A client comes into your office, eyes agleam over the idea of starting a new business. When four out of five new businesses fail within two years, what do you tell them? 

“‘You never worked so hard and so long for so little for several years, and if you can deal with that you have a chance,’” said Enrolled Agent Georgianna Adkins of GMA Financial Services in Van Wert, Ohio. “Also, ‘How much capital do you have? A business plan?’”

“‘Do your homework and prepare to sacrifice all,’” said EA James Berardi in San Antonio.

“Find out the costs of doing business when they are not making any money,” said Sue Henderson of Bristol Tax and Accounting, in Bristol, Tenn. “This helps them figure out how much they are going to have to pay out and estimate how long they will have to wait for their customers to pay.”
“I always recommend they go into a business in which they have experience,” said Stephen DeFilippis, an EA at DeFilippis Financial Group, in Wheaton, Ill.

Added Duane Carey, an EA in Napa, Calif.: “Most [new companies] fail within five years. I tell most clients to start small and build experience … if this is a new area or they do not have a lot of expertise.”

“‘Put more thought into your accounting systems set-up,’” said Darcy Alvarez, a preparer with Liberty Tax in Southern California. “The more they put in during the year, the better they’ll be prepared come tax time every year.”

“That if they don’t plan on running a business by the rules laid out by the IRS, I have no wish to occupy the cell next to them,” said Philip King of Crown Tax Service, in San Antonio. “The largest cause of business failure is poor recordkeeping.”

“I discuss the type of business and why they want to do this, expertise, licensing requirements and what’s expected of a business owner,” said Jeffrey Schneider, an EA in Port St. Lucie, Fla. “Depending on the person, this can be a short conversation.”


Their own boss?

“You know the old story about being in business to be your own boss? What a bunch of crap,” said Jim Loperfido of JGL Management Consulting in Auburn, N.Y. “A SWOT analysis, business plan and cash flow needs are a must. But there is also the values factor: Owner values must be aligned with the needs of the new business.”

Delmar Gillette of Coastal Tax in Newport News, Va., asks several questions, among them:

  • Do you have a written plan?
  • Is there a market for your services/products?
  • Do you have the financial resources to start a business? If not, where will you get the funds? “If the client talks about taking funds from an individual retirement plan,” Gillette said, “we discuss the tax costs and possible penalties.”

Preferred Financial Services in Mays Landing, N.J., usually provides a consultation with a client who wants to start a business, according to Philip Garofalo,an EA with the firm. Topics include:

  • The type of business entity that fits the needs of the client: LLC, LLP, single- member LLC, corporation or sub-chapter S corp.
  • Tax-return due dates and the forms to file for the new business entity – and that return’s effect, if any, on the client’s individual return.
  • Recordkeeping and insurance requirements.

“When we schedule a consultation for a potential client’s new venture, we also discuss all other taxes the business may be subject to,” Garfalo added. “That seems to get them on board as a new-business client.”
Startup recommendations in Small Business Taxes Made Easy by TaxMama blogger and EA Eva Rosenberg include setting up an advisory team (“Formal or informal,” she said), which includes a tax professional, banker, insurance broker and other key people.

“Get the bookkeeping in order from the beginning,” said Becky Neilson of Neilson Bookkeeping in Sheridan, Calif. “Then determine the type of entity to form.”

“Another suggestion: Start small,” said Kerry Freeman, an EA at Freeman Income Tax Service in Anthem, Ariz. “Often new businesspeople want to buy everything and write off everything. Rushing in buying equipment or a truck before you have enough cash is a recipe for disaster.”

“We ask enough questions to determine if the person has done their homework or if their business idea might not have merit,” said Timothy Oatney, a Lancaster, Ohio-based CPA. “We discuss having a business plan and suggest that if not, they call the local SCORE [counselling] group of the Small Business Administration to discuss some free assistance in the preparation of a business plan.”

 

Ups and downs

“I always tell them what I think is the upside, as well as the downside,” added EA Debra James, of Genesis Accounting & Management Services in Lorain, Ohio. “The upside being the satisfaction derived from making something from nothing, and overcoming the fear of failure. The downside being the misnomer that you can make your own hours, get rich quick, not have to deal with a boss anymore.” She also discusses clients’ need for capital not only to run the business but to support themselves. “For those who will be sole proprietors, I talk about self-employment tax and estimated payments,” she said. “Also networking and marketing.”

Carey offered the example of a client who claimed to have created an LLC via the Internet, a “high-end janitorial service. He had no experience in this area but felt he’d make money. He took more than $200,000 from his 401(k) [and] purchased a Mercedes SUV, expensive equipment and supplies, uniforms for his employees and so on. He’s been in business two years with no profit and is draining his 401(k) to stay afloat. And he hasn’t changed his business plan.”

“I express the importance of keeping things separated between personal and business expenses,” said Stephen Anderson, an EA in Carlsbad, Calif. “It’s also very important to emphasize the importance of reconciling the cash bank account(s). Typically if the cash balance is reconciled, the rest of the accounting usually is pretty good – especially with QuickBooks and similar software programs.”


Entities

Schneider said one of the other first considerations is the type of business entity, such as LLC, incorporation or sole proprietorship. “I don’t discuss tax issues before I advise them to see a liability lawyer,” he added.

Carey said most want to start C or S corps or LLCs right away. “Here in California, there’s a minimum yearly tax franchise fee of $800 for these entities plus tax on income if over a specified amount, plus fees to someone to write and file the incorporation documents and another return to be prepared at an additional cost,” Carey said.

“When asked why they want one of these entities they almost always say, ‘Liabilities – we want to protect our assets,’” Carey added. “I then point out that these entities require annual filing of documents with the state agencies and records of meetings to be maintained, that the maintenance of the entity is a requirement, as a clever attorney can easily pierce the veil of protection. Additionally, banks will not make loans to these ‘new’ entities and will normally require the owners to be personally liable for any loans.”

“As for liability protection, simply purchase a million or multi-million dollar umbrella insurance policy for a lot less with more coverage,” Carey added.

“Many clients rush into incorporating without consulting with me and not realizing the administrative challenges this creates,” said DeFilippis. “Clients need to focus on what will make their business successful, not spend an inordinate amount of time on administration. Unless liability issues are acute, I suggest operating as a sole proprietor. This keeps the administrative headaches and costs to a minimum. If liability issues are a concern and there is only one owner, I suggest a single-member LLC. This costs more than a sole prop, but allows you to file as a Schedule C and minimizes the administrative burden.”

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