Calling tax law “vast and complex” is an understatement. It’s also a reality that can lead to confusion when trying to interpret any and all related regulations. Just look at some of the acronyms: AMT, DPAD, NOL. It all reads like a bowl of alphabet soup — and makes about as much sense as one.
The biggest contributor to confusion about tax code is its fluid and always changing nature. A survey by Thomson Reuters on the
Knowing the lingo is crucial
Learning context is just as vital as learning the words of a new language. “Bare” and “bear” have identical pronunciations, yet the former is an adjective and the latter is, well, an animal.
Tax compliance works in a similar fashion. Sure, there are countless credits, deductions, and exemptions a company can capitalize on, but it’s important to understand when and how to apply them. Knowing which compliance matters are one-time deals and which ones have to be maintained consistently is essential to keeping surprises to a minimum for a young company.
It’s led me to discover more than a few tax balance surprises over the years. When it comes to tax law, it helps to approach it the same way you would learn a foreign language. Stick to these five steps when translating tax laws for your startup:
#1. Hire the best translator you can find
Engage a tax professional prior to formally establishing the legal entity for your company. Establishing the correct structure from the start can save a lot of heartache down the road.
For example, if you start off as an LLC, you’ll limit the potential for outside capital investment. Most investors prefer to invest in corporations, a bit of information that a seasoned tax specialist should be able to convey to a startup founder.
#2. Communicate with that professional prior to any major event
The tax specialist at a startup should be a consultant on any and all major moves. Whether it’s engaging in a new round of financing, taking your business across state lines, restructuring your company, or participating in an exit event, communicating with a tax professional before acting is key. It’ll ensure you’re in a better position to use tax minimization strategies prior to finalizing a transaction.
For example, a client of ours recently switched from an LLC to a C corporation to attract additional funding from outside investors. But, the owner was unaware that a company only has 3.5 months to file an LLC form once such a conversion is made. As a result, the IRS issued thousands of dollars in late filing penalties that caught our client off guard.
We were able to speak on the company’s behalf and get the penalties waived because it was an unintentional oversight and not a deliberate act of omission. The client came away with a greater respect for the IRS’ nuanced language and those who are fluent in it.
Engaging a tax professional knowledgeable in these types of transactions can yield a tax-free conversion and keep a company from burning critical cash on tax penalties.
#3. Take notes, and go back to them regularly
Tax law requires companies to maintain an accurate set of books and records. If your firm is ever audited, these will be the first things the IRS requests.
Ensuring that any resulting lower effective tax rate is achieved legitimately and not through compliance shortcuts is a top priority for the IRS. Only 6 percent of businesses currently file under corporate tax code, down from 17 percent in 1980.
If these records aren’t accurate and properly documented, it will be easy for an IRS auditor to make adjustments and assess additional taxes and harsher penalties.
#4. Be careful how you classify employees
Establish the status of all your employees immediately, if not sooner. The IRS is particularly sensitive to this because it can lead to billions of dollars in lost tax revenue.
Worker classification issues most frequently crop up when employees are incorrectly tagged as independent contractors. These issues can also occur when common law employees are categorized as statutory employees.
It should be noted that while employment audits are often initiated at the state level, the information is shared with the IRS. What may start as a manageable state audit can quickly become a federal case if something isn’t right.
#5. Conduct a state nexus study as the company grows into other markets
It’s important that your company properly files and pays taxes in all of the jurisdictions in which it operates.
With every company I work with, I proactively check to determine whether it’s in good standing in Delaware — where most companies incorporate — and whether its annual franchise taxes are paid and updated. I’ve found too many companies are unaware their responsibilities didn’t end with incorporation.
And be forewarned — this is something that interests more than the tax authorities. A potential buyer of your company will carefully scrutinize this as part of the due diligence process.
Clear up any compliance confusion
Many founders are new to business ownership and the complexities associated with keeping a company tax-compliant. For some, their only prior experience with taxes has been filing their annual personal tax returns using TurboTax or some other online tax software.
That just makes dealing with the laundry list of potential tax issues and the constant updating of regulations that much more difficult. Tax compliance fluency won’t come overnight for a startup. But the sooner a company’s founder learns an appreciation for the language — and the role those fluent in it can play in applying it — the less likely the company is of speaking, or filing, out of turn.
Can you or anyone in your company speak conversational tax compliance? If not, get to it.