Choosing an Organization Type

At DMF, we often meet with prospects who are, have, or have thought about starting a new business. Usually these people want to "ask just a few questions" about how their business should be set up. More specifically, they want to know which organizational type they should be.

If you've ever researched or talked with prospective clients about organizational structure types, you know that trying to educate a potential client on all the possible pros and cons of each option is the equivalent of trying to get a drink from a raging fire hose; it's just too much information for their brains to absorb in an hour consultation.

So what are the options? Well, briefly, new businesses can choose between a general partnership, limited partnership, limited liability company taxed as a sole proprietor, limited liability company taxed as a partnership, limited liability company taxed as a c-corporation, limited liability company taxed as an s-corporation, s-corporation, c-corporation, or plain 'ole sole proprietorship. And I'm sure there are some options I'm leaving out.

Suffice it to say that, as in anything dealing with small businesses, there is no "one-size-fits-all" solution for organization type. When we have the organization type discussion with clients and prospects, we usually end up fighting off some argument that starts with "my brother-in-law's neighbor's pastor told me that his nephew's mother-in-law started a corporation and that's what I should do."

Well, did that person have partners? Did they contribute assets to the business? Is it a possibility that they will take on additional partners? Are there any partners with limited participation in the business? Are they paying themselves or others? How are they paying themselves or any other partners/members? And so on...

If you're worried about your organization type or thinking about starting a business, do some research. Get a good background of your options. Understand what your intentions are for the business, both short-term and long-term. Then go talk to your CPA.

Generally, we like to use the K.I.S.S. method at our firm: Keep It Simple, Stupid. Start with something easy, because there ARE rules to follow if you start something complicated and it's much easier to unwind something simple than a partnership that also has corporate owners.

That's all. KISS.

Why an Accounting System?

Most CPAs will tell you (just like we will) that if you're running a small business of any kind, you need to be on some type of accounting system. It doesn't have to be any specific type of system, just something that works for your operation.

But are we as CPAs just going around telling our clients and prospects that "you need to be on an accounting" just to see them suffer through setting it up and learning something new? Are we perhaps getting kick-backs from companies like Intuit (QuickBooks) or Sage (Peachtree) for every new client that buys their software?

While we DO actually like watching a few of our clients suffer through learning a new software (we won't name any names), we actually do have their best interests in mind when we recommend moving to an accounting software. Recently, an encounter with a client really drove our point home. It went something like this:

A client of mine has never accepted the fact that his business needs to move to an accounting system. He runs a business that grosses around $500k per year. The first year that I did his business tax return, he actually brought his information to me on 14 column paper. It was horrendous. To this day, I'm still dealing with a payroll issue from 4 years ago.

Recently, this client put his business up for sale. What was the first thing he needed? That's right...financial statements. The business broker wanted the financials for at least 2 years. And he didn't have them. And neither did I. We had to scrounge around to put the most recent financial statements together, just so my client could have an intelligent conversation about his business with the broker and prospective buyers. I believe my client's inability to adopt an accounting system severely hampered his ability to successfully sell his business.

Here's the lesson. If my client had been using an accounting system, the financial statements would have been easy to develop. We could have produced them for each month and at any point during the year. But each time they are requested, we have to start the process of collecting the information all over again, which is labor-intensive...which translates to higher costs for my client.

If you're a small business and you don't currently have a system, it's a perfect time of the year to start. It's not too late to add everything from this year into the system, but the farther into the year we go, the more difficult the process becomes.

Here are some things to remember when picking an accounting system:

1. It needs to be easy for YOU to use.

2. It should simplify some process of your business, such as billing, collecting money, paying vendors, or producing financial statements.

3. Make sure it comes with support should you have questions.

If you have questions about possible accounting systems, ask someone who has used them. Like your CPA. He actually knows what he's talking about.

How big is YOUR refund?

I get the impression from time to time (usually when meeting with tax client prospects) that the general (read: uninformed) public has a tendency to rate the competency of tax preparers based on how large or small their refund is. The meeting usually starts something like this:

Prospect: My tax guy last year got me $10,000 back. Can you all do the same thing?

That's when we typically begin to educate the prospect that the return is in fact their responsibility and that our goal in the process is to 1) help them take advantage of tax breaks available to them and to 2) help them comply with all the necessary tax regulations. We cannot control variables that our not made known to us before they happen, such as: how much you are having withheld from your paycheck; whether or not you have taken an early IRA distribution; the fact that you had a dependent roll off of your return from last year; or any of the other thousands of different scenarios that could affect your taxes this year as compared to last year.

Bottom line: there is no correlation between refund amount and tax preparer competency.

Beware of anyone who either guarantees you a certain refund or that charges you based on your refund amount. And as always, interview your preparer to make sure they are a good fit and that they appear ethical.

(If you'd like to talk to someone at DMF about this post, please email us at admin@dmfcpas.com)

What is a PTIN and why should I care?

You may have heard some rumblings about new income tax return preparer requirements beginning in 2011. If you are paying someone to prepare your tax return for you, they will be required to have what's called a PTIN: which is a Preparer Tax Identification Number.

Why the changes? Historically, almost anyone with a calculator and a brain was able to prepare and sign income tax returns and receive compensation to do so. That's right, your hairdresser and postman have been able to prepare, sign, and receive compensation for the preparation of your income tax return. Let's just say the return preparer "industry" has been controlled in a less than ideal manner.

Beginning in 2011, all paid preparers are required to have a PTIN to identify themselves with the IRS. Additionally, anyone who is not a CPA, lawyer, enrolled agent (or anyone who works for those people) will be required to pass education requirements in order to continue to prepare returns.

My belief is that the primary goal of this endeavor is to protect taxpayers when they select persons to prepare their tax return. It has been estimated that it takes around 6.1 billion hours for everyone to comply with the internal revenue code each year. Let's remember, the IRS code is (at this moment) roughly 3.8 million words. Shouldn't you be sure your return preparer is qualified to prepare your return?

From the IRS, some tips on selecting a tax preparer: http://www.irs.gov/individuals/article/0,,id=133088,00.html

Taxes on Cash?

A common question we get here at DMF is: Should I get rid of my cash balance in my business in order to help reduce my tax liability?

While there are many answers to that question, the short answer is: No. You don't pay taxes on cash balances in your business; you pay taxes (at the individual level most likely) on activity that creates that cash balance.

In a perfect cash-basis environment, your year-end cash balance would in fact be your taxable income. However, none of our business clients operate in an environment like that. That's because most businesses enter into transactions that affect cash but don't affect their tax liability. Or transactions that affect taxable income but don't affect cash.

These transactions include (but aren't limited to): incurring or paying off debt, buying or leasing equipment, expenses for meals and entertainment, and inventory purchases.

Bottom line: the differences between cash flow and taxable income are sometimes difficult to explain and even harder to understand. Make sure your tax professional explains or reconciles the difference for you.