Navigating the Differences: Legal Avoidance vs Illegal Evasion

Tax Evasion Is Theft!

Being profitable is a major goal for any business. Many people who’ve never run a business may not realize how challenging it can be to make a profit because, though they may see how much revenue can be generated, they rarely understand how much it costs to operate a business. And, while there are many legitimate costs in running a business, some business owners or managers sometimes attempt to count things as expenses when they aren’t allowed. The difference between an illegitimate and a legitimate business expense is important as it can cost more in penalties and fines later and possibly even lead to jail time if it’s serious enough. The difference between the two is tax avoidance and tax evasion, the former being legal and the latter being illegal.

Tax Avoidance utilizes the legal forms of deductions, credits, and other strategies within the framework of the law. This includes contributing to retirement accounts, investing in tax-advantaged accounts, accelerated depreciation, utilizing established tax credits, and other opportunities and incentives established by federal, state, or local governments.

Tax Evasion involves deliberately misrepresenting or concealing information to reduce tax liability. This could include underreporting income, inflating or misrepresenting deductions, or hiding money in offshore accounts. Sometimes this is done unintentionally such as deducting more than the legal limits for gifts. Other times it’s deliberate such as charging personal expenses to the company.

What often happens is that a mistake is made and the owner realizes it later and feels like it’s acceptable because they got away with it. This may then turn into a habit or even escalate. If that happens, the chances increase greatly that it will trigger an audit and they’ll get caught. If (or when) this happens, the benefits and feeling of getting away with it disappear very quickly with the aggravation and time as well as the money that it costs to correct the issues. Instead of getting caught, the smarter course of action is to recognize what happened and make adjustments to the accounting. This may involve filing amended tax returns or making other changes, but these are better than the alternative of getting caught breaking the law.

There are a great many ways to legally use tax avoidance to decrease your company’s tax burdens and to benefit both the individuals and the company itself. This is why it helps to work with experts to not only review your past actions, but to also create a strategic plan to reduce your taxable income while providing financial benefits for the business, employees, and owners. Brightleaf loves to help small business plan for the future and to help make corrections if mistakes were made in the past. Reach out to us to see how we can help your business!

Beginning Networking for Small Business

Networking Is Easy!

One of the things that many people don't think about when getting started in a small business is how important it is to start in-person networking. They may know about needing a website or using social media to promote the business, but going out and actually meeting other people face to face may be something they didn't think about doing. For some, especially for introverts, this can be intimidating or even anxiety inducing.

It really shouldn't be.

If you're just getting started with business networking as a business owner or employee, the first thing you need to do is just meet people and have conversations. That's all. Get to know them. Help them get to know you. It really is that simple.

Of course the reason people network for a business is because they want to sell their products or services. And yes, you're going to start selling through networking... but if you expect that you're going to go to a networking session or have a coffee and get sales immediately, you're going to get discouraged. That's not how it works.

The basic concept that anyone new to neworking needs to keep in mind is "Know, Like, Trust". The reason many people buy from a company and especially an individual is because they know the person, like them, and trust that they'll do right buy them. There is, of course, more to making a sale than just this; however, you don't need to worry about those when you're just getting started. More importantly, doing those things now may actually make things worse. Your goal is very simple... meet people. Introduce yourself, ask their names, and start a real conversation.

Yes, you're going to talk about their business and what they do, but one of the best things you can do is talk about things that aren't related to work. Where'd they grow up? What's their family like? What are their hobbies? What did they do last weekend? Where'd they get their shoes? Really find out who this person is that you're speaking to and get to know them and let them get to know you.

If you don't talk about business more than 10% of the time, it's fine. If they remember you as a person and not as something just trying to extract money from their pockets, you've done well. When they get to know you and get to like you, they'll eventually trust you to help them with a need they have and will gladly compensate you for doing so. But that's later. Right now, your goal is to get people to know and remember you as you get to know and remember them.

Now get out here and meet some people!

5 Skills That Every Business Owner Should Have

Not everyone will be good at running a business. Why? It’s not because of having a degree or having connections or a large amount of money to get started. Running a business really requires having a decent amount of discipline and the ability to develop the following skills.

• Organization - Being organized is one of the most important things to help run a business. If you’re working for yourself, your system only has to make sense to you; but, if you have partners or employees, it’ll help immensely to have systems or programs in place so people can find documents, tools, etc. This will help with accounting, marketing, sales, and day to day operations.

• Financial literacy - Businesses deal with money every day, so having an idea of how money works is immensely important. This means understanding both revenue and especially expenses. Many new business owners don’t do a great job tracking those expenses and are surprised to see how much they’ve spent, making this an important skill to develop as it impacts everything from accounting to sales and pricing to managing the business as a whole.

• Problem solving - Being able to think through problems and to find solutions is tremendously important to running a business, especially since the goal for many companies is to solve problems faced by their potential customers. Being able to apply that same skill to the business itself, to learn new things and get creative, will help with managing employees, operations, sales, supply chain management, risk management, and many other aspects of the business.

• Optimism and a Positive Outlook - This isn’t just an attitude, but is a true skill when it’s applied. Being a business owner is challenging, but the owners who can find a way to enjoy these challenges and even make them fun are the ones that are more likely to succeed, to identify business opportunities, to attract better employees, be better managers, and to get more sales.

• Communication - Being able to share your ideas and thoughts in a coherent and capable way is a tremendously important skill to have, both with the members of your team as well as your customers. Those that don’t communicate well realize how expensive this can be eventually when the problems occur, but those that are able to understand what they’re told and to effectively communicate with others end up being better leaders, are better able to attract potential customers, and to retain them once they’ve made the sale.

These skills alone may not guarantee success in business, but they’re the foundation that successful businesses are built upon.

- John Thrush

Starting A Business? Choose the Right Business Structure!

You’ve come up with a business idea and decided to start a company. Excellent! But what’s next? How do you do it? Do you hire an attorney to file the registrations? Do you pay a registered agent? What kind of business structure do you need?

There are several options on how to get started and registered as a business. Going with an attorney or other service generally costs more, but is often faster; however, there is still a chance that things may not go as expected and it’s very likely that the business owner will be the one who has to deal with the fallout. This is why we typically recommend that anyone starting a business be the one to file everything so that they are fully aware and informed of the process.

Another important factor is making sure that owners choose the right business structure as it affects their liability, taxes, ability to raise funds, and management of the business. There are also some business structures that are easier to change later should the situation of the company change. Here are several business structures with some benefits as well as detriments to choosing them.

Sole Proprietorship

The Sole Proprietorship is the simplest structure. A single individual owns and operates the business. This is useful when starting out as it’s cheap to start, cheap to maintain, requires limited paperwork, and allows complete control over the business. The income taxes are filed on your personal income tax return and sales taxes are handled much the same way as other structures.

Some disadvantages that should be kept in mind are that your business liabilities are also personal liabilities. This means that if someone comes after your business, they can come after everything that you own as well. You also can’t officially raise capital to start the business… in other words, you can’t have investors. You can accept loans or gifts from people to start the business, but it’s important to keep in mind that these are personal rather than linked to the business because you are the business.

Partnership

A Partnership is a business owned by two or more people. These can include General Partnerships (GP), Limited Partnerships (LP), and Limited Liability Partnerships (LLP). This shares ownership and responsibility of the company while combining resources, skills, and expertise. These require registration with the state as well as with the IRS in most cases and will have annual responsibilities to keep that registration active; however, these are neither complicated nor very expensive. 

Some potential disadvantages with LLPs are that there are limitations in their ability to raise outside capital. There is also the potential for conflict between partners, which is why it’s always a good idea to have a well thought out partnership agreement in place before business activities really start. And, while partnerships generally shield liability to the limited partners, general partners have unlimited liability and risks. Finally, although this is a pass-through structure and taxes are ultimately paid with the partners’ personal tax returns, a separate tax return must be filed at an additional expense.

Limited Liability Company

The LLC is a hybrid business structure that provides the liability protection of a corporation with the tax benefits and flexibility of a partnership with less formalities than a corporation. LLCs have a great deal of flexibility in management and tax options. Because there’s no firm limit on the number of owners, this makes them useful for everything from a single individual to large companies. This makes them very useful as subsidiaries for specific functions of larger companies (e.g., Amazon is a corporation, but operates a number of subsidiaries including Amazon.com LLC and Amazon.com Services LLC). LLCs are also commonly used in private equity to collect funds from multiple investors in order to put those funds into other companies. As with Partnerships, taxes are paid on the personal returns of the owners of the LLC and, if there’s a single owner, the business tax return can be filed as part of the personal return.

LLCs can also take on outside investment from individuals as well as organizations including other LLCs. They also protect the personal assets of owners by limiting losses to what is invested in the LLC, meaning they’re attractive to people looking to put money into private companies. Another advantage to LLCs is that they can be converted into S-Corporations or simply treated as an S-Corporation for tax purposes without much difficulty.

Though LLCs are flexible, there are some disadvantages based on how complex management and operations get. Like partnerships, there are some registration requirements that can increase in complexity depending on how the LLC chooses to operate. Also, the number of members in an LLC can increase the potential for disagreements, meaning partnership agreements are highly advisable before conflicts occur. Another disadvantage is that, unless the LLC is taxed as an S-Corp, income that passes through to owners of the business is subject to Self Employment tax. Finally, if there is more than one owner or in special circumstances, LLCs require separate tax returns to be filed with the IRS and possibly multiple states depending on the business operations and owners. 

S-Corporation

A Corporation is a separate legal entity from its owners. We’ll talk first about the S-Corporation. This is a special type of corporation that passes its income, losses, deductions, and credits through to shareholders for federal tax purposes. This provides the benefits of a corporation without double taxation. This also provides the same limits in liability as LLCs. Like LLCs, S-Corps can take outside investment, allowing up to 100 members. An interesting advantage to S-Corporations is that owners active in the business are paid as employees rather than partners. This means their employment taxes taxed only on their earnings rather than the total income of the business. If the business is profitable, this can result in owners paying less in taxes.

Many of the disadvantages are similar to those of partnerships and LLCs. All members of an S-Corp must be individuals rather than LLCs or other corporations. This makes them somewhat less flexible than LLCs. Another disadvantage is that all S-Corps, even those with only a single owner, must file separate tax returns from the owners. This and other registration requirements can make them more complicated than LLCs, but this is highly dependent upon the complexity of the business.

C-Corporation

The C-Corporation is generally reserved for more complex businesses with multiple owners with the intention of scaling. Like LLCs and S-Corporations, they limit liability to owners. They also allow investment from individuals and other organizations such as LLCs and other C-Corps, which means they’re also capable of incredible flexibility and complexity. C-Corporations are also the most common form of business structure if ownership is expected to change regularly and if it’s intended to last past the lives of the founders. Larger and more experienced investors also tend to prefer investing in C-Corporations because the reporting requirements tend to be more strict.

Despite their scalability and potential for perpetuity, there are many disadvantages to C-Corps. First, their complexity makes them difficult to set up and maintain without some degree of expertise. There are also more regulations and oversight that go along with them (e.g., the reporting requirements mentioned earlier), which means it can cost more to stay in compliance… and even more in fines if you’re not. Another disadvantage, double taxation, is unique to the C-Corp. Whereas other structures are pass-throughs where all taxes are paid by the individual owners, the C-Corporation must pay income tax on its profits and the individual owners pay taxes on the dividends received. 

Which business structure makes the most sense for your company means looking closely at what the business will do and how you expect the operations to change over time. While the LLC has the most flexibility and will work for most businesses getting started, it’s best to put in some thought about the ownership, goals, and operations of the business over the next few years. Doing things right the first time can save a great deal of time and money in the long run. If you want to do things right or just want to bounce some ideas around, give Brightleaf Consulting Group a call. We love talking about these things and helping people make informed decisions!

- John Thrush