A Short Guide to Accounting For Startups

1.    Choosing the correct legal entity

Entrepreneurs face a myriad of choices when deciding what entity type they choose. The most common being sole proprietor, partnership, LLC, or Corporation. What entity type chosen is largely based upon the objectives of the company. If the objective is to raise funding through angels or venture capital, a corporation incorporated in Delaware is the most common entity choice. Reasons for popularity of a Delaware corporation are centered on its court system and corporate laws which are almost universally accepted by public companies and private companies with visions to scale.  If the objective is to take on partners both managing and silent, then an LLC or LLP will provide both the structure and limited liability a company needs. From a tax perspective, partners or “members” of an LLC, receive K1 forms at the end of the tax year that reflects partner or member shares of company profits, losses, distributions, and other tax adjustments. The K1 forms are needed by the partners and members to file their own personal or company taxes. For this reason, if startups are planning to raise money from external investors – the LLC/LLP entity may not be efficient as investors would have to wait for startups to file their taxes before they can file their own.

2.    Saving receipts

Since businesses are taxed on “profits” (Revenues – Expenses), instead of “Revenue,” it is essential to have expenses documented. Higher profits mean higher taxes. Having a bookkeeping system that captures money spent for business meals, travel, materials supplies and other expenses is essential. Today entrepreneurs can use smartphone cameras and apps to save their receipts. The IRS accepts digital receipts as proof under IRS Rev. Proc. 97-22.  Startups also have many choices in using cloud based accounting systems such as Wave Accounting, Quickbooks, Xero, Freshbooks, and many more that help with expense tracking as well as other features. In short, saving receipts can save a startup money that would otherwise go towards paying taxes.

3.    Paying and filing taxes on time

April 15th is tax day, however this due date applies mainly towards individuals and not necessarily all businesses. Calendar year Partnerships and LLC’s also adhere to the April 15th deadline, however corporations don’t. Calendar year Corporate tax returns are due on March 15th. Some companies elect to have fiscal years (years which are not calendar years i.e. July 1st – June 30th). These entities will file taxes either two and a half months after their fiscal year end date if they are a corporation, or three and a half months after their fiscal year-end if they are a partnership or LLC.

It is also important to be aware of quarterly tax due dates. Once your business completes its first year of business, it is expected to pay taxes quarterly. Calendar year businesses quarterly tax due dates are usually Jan 15th, April 15th, June 15th, and September 15th.

Finally, it is important to be aware of State and City taxes that your business may be subject to. Most states follow Federal tax due dates, however it’s best to be aware of different rules and due dates depending on where your company is located. States also often subject businesses to sales tax if they sell goods in their territory.

4.    Understanding the difference between an employee and a contractor

For startups trying to grow, where every dollar is a premium, dealing with payrol  taxes can be an unexpected hassle. Hiring contractors seems like an easy way out, however it can come back to hurt in the form of back payroll taxes if those contractors were more like employees than independent contractors. The IRS generally uses the following factors to determine whether contractors are actually employees:

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue, and is the work performed a key aspect of the business?

More information on this subject can be found here.

5.  Working with a great accountant and attorney

With the internet, more and more information can be found in blog posts just like this, and Google searches.

However there is no substitute for professional advice tailored to each person and a startup’s circumstances from a Certified Public Accountant (CPA) and an attorney. CPA’s and Attorneys are licensed to practice by their State and can provide information that is unique to localities and cities.

Have more questions about accounting for your small business? Let us know in the comments!