Bridging the Gaps in Business

Depending on your business structure and location, you may be responsible for several types of taxes, including:

- Income tax: Based on your business profits.

- Self-employment tax: Covers Social Security and Medicare taxes for owners of sole proprietorships, partnerships, and LLCs.

- Employment/payroll taxes: Withheld from employee wages for Social Security, Medicare, and unemployment insurance.

- Sales tax: On goods and services sold (if applicable).

- Property tax: If your business owns property or equipment.

- Excise and use tax: Applies to specific industries (e.g., fuel, alcohol, tobacco).

- Franchise taxes: for certain legal entities (depending on state requirements).

Investors and banks want to see that the company maintains proper compliance with tax obligations to avoid legal and financial risks.

Please refer to the in-depth analysis provided above in the Tax Tools.

• LLC + Partnership;
• LLC + C corporation;
• LLC + S corporation;
• Corporation + C corporation; and
• Corporation + S corporation.

So, you really only have five options. There are lots of other weird entities that exist (limited partnership; limited liability limited partnership; etc.) but almost no one without an extraordinarily unique situation chooses those."

With that said, your business’s legal structure (e.g., sole proprietorship, partnership, LLC, S corporation, or C corporation) significantly affects how your business is taxed:

- Sole proprietorship/partnership/LLC: Business income "passes through" to the owner’s personal tax return, and you pay taxes at your individual rate.

- S corporation: Similar to pass-through taxation, but owners may pay themselves salaries and take dividends.

- C corporation: Subject to double taxation—corporate income tax and then personal tax on dividends paid to owners.

Investors may prefer certain structures like C-Corps for equity financing, while banks might assess the risk differently based on liabilities and tax treatment.

Tax deductions and credits reduce your taxable income. Some common deductions for growth companies include:

- Business expenses: Rent, salaries, benefits, marketing, and office supplies.

- Salaries and wages: Payments to employees, contractors, and even yourself (if structured correctly).

- Vehicle and travel expenses: For business-related transportation

- Startup costs: Costs incurred before launching operations.

- Health insurance premiums: For self-employed individuals or if you offer insurance to employees.

- Qualified Business Income (QBI) deduction: Allows pass-through entities to deduct up to 20% of business income

- Depreciation: On assets like equipment and real estate.

Credits differ from deductions because they directly reduce your tax liability. Some examples include:

- Research and development (R&D) credits, especially tech or innovation companies.

- Energy-efficient property credits.

- Tax credits for hiring certain employees (e.g., veterans, disadvantaged workers).

Maximizing deductions improves cash flow, a metric both investors and banks value for financial planning and stability.  We recommend working with a tax professional to reduce your potential tax liabilities. 

Please refer to our article on Nexus HERE:  Planning for Nexus: The Sales Tax Monster.

Sales tax management requires obtaining sales tax permits in states where your business has nexus, either through physical presence or economic activity.  The business should:

- Maintain accurate records of taxable sales and regularly remit sales taxes to the appropriate state authorities, following the required frequency (monthly, quarterly, or annually).

- Leverage sales tax automation software (e.g., Avalara, TaxJar) to ensure compliance as your company grows.

- Conduct an annual nexus review by state for revenue allocation purposes and consult with a tax professional to establish a method of apportionment. Examples include revenue markers by state, such as income tied to Medicare populations, or the location of service, such as customer headquarters.

Sales tax obligations differ across states and localities. Key considerations include:

- Which products or services are taxable? (Taxability varies by state.)

- Where do you need to collect sales tax? This is based on your physical presence (nexus) or economic nexus if you sell in states that impose such requirements (e.g., online sales).

- How do you file and remit sales tax? Be sure to understand the reporting and payment schedules in each state where you collect sales tax.

 Proper sales tax management prevents legal risks that can deter investors or banks from providing funding.

Tax filing and payment deadlines depend on the type of taxes:

- Estimated quarterly taxes: Many small businesses and self-employed individuals need to make quarterly tax payments to avoid penalties.

- Annual tax return: Most businesses must file a tax return annually, though corporations may have different deadlines.

- Sales tax: Typically paid monthly, quarterly, or annually, depending on the jurisdiction and your sales volume.

- Payroll taxes: Deposits are usually required either monthly or semi-weekly, depending on the size of your payroll.

  ❖In addition, HR experts should be consulted for paying people in the proper states and proper payroll tax filings. ADP can help setup states for $150 per state so you don’t have to complete the paperwork or phone calls. They can also ensure quarterly filings, power of attorneys, and annual payroll tax filings are completed timely and correspondence with each state. 

❖Payroll taxes over a certain $ threshold will have to be deposited by wire the next day to IRS. If not in compliance, the business will get fined for late filing and accessed penalties. This usually triggers when a company is above 40 people.   

Timely filing is crucial to maintaining credibility with investors and avoiding penalties that can affect cash flow and creditworthiness with banks.

Keeping accurate and detailed records is essential for compliance and to substantiate deductions. Required records include:

- Income and sales records.

- Expense receipts and invoices.

- Employee payroll records.

- Credit card statements.

- AP and AR aging reports.

- Bank reconciliations and statements for year-end and first month.

- Tax filings and correspondence with the IRS or state tax authorities.

- Mileage logs for business travel.

- Proof of business deductions (e.g., utilities, equipment purchases, lease agreements).

- Fixed asset listing by location (including disposals).

- Confirmations of quarterly tax payments, if any.

It’s important to store these records for at least three to seven years, depending on local laws and tax authorities. Accurate records ensure compliance and can provide data to investors or banks during audits, funding applications, or due diligence.

If you're self-employed, you’re responsible for paying both the employer and employee portions of Social Security and Medicare taxes (around 15.3% of net earnings).

Self-employed individuals must also make quarterly estimated tax payments to avoid underpayment penalties. You may be eligible to deduct the employer-equivalent portion of your self-employment tax on your tax return. A trick is to apply your first quarterly tax payments to prior year to avoid any underpayment as you are always a quarter ahead. 

Investors expect founders and key stakeholders to be compliant with personal tax obligations, as it reflects responsible business management.

Owners can reduce tax liabilities by taking advantage of:

- Tax-deferred retirement plans: Contributions to plans like a SEP IRA, SIMPLE IRA, or 401(k) can reduce taxable income as a tax-advantaged strategy.  A Cash Balance Plan is a great option to maximize retirement now.  

- Business expenses: Ensure all legitimate business expenses and research activities are accounted for and properly classified.

- Business Assets: reinvestment into business assets.

- Depreciation methods: Maximizing depreciation deductions on large business assets (e.g., machinery, vehicles).

- Structuring the business: Choosing the right business entity can help reduce taxes (e.g., switching from a C corporation to an S corporation if it makes sense). Evaluate your business structure to ensure it offers optimal tax treatment.

Please refer to our Tax Tools above for detailed analysis on which business entity will fit your business needs.

A cash balance plan is a type of defined benefit plan that blends features of traditional pensions and 401(k)s. Employers contribute to a hypothetical account for each participant, which grows based on:

1. Pay credits: A percentage of salary or a flat amount.

2. Interest credits: A fixed rate or a rate tied to an index like U.S. Treasury yields.

Unlike a 401(k), the employer bears the investment risk and guarantees a retirement benefit. Employees can take a lump sum or annuity at retirement.

Maximum Contribution for a 50-Year-Old (2024):

For a 50-year-old, annual contributions can range between $150,000 and $250,000+, depending on compensation, plan design, and actuarial assumptions.  These contributions are calculated by actuaries and are designed to provide a specific amount of income at retirement and these limits are much higher than those for a 401(k), and contributions grow with age, as older participants need to accumulate retirement funds faster.

Tax Benefits: Employer contributions are tax-deductible, and taxes on contributions and earnings are deferred until withdrawal. Cash balance plans are often paired with 401(k)s for higher retirement savings.

For precise limits, consult with an actuary or plan administrator for the risk and reward analysis on a cash balance plan.

Missing tax deadlines can lead to penalties, such as:

- Failure-to-file penalty: 5% of the unpaid taxes for each month the return is late.

- Failure-to-pay penalty: 0.5% of unpaid taxes per month, plus interest on unpaid taxes.

- Underpayment penalties: For failing to pay estimated taxes.

Sales tax failure to pay penalties are state by state and can be negotiated with a VDA. See our article about Nexus on the process in Planning for Nexus: The Sales Tax Monster. 

These penalties can impact cash flow, making your company less attractive to investors and putting your creditworthiness at risk with banks. 

There are distinct tax and insurance obligations for employees vs. independent contractors:

- For employees, you must withhold and pay payroll taxes (Social Security, Medicare, federal and state income taxes) and file necessary tax forms (e.g., W-2s).  In addition, you must offer benefits for health insurance, 401K, workers comp, and company perks (that can amount to upwards of $30K+ per employee depending on your benefit structure).

- For independent contractors, you generally do not withhold taxes. However, you must file a 1099-NEC if you pay them $600 or more in a year.  In addition, you will need to collect insurance certificate or will be liable for workers comp to the insurance company when they conduct the annual audit, which is insured at the state level.

Misclassifying employees as contractors can lead to penalties, so it's important to understand the classification rules.

Proper classification is essential, as misclassification can result in penalties and legal challenges, negatively affecting investor trust and bank financing options.

Please refer to our Contractor Guide in our Tax Tools for the criteria for an employee vs independent contractor.

Businesses operating in multiple states may face state income taxes, sales taxes, and other local taxes in each state. Important considerations include:

- Nexus: Determining if your business has a physical or economic presence in a state.

- Apportionment: Some states require apportioning income based on sales, property, or payroll within the state.

- Sales tax: Collecting and remitting sales tax for sales made in multiple states, depending on their specific laws.

Use tax software to manage the complexity of multi-state taxation.  To note, although states don't talk to each other, you will have to agree on a universal method for allocation of revenue.  A tax professional will not let you apply different approaches to different states as that is consider tax manipulation.  See our article about Nexus on the Nexus process and planning in Planning for Nexus: The Sales Tax Monster. 

Investors and banks expect you to manage multi-state taxes efficiently, as failure to comply can lead to costly audits and legal liabilities.

Selling a business or transferring ownership has significant tax implications that need planning a year ahead of time, including:

- Capital gains tax: If you sell your business at a profit, you may owe capital gains tax on the sale. It is important to identify what portion is long-term (taxed at 20%) vs short-term (taxed at ordinary income levels) and your individual basis.

- Asset vs. stock sale: In an asset sale, individual assets are sold, potentially resulting in different tax treatments. A stock sale involves selling ownership shares, which may be more favorable for the seller. It is important to understand the “hot assets” like AR that will be taxed at ordinary income rates and any asset transfers staying with OldCo as you may want to keep your “investments”, if any and not include in the sale.

- Deal costs: It is important to understand which deal costs can be deducted in the year of sale and which are capitalized as deferred cost amortization over life of loan.

- Distributions vs. Guaranteed Payments: Guaranteed payments are taxed as ordinary income, while distributions may benefit from lower capital gains tax rates. Proper classification ensures the correct tax treatment for both the seller and the buyer. 

- Succession planning: If transferring ownership within a family, there may be estate and gift tax considerations.

Ownership changes can affect tax elections, liabilities, and benefits (e.g., loss of S-Corp status if ownership rules are violated).  Consulting with a tax advisor is essential during this process to minimize tax liability and understand the true cash (after tax) waterfall on a sale.

  Yes, it's important to understand if any §743(b) deduction benefits apply to you as the seller or if they all go to the buyer in a business sale.

What is §743(b) Adjustment?

- A §743(b) adjustment allows the buyer to step up the inside basis of partnership assets to match the purchase price they paid, enabling future deductions like depreciation.

- This adjustment only benefits the buyer if a §754 election is in place. The seller generally does not benefit from it.

Key Considerations for Sellers:

- No §743(b) for Seller: As the seller, you won’t receive the benefit of the §743(b) adjustment. You are taxed on the sale based on the outside basis (the difference between what you paid and the sale price).

- Buyer’s Tax Benefit: The buyer gets the future tax deductions, which may increase the value of the deal. This can be a negotiation point when setting the sale price.

Conclusion:

The §743(b) deduction primarily benefits the buyer, not the seller. It’s essential to know how this affects the overall deal and to negotiate accordingly. Consult a tax advisor to ensure proper handling of these tax implications.

Yes, business owners benefit from working with a tax professional, such as a CPA or tax advisor, is highly recommended for:

- Tax planning: Maximizing deductions, credits, and creating efficient tax strategies.

- Tax preparation: Ensuring accuracy and compliance when filing returns.

- Navigating complex tax rules: Handling multi-state operations, international sales, or mergers and acquisitions.

- Audit support: Providing assistance in the event of an IRS audit or dispute.

Engaging a tax professional demonstrates a commitment to compliance, which reassures both investors and banks about the company’s financial management.

International business activities may create additional tax obligations, including:

- Foreign tax credits: Avoid double taxation on income earned abroad.

- Transfer pricing rules: When transferring goods, services, or intangibles between subsidiaries in different countries, certain pricing rules apply.

- Value-added tax (VAT): In many countries, VAT applies to goods and services, and you may need to register for VAT in the country where you sell.

- Understanding tax treaties between countries to avoid double taxation.

You must comply with U.S. international tax laws, including foreign tax credits and reporting foreign income (e.g., via IRS forms 5471 or 8858).

Managing international taxes effectively is crucial for reducing risks and maintaining investor and bank confidence in your global expansion strategy.

If audited, you will need to provide documentation supporting your tax filings (income, deductions, credits):

- Be prepared with records: Ensure all financial records and receipts are organized and available for review.

- Cooperate with the IRS: Provide requested documentation and comply with deadlines 

A tax professional can represent you during the audit to ensure proper handling. If discrepancies are found, you may face penalties, interest, or adjusted tax liabilities.