JUSTLAW

The best advice you’ll ever get for starting a business

                                                 About the Author

Dov S. Rosen is a JUSTLAW network attorney who represents private and publicly-traded companies in negotiating mergers, acquisitions, private placements,  IPOs, and commercial contracts.  He also has an active practice negotiating commercial real estate loans,  property acquisitions, and commercial leases.                   

Dov graduated from Georgetown University Law Center in 2011 and, in 2020, founded The Law Offices of Dov S. Rosen. 

He can be reached at [email protected]

(This article is the first in a multi-part series. Stay tuned to The Verdict for the next installments!)

 

You’ve got a winning idea. You have a business plan set up. Maybe you even have some investors lined up.

Congratulations – you’re on your way to starting your own business.

What’s next?

Part I: Cash 101

Cash is the lifeline of any business. And the key question for your business is how that cash flows in and how it may be expected to flow out. This leads us to the first big choices your business will make: how to raise money, whom to raise it from, and what to give up in return.

 

Early-stage startup investors will often include family and friends, “angel” investors (generally, high-net-worth individuals who are willing to invest in early-stage companies in exchange for preferred equity), and – for particularly promising new companies – venture capital firms. Nowadays, crowdfunding platforms like GoFundMe are also becoming increasingly popular for early-stage companies (we will explore the advantages and limitations of crowdfunding in a later installment). For startups later in their business lifecycle, institutional investors may play a greater role, and for more advanced companies the public equity markets may become relevant.

 

Each of these investors will have different expectations about what they will receive in return for their money. Typical forms of startup capital include common equity, preferred equity (often with the right to convert to common at a later time), and convertible debt (debt with a right to convert to equity at a later time). Other equity structures like simple agreements for future equity, or “SAFEs”, offer distinct advantages and disadvantages and are becoming more common. And for many businesses, business loans (including SBA loans for qualified borrowers) are a good option for providing initial capital – but with their own advantages and disadvantages. We will discuss these various types of startup capital later in our series.

 

A note on securities laws:

Our focus is on early-stage startups engaging in private offerings that are exempt from registration with the SEC or other state regulatory commissions. Securities laws are not just for public companies – any company that issues equity to raise money is potentially subject to them and must fall within an exemption avoid registration and reporting requirements. In later parts of this series, we will speak about the various exemptions from securities laws and

how to make sure you stay within the rules throughout your business lifecycle.

Trade-Offs

Cash will almost always come at a cost. To make your idea a reality, you will inevitably have to trade a piece of ownership over the idea you have created and often a degree of control over the business you are building. But that does not mean all equity raises will have the same impact on the future of your business. The choices you make early on can determine the evolution of your business for years to come, preserving your flexibility and a large degree of your control. Conversely, a sub-optimal equity structure, poor entity choice, or improperly drafted company agreement can hamstring your ability to raise cash, leave you stuck with a bad partner, and even cost you the control you need to make your business grow.

 

But making necessary trade-offs is a natural part of the growth cycle of every business. The key is to establish clear expectations and to structure investments in a way that respects the needs of investors while preserving your ability to grow the business. The trade-offs you will have to make will generally come in the following areas: keeping cash in the business, keeping the flexibility to raise more cash, and keeping control over business decisions

Top Tax Deductions for Small Businesses

Small businesses provide a critical pillar within the United States economy. According to the JP Morgan Chase Institute, small businesses comprise 99.9% of all U.S. businesses, accounting for 45% of the national GDP. However, many small business owners actually pay more tax than they need to; while large corporations tend to retain accountants, working full-time to find tax savings, many small businesses do not have this privilege. As a result, small businesses will often miss out on a plethora of potential tax savings that fly under the radar.

This article covers the most commonly missed deductions for small business owners — and how you can determine if your business is eligible.

The Home Office Deduction

Many small businesses conduct business from a home office. A home office can be located within a room within your residence or an outbuilding unattached to your home. Working from a home office comes with several benefits such as flexibility, ease of access, and of course, inherent tax deductions.

However, the IRS can be a stickler for eligibility; to ensure that your home office is eligible for deductions, it must pass two tests.

1. The Regularity Test: You must use the room regularly.
2. The Exclusivity Test: The room must be exclusive to business activities.

In addition, your home office has to be your “principal place of business.” As your principal place of business, you must use your home office as the primary location for meeting with clients or conducting business activities. If you perform administrative or management duties elsewhere — or have a secondary office — the IRS will reject your home office deduction.

The Mileage Deduction

Business travel can make up a significant expense, especially for small business owners. Luckily, there is a deduction for that; currently, the IRS permits a deduction of 56 cents per qualifying mile. This rate is subject to change each year but should remain within the same ballpark. You can easily track your business miles with QuickBooks Online or a service such as Mile IQ.

Unfortunately, you cannot deduct your commute. However, there is a workaround within the tax code language; the difference lies in how ‘commute’ is defined.

Commuting travel is defined as travel to and from your home to your business. Traveling from your business to another business site, such as a branch or a meeting place with a client or prospect, is considered travel eligible for a mileage deduction. This is where a home office can come in handy; when you have a qualifying home office, business travel from your home to another place of business can be deductible because it doesn’t meet the definition of a commute.

For the sake of example, let’s say you own a restaurant 30 miles from your residence. Suppose your restaurant doesn’t have any office space, and you can do business in a qualifying home office. In that case, the 30-mile trip can count as deductible mileage instead of a non-deductible commute.

S-Corp Tax Benefits

While the S-Corporation designation is not for every business, it may open the door to some next-level tax savings. Unlike standard corporations, S-Corps are considered “pass-through” entities because income, losses, and deductions “pass through” directly to shareholders, circumventing corporate income tax. After being passed through to shareholders, income, losses, and deductions are taxed at each shareholder’s income tax rate.

The S-Corp designation can be a popular choice for certain business owners because they avoid double taxation, but it is not suitable for everyone. In fact, many businesses are not even eligible — companies with more than 100 shareholders or foreign shareholders, ownership by a separate corporation or partnership, or multiple classes of stock are disqualified.  If you are unsure whether the designation is right for you, find a good small business lawyer to help you evaluate the option.

Even if you are eligible for an S-Corp designation, several downsides must be weighed. For example, S-Corps must run payroll and withhold taxes. In addition, the IRS closely watches S-Corps to dissuade those taking advantage of the designation. Also, outside investors tend to prefer investing in C-Corps over S-Corps because C-Corps are more conducive to growth. S-Corp profits are subject to taxation, whereas C-Corp gains are only taxed once distributed, encouraging C-Corps to keep money in the business to fund growth.

Designated your business as an S-Corp is not optimal for every business, but for highly profitable small businesses with shareholders, it can save a lot of money by circumventing double taxation.

Business Meal Deductions

Business meal deduction goalposts are constantly shifting, but 2021–22 is shaping up to be an optimal period for meal-related tax savings. The recent COVID-19 Relief Bill permits businesses to write off 100% of the cost of business-related restaurant meals, food, and beverages in 2021 and 2022.

By definition, deductible food and beverage items include all food and beverages, including snacks, alcohol, and other non-traditional “meals”; delivery charges, sales tax, and tips included. Notably, entertainment expenses are not deductible — but meals at entertainment venues can be. While it may seem like an inconvenience at the time, always ask for an itemized receipt at entertainment venues that separate the meal from the entertainment expense.

It’s always good practice to document every business-related expense, and business meals are no different. After each business meal, remember to put the receipt somewhere safe like in Hubdoc of QuickBooks Online; doing so is crucial to protect your finances in the event of an audit.

Miscellaneous — But Useful — Deductions

Giving gifts to your clients is more than a fast-track to their hearts; it can save your business money on its tax return. The IRS allows a business deduction of up to $25 per client per year.

Business clothes can also be deductible, but with many strings attached — you cannot deduct street-appropriate work clothes, for example. To qualify for the business clothes deduction, the clothes in question must be “mandatory for your job and unsuitable for everyday wear.” Unfortunately, this means you cannot deduct a brand-new, custom-tailored Italian suit — even if it is required for your job — but a bariatric welding contractor could deduct the cost of wetsuits, for example. However, there is a workaround to deducting street-appropriate wear: if the clothing contains a visible business logo, it can be considered advertising — which is deductible.

Another deduction opportunity lies in charitable contributions. However, deducting these contributions is not as straightforward as one might expect. The only businesses that can directly deduct charitable donations are C-Corps — and most small businesses are not C-Corps. Fortunately, there is a workaround: classifying the charitable contribution as an advertising expense. This isn’t a simple “misclassify the deduction and hope the IRS doesn’t notice” type job — which, by the way, is illegal. To successfully classify your donation as advertising spend, you must be able to show how you leveraged the donation into an advertisement. A business can accomplish this by, for example, donating money to a local high school sports or arts program, which will, in turn, list the business as a sponsor, such as in a printed program or on a scoreboard panel. In turn, the donation becomes classified as a “necessary business expense” and is now deductible as advertising spend — while still supporting a cause you care about.

The Big Picture

Tax benefits for small businesses exist for a reason. Unfortunately, many small business owners who aren’t financially savvy — or don’t employ specialized small business accountants — miss out on what is, basically, free money. Familiarity with top tax deductions is highly beneficial for any business’s bottom line and may even help business owners scope out opportunities for further tax write-offs. Because the business tax landscape is prone to rapid, yearly change, it is crucial for business owners to keep their ears on the ground for more upcoming opportunities to save.

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ANNOUNCING FREE WEBINAR

Want more great tax and legal tips for your business? If so, we invite you to join us for a complimentary webinar co-hosted by JUSTLAW and FinancePal, where we’ll take up such critical topics as:

• Most commonly missed deductions
• Selecting the right corporate structure for your company
• Understanding the difference between employees and independent contractors

Wednesday July 14, 2021 at 2:00 pm ET

Register Here