From Self-Employed to Small Business Owner
By Mike D’Avolio
Growing your business is both rewarding and stressful: you can see your dream slowly coming to fruition, but your growing organization also comes with more processes, controls and people to manage. Too much growth too quickly can create risks to the business. Here are tips that may help you overcome those hurdles.
Transitioning into leader
One of the biggest challenges for entrepreneurs is learning to evolve from a doer of all tasks to a manager of employees. Delegating and trusting your team to manage day-to-day tasks is vital. Once you recruit good people and train them, hold them accountable for the work. This will free you up to think strategically about your business.
If you don’t possess these skills, consider attending training classes and networking with experienced business owners and learn from them. You can also think about appointing someone else to act as managing director or chairman.
Hiring an employee v. independent contractor
It may be tempting to classify an employee as an independent contractor because of the cost savings, but it’s not as straightforward. There are strict rules surrounding the proper classification of a worker and steep penalties for failure to apply the law correctly. Some businesses misclassify an estimated 10-60 percent of their workers as independent contractors and nearly 30 percent of firms misclassify contractors.
If you answer “yes” to any of the following questions, you’re likely hiring a W-2 employee and not a 1099 independent contractor: (Use this infographic to help you distinguish between the two.)
- Will the work be performed on company premises?
- Will the individual work only for you?
- Will you provide tools and training for your worker?
- Do you control the hours the person works?
For employees, you need to withhold taxes, pay payroll taxes and file Form W-2. This form is used to report wages and is filed with the employee and the Social Security Administration. For independent contractors, such as attorneys and accountants, no withholding is required, but you need to provide the contractor and IRS with Form 1099-Miscellaneous. This form is required when you make payments of $600 or more for services performed.
What to do with that profit
Finally turning a profit is a huge milestone for entrepreneurs; however, determining whether to invest, spend or save extra money generated by the business can be difficult and requires some judgment. You need to balance the needs of the business, such as investing in new growth opportunities, investing in employee benefits to retain top talent and saving the money for a rainy day. You can prioritize these options based on need (including a combination) or seek the advice of an accountant or small business consultant.
Investing in your business: Growing your business to support sales, marketing and product development will require investments in people, technology, equipment and supplies. If the growth is seen to be sustainable and not temporary, you should run some projections to make sure there is a good return on investment (ROI). Before spending a ton of money, start small and run some experiments to test out your theories.
Retirement plans: There are a variety of retirement plans available to small businesses, such as a SEP, SIMPLE IRA, 401(k) and Qualified Plans. Contributions made by the owner for themselves and for employees can be significant tax deductions and the earnings on the contributions grow tax free until the money is distributed. Some of these plans allow you to make contributions up until the due date of the tax return. The small business owner is also allowed a tax credit equal to 50 percent of the first $1,000 incurred in starting up a plan.
Healthcare premiums: In general, you’ll be able to deduct healthcare premiums for yourself, your family and employees. Plus, there is a small business health care credit available to employers who pay more than half the cost of health insurance premiums of the employee.
Do nothing: You may determine that you want to hold the extra cash in case you’re in a pinch down the road or a better opportunity presents itself.
Choosing the right business entity
As your company starts to grow into a larger, more complex organization, there are several options when deciding what type of entity to create for your business. The following provides a very high-level overview of the different entity types. In deciding how best to structure your company, you should consult an attorney or CPA experienced in this area.
Sole Proprietorship: The simplest and most common business structure with one owner. The business is unincorporated and there is no legal distinction between the business and the owner.
Limited Liability Company (LLC): A hybrid legal structure that provides a way to limit the company’s liability, while allowing many of the benefits of the underlying taxable organization (sole proprietorship, partnership or corporation).
Partnership: An agreement of two or more people to go into business together. For tax purposes, a partnership is not subject to tax, but a conduit to distribute all income and expenses to the partners.
S corporation: An entity that is incorporated, but then makes a special election with the IRS. This election helps avoid the problem of double taxation that affects C corporations and causes the S corporation to act much like a partnership, in that the profits are passed through to the shareholder owners.
C corporation: An independent legal entity owned by shareholders. Owners of a corporation only pay taxes on the salary, bonuses, and dividends paid to them, with the remaining corporate profit taxable at the corporate tax rate (which is usually lower than the personal income tax rate).
You may evaluate different ways to grow your business, such as opening another location, diversifying or targeting other markets, and expanding globally or on the internet. Determine whether the opportunity adequately enhances company strength and results in a compelling customer value proposition. Don’t say yes to everything and stay within your wheelhouse – know when to say “No.”
Best wishes on the journey!
Mike D’Avolio, CPA, is senior tax analyst with the Intuit ProConnect Group. D’Avolio has been a small-business tax expert for more than 20 years and serves as the primary liaison with the Internal Revenue Service for tax law interpretation matters, manages all technical tax information, and supports tax development and other groups by providing them with current tax law developments, analysis of tax legislation and in-depth product testing.