(Photo credit: alancleaver_2000)
So, either you survived as a small business through the Great Recession, or out of necessity you started a business that is now in its third or fourth year of operation. Many businesses like yours are small even by SmallBusiness Administration standards with perhaps ten or fewer employees and annual revenue below a million dollars. Watching your expenses, you may not have received much business, accounting or tax advice when you started the business. As a result you may not be using the best practices, or worse, left you or your business exposed to unnecessary risks and liabilities. Here are a few comments and ideas I would like to share with you.
First, CONGRATULATIONS because less than half of micro-businesses survive more than four years. Hopefully you are making enough to provide for your family and the business is providing a stable source of earnings for your employees as well. Key to your relative longevity, you have been lean enough to compete while establishing a good reputation for your products and/or services. Most small businesses cannot continue to fill the pipeline with new business without these traits. Still, you are vulnerable to competition and changes in demographics and economics specific to your business. Although it is sobering to know the short life of most businesses your size, I believe it is better to know what you are dealing with. As you have done so far, you have to earn your business and reputation every day.
For planning purposes here are a few things you should consider:
Important Insurance Coverage
In managing risk you should not have substantial gaps in insurance coverage. This means managing risks at the individual level which can make you just as vulnerable as risks at the business level. I believe it is better in most instances to obtain coverage rather than save the cost of the insurance premiums. Unless you truly cannot afford it, failure to acquire the necessary coverage should go under the heading of a penny wise and a pound foolish. Please consult with an insurance agent about the following.
Life Insurance: You and your spouse should be covered by life insurance. If the micro-business is a significant source of income who is going to run the business if you are gone? Who is going to replace income earned by your spouse or care for the household if your spouse dies? Coverage should be sufficient to cover household expenses for several years as well as the future needs of your children like a college education.
Disability insurance: This is an important income replacement tool. Premiums can be structured as employee paid so disability payments will be tax exempt income. As with life insurance, your spouse should consider disability insurance if eligible. Long-term care insurance on both spouses can also provide a level of disability coverage.
Health Insurance: Premiums can be structured as a corporate business deduction or deducted form the owner’s gross income, better than an itemized deduction.
Casualty and Liability Insurance: Make sure that in addition to liability insurance for the business you have substantial coverage for home and auto, plus an umbrella policy. Of course, professionals should have malpractice insurance as well.
Choice of Business Entity
If you are still operating as a sole proprietor, joint venture/general partnership or limited partnership with you as a general partner, you should consider incorporating or becoming a limited liability company (LLC). A corporation or a LLC will provide an additional degree of owner protection from liabilities emanating from the business. As mentioned above the business should still have casualty and liability coverage to protect a significant asset, the business itself. I caution that a LLC or corporation will not protect the owner from all business liabilities. For example, a lender may require the owner to be a co-borrower or guarantor for amounts loaned to the LLC/corporation. Also, the owner may not be protected from personal liability for the business’s failure to collect and/or pay over sales taxes, payroll taxes and withholdings.
Usually, a LLC with only one member (owner) will still be accounted for as a sole proprietor, with the information reported on a Schedule C that is filed with the owner’s individual return, Form 1040. A LLC with more than one owner usually will file a partnership return, Form 1065. The LLC will provide each owner with a K-1 reporting his share of LLC income, loss, expenses, etc. The K-1 and accompanying information will provide instructions as to where items are to be reported on each owner’s individual return. A corporation can be a regular or S corporation and file either a Form 1120 (taxable corporation) or Form 1120S. Similar to a partnership, a S corporation will provide each shareholder with a K-1 with items to be reported on the shareholder’s return. Each entity has its benefits and determents depending on specific facts and circumstances, how big the business is expected to grow and the owner’s exit strategy regarding its disposition or sale.
Combining Asset Protection with Retirement Planning
Hopefully the business is producing enough so you can sock some income away for the future. Pension plans, IRAs, 401(k) and profit sharing plans allow you to fund such plans with pre-tax dollars allowing you to keep more. Very important, these plans are generally protected assets exempt under federal and state bankruptcy laws.
Employee verses Independent Contractor
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This is a big issue when people are working full or even part time for a business, but are being treated as independent contractors instead of employees. Instead of providing each person a W-2, the business issues a 1099-Miscellaneous (or perhaps no information at all) for the gross amount paid during the year. As a result the business does not pay over to the government employee payroll taxes and income tax withholdings it should have deducted from gross pay. In addition, the business fails to pay the employer payroll taxes also due. As mentioned earlier, a corporation or LLC most likely will not prevent the personal liability of its owner with respect payroll taxes and income tax withholding the business owes but fails to pay. In a relatively short period of time this liability plus interest and penalties can become quite substantial. If you are concerned that you have not properly accounted for people working for you as employees, you may want to seek the advice of a tax attorney.
There are a few other items I could mention but I will stop here. Some of my observations and comments may have already caused enough anxiety and concern. While you should still consider what I have said, I suspect that after a goods nights sleep you will be yourself again. You are a survivor.
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