A common question from business owners is, how can a small business avoid the crush of taxes and regulations while still staying within the confines of the law?
Based on my experiences with business owners, I’ve identified three things that cause the most stress for those owners. Thus, the 3 things a business owner should avoid doing if they want to avoid hassle.
ONE: Don’t Hire Employees (Without Knowing What You’re Getting Into)
One time I was presenting to a group of entrepreneurs at an event sponsored by the local “economic development” organization, and I said that rushing to hire employees is the single worst thing a new business can do. Afterwards I got called on the carpet by the organizers because the organization is all about encouraging businesses to hire employees, and then I came along and told entrepreneurs to be wary of hiring employees.
Since then, I’ve modified my stance a little bit. I now tell business owners the following: don’t hire employees unless you know what you’re getting into and you can 1) actually pay the payroll taxes, and 2) can handle the mountain of paperwork and obligations that comes with having employees.
Many, many businesses I’ve worked with have hired employees without thinking through the costs. And then they either can’t afford to pay the payroll taxes, or the owner gets resentful of the fact that they pay so much in payroll taxes. Or, the owner hires employees without understanding the regulatory burden (941s, W-2s, workers’ comp insurance, etc.).
TWO: Don’t Operate in Multiple States
This is especially true if you’re a service provider. I’ve had service-provider clients who are based in Iowa but who cross state borders to provide their service. The owners of these businesses are always stunned when I tell them they have tax and regulatory obligations in any state they set foot in.
Is it a pain in the butt? YES! But “it is what it is.” If you operate in multiple states, you need to know what the tax and regulatory rules of those states are. If the regulatory burden bothers you … then set up your affairs so you’re not crossing state borders.
THREE: Don’t Incorporate Too Soon
I see this all the time. Someone starts a business — it may just be a side business — and they immediately create an S-corp. Usually they do this because of something they read, or something a friend told them. Oftentimes they do this without ever asking me what I think.
Then, once the corporation is set up they get angry because 1) there’s payroll to deal with, 2) they have to file a separate tax return for their corporation, thus increasing the amount of accounting fees they have to pay, and 3) unless they’re turning a large enough profit to pay themselves a reasonable salary, they find that the potential savings on FICA/self-employment tax aren’t large enough to make it worthwhile.
Here’s an example. I once had a client start an S-corp for a business with $5,000 of gross income. His business expenses other than salary totaled about $750. He then paid himself a salary of around $4,000. (At least he actually paid himself a salary!) But there was no FICA savings here. In fact this was a money loser, because of the extra professional fees and headaches. The client had started the S-corp on the advice of his attorney and based on things he had read and things a “cousin in Las Vegas who has a drywall business” had told him. (Notice: he never once asked ME what I thought or even bothered telling me what he was up to until after he did it.)
When I explained to him that the S-corp wouldn’t save him money until his income was high enough to support a full-time salary, he disbanded the corporation and decided to just have his business be a sole proprietorship because he didn’t anticipate his revenue increasing in the coming years.
Moral of the Story
If you plan on having a “real” business (not a side business), you’re going to have to come to terms with the fact that there’s a tax and regulatory burden, and that there’s no magic-wand cure to make all that “stuff” go away. But as outlined here, there are some things you can do to keep some of the regulatory headaches away.
One big caution, especially with the first 2 items on the list: by doing these things, you avoid regulatory burdens but you might also be limiting your potential for growth. You might need employees in order to take on more business and bring in more revenue. You might have customers in other states who desire your service and who could be a revenue stream for you, even if you have regulatory burdens in crossing state borders.
Most of the business owners I encounter are “Joe the Window Washer” types. They want to run their business and be left alone. There’s nothing wrong with that, but you have to understand the potential limitations on income when you go that route.
As with everything in business ownership, there are no easy answers and there’s certainly no “magic-wand” solutions.