As an entrepreneur it is never too soon to employ smart tax planning strategies to minimize tax risks and cash outflows.
Getting an emerging growth company up and running is one of the most exciting and stressful times any entrepreneur can face. It can involve testing the viability of the business model, acquiring paying customers, hiring and managing a new staff, testing the viability of new products or services, finding space for the business and of course starting to raise money.
It’s important to add another task to this list: Talk to a qualified CPA about tax requirements for your business, so you don’t run into any unpleasant and potentially costly surprises down the road.
Let’s look at a scenario one start-up recently experienced. Carl was a bright and energetic entrepreneur in NYC with a hot SaaS (software-as-service) business model. He was so busy developing; marketing and selling his product he didn’t have time for much of anything else.
All of a sudden the business took off, and revenue started pouring in. Carl wasn’t sure if he was lucky, or if his upfront work setting up the business plan was paying off handsomely. Since he had lots of expenses, Carl did not feel he had to worry about taxes.
Unfortunately Carl was unaware that his SaaS service is treated as the sale of tangible property in New York State, and therefore subject to sales tax. He simply failed to collect NYS sales tax on the SaaS revenue he collected from his NY State customers.
Much to his chagrin Carl later learned that NY state sales tax falls within the category of a “trust fund tax” which means companies are responsible for collecting sales tax on behalf of a state and/or local tax jurisdictions.
It also means:
- The corporation is responsible for paying all appropriate sales tax to the state, even if they are not collected from customers.
- If the corporation has inadequate funds to pay the sales tax liability, the “responsible person” (the founder in this case) must pay the sales tax liability out of his/her personal funds.
- The corporate structure of the business offers no protection to the founder from this liability.
Here are some “smart moves” for entrepreneurs in terms how to avoid potentially scary tax liability scenarios:
- Don’t pay other people’s taxes because you neglected to withhold payroll taxes from employees, or failed to collect sales tax from customers.
- Avoid the tax trap of mislabeling your employees as “independent contractors” and have to spend time and money on heavy fines and penalties; or perhaps fighting against tax authorities over labor, employment and tax laws. The IRS offers specific guidelines on this issue.
- Don’t pay tax twice on the same income by ignoring your physical presence in non-US countries and ignoring foreign tax credits.
- Steer clear of unlimited future risks by failing to file federal, state and local tax returns in a timely manner.
- Don’t raise red flags with the IRS and state tax authorities by mixing your business and personal accounts, and failing to save receipts / documenting the specific business purpose of expenditures.
Also work to avoid the following tax-related penalties:
- Trust Fund Tax Recovery Penalties can equal 100% of the past sales tax due, and can apply to federal income, social security or Medicare taxes not withheld or deposited.
- There can be an automatic assessment of punitive damages amounting to $10,000 per form penalty for each late filing or failure to disclose forms for foreign corporations or foreign partners.
- Penalty of up to 40% of underpayment of tax for gross valuation misstatement of transfer pricing.
- Severe penalties for willful failure to disclose foreign financial accounts equal to the greater of 50% of the account, or $100k/year and possibly criminal penalties may apply.
- $50k preemptive assessment from the New York State for mislabeling employees as independent contractors.
- In 2012, the IRS assessed 37 million penalties against taxpayers
See some grisly tax penalty and interest specifics in the IRS Penalty Handbook.
You’ll quickly see for yourself that focusing on tax requirements (ahead of time) with your CPA will be time and money well spent.
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.