave here is up to you”.

Lead by example. Some companies publish mission and value statements that are full of lofty ideals and words depicting high standards of integrity and customer service. Unless the persons responsible for setting these ideals also sets the example by following the code, then your mission and value statements are meaningless.

It is never too late to start doing the right thing. Very often a change of direction requires repentance, which is a willingness to recognize that you have been going in the wrong direction and a commitment to do what you must, to make it right. Repentance requires courage and character and is certainly never the easiest way out. In my experience however, it is always rewarded by a promise of better things to come.

Good luck with your business.


Reasons to Hire a Small Business Marketing Consultant

Many business owners operate under the false assumption that marketing consultants are only affordable for larger companies. In truth, there are many benefits to hiring a small business marketing consultant, as outlined below.

What Marketing Consultants Do

First, here’s a look at just what a consultant does for organizations:

Overall company evaluation. It’s hard for new business owners to evaluate their young organizations. A consultant can pull from years of business experience to assess the weaknesses and strengths of a fledgling business.

Strategic planning. Consultants must have:

1. A strong educational record in business.

2. Extensive experience as a business leader.

3. Exceptional understanding of how business trends work.

These features allow marketing planners to provide suggestions on how a business can succeed. After learning about an organization and identifying major opportunities and obstacles, a small business marketing consultant should be able to create a strategic plan to lead the firm to success.

Marketing design. Chances are your small business marketing consultant can write excellent ad copy to draw in new customers. Beyond designing small business marketing strategies, consultants can construct complete marketing campaigns. From graphic design to copywriting and editing, a small business consultant can wear many different hats while helping your business succeed.

Project and process management. The consulting lifestyle appeals to many leaders in the corporate world. Indeed, most small business consultants are top business performers who have decided to shift to a different way of life. This means consultants usually have project management and process design skills, which they can employ to improve your business’s performance.

How Small Companies Benefit

Let’s explore the benefits of hiring such consultants:

A fresh perspective. Contracting with a consultant as one of your marketing strategies will bring you an unbiased, fresh perspective. Internal conflicts and ongoing office politics can limit one’s vision. Outside consultants are free of preconceived ideas about your business, so they can provide a fresh perspective.

High-quality help. As mentioned earlier, most business consultants have transitioned to consultancy from a star-studded business career. In other words, you’ll likely receive top-shelf advice from your consultant – and for less than the cost of a single employee.

Peace of mind. Partnering with a marketing contractor can help you feel calm and confident about the future of your business. With peace of mind, you can better focus on your organization’s core offerings and drawing in new business.

Cost and time efficiency. You get great bang for your buck when you hire a marketing contactor. Since most marketing strategy planning consultants charge hourly rates, you avoid paying employee-related taxes by hiring them. Moreover, consultants are experienced, versatile professionals capable of handling everything from social media to long-term strategic planning. Rather than bringing in a new crew of writers, marketers, project managers and designers, you can pay a trusted advisor on an as-needed basis. Hiring a small business marketing consultant maximizes cost-efficiency.

Clearly, there are multiple benefits to partnering with a small business marketing consultant. From creating comprehensive small business marketing strategies to performing overall business check-ups, marketing consultants can help your company shine.