Items to Consider When Starting a Business

Gregory Smith, CPA, MBA (Nov, 2016)

Ever have a great idea for a business, or want to be your own boss?  Did it leave you wondering how in the world to get started? Do you start a corporation, or partner with someone? How do you get the resources and money to get started? This article will walk you through the various considerations to think about when making your dream a reality.

The first test to consider is whether or not this new found passion is simply a hobby. When creating a business, one of many objectives is to make a profit. However, profit is not always achieved in the first few years and business owners need to be aware of the hobby loss rules. If business expenses exceed business income, the business has a loss that is deductible against other sources of income, even against your spouse’s wages. A loss that is related to a hobby, and not a true business activity, is not deductible against other sources of income. The IRS provides guidelines in determining if an activity is that of a hobby, or truly a business venture. Not one factor, or a number of factors, draw the line as to whether a venture is a hobby or business. As the saying goes, it depends on the exact facts and circumstances of each situation. IRS Regulations section 1.183-2(b) provides the following tests:

  1. The manner in which the taxpayer carried on the activity,
  2. The expertise of the taxpayer or his or her advisers,
  3. The time and effort expended by the taxpayer in carrying on the activity,
  4. The expectation that the assets used in the activity may appreciate in value,
  5. The success of the taxpayer in carrying on other similar or dissimilar activities,
  6. The taxpayer’s history of income or loss with respect to the activity,
  7. The amount of occasional profits, if any, which are earned,
  8. The financial status of the taxpayer, and
  9. Elements of personal pleasure or recreation.

So, you have determined this new venture is truly a business, and not a fun weekend hobby. Now what? The next phase of business creation leads to entity formation. There is a vast number of business entities that you could choose.  At the end of the day the ultimate goal is allowing protection of personal assets, and fostering future growth of the organization. Having an entity structure in place can protect one’s house, vehicle, and life savings from being stripped in the event of a lawsuit, or creditor claims.

An entity can create a corporate veil to separate personal assets from the business. Some common entities for small businesses are a single member LLC, a multi-member LLC, general partnership, or an S-Corporation. Each one is distinctly different in regards to the number of owners, types of owners, and taxation of the entity profits. Another advantageous entity could be a C-Corporation. A reason many business owners take this route is future business plans. If you’re going to have outside investors that want a cut of ownership, or if you have dreams of taking a company public, a C-Corporation might be the best option.

Once you have decided on and executed your business entity, you need to consider how you are going to keep track of all the numbers. Often times CPAs are called after a business owner has started operations, once it is realized the bookkeeping and accounting is a larger task than anticipated. Many business owners are very efficient at tracking income and expenses, but the large majority of business owners want to concentrate on what they are passionate about which is developing their business operations, not the accounting tasks. Like any aspect of a business venture, having a solid accounting, finance, and growth plan in place at the beginning of operations is vital to success. Accounting is really the pulse of the business.  Without a good handle on the pulse of the business, how do you grow?

Step four of owning a successful business; taxes. No one likes to pay taxes, but paying taxes demonstrate you are carrying on a successful operation. This is one area of business no one likes surprises. Having a tax professional or CPA should not be just a simple commodity of being handed business documents at the end of the year (such as tax returns or financial statements), learning how much tax is owed the federal or state government, and being billed for the accounting services. Having a tax professional is vital to your success and future plans. As you and your business grow, you should be meeting with your tax professional throughout the year to discuss ongoing business operations, projections for the remainder of the year, as well as future business plans and tax strategies. Your relationship with your accountant needs to go well beyond just writing a check to the government.

Starting a business should be an exciting milestone for anyone and you should ensure you are receiving valuable advice during all phases of your endeavor. The professionals at Dermody, Burke & Brown are experienced in walking you through the various phases of starting a business; from determining if your idea is truly a business venture that can stand up to the IRS tests, as well as designing and implementing an accounting system. Please contact the professionals at Dermody, Burke & Brown if you are considering taking your idea to the next level.

 

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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