The Winning Game Plan For Your Home-Based Business
By Greg Crabtree, CPA
Whether your home-based business is by choice or necessity, you need
to focus on three keys to have a winning game plan:
Define what success looks like
Choose simplicity for organization structure
Count the cost by paying vendors and taxes before you take money out
of the business
As the owner, you get to make the initial decisions on how things
will work. However, you have to understand the IRS defines tax
implications and �business physics� will define your economic
outcome so choose your course wisely!
Passion over profit
� This is the entrepreneur that loves the idea of a product or
service they have personally experienced, and want to share it with
all the people they know. It is great to have passion, but you will
need profits to make the business sustainable unless you like
working for free and have other sources of funds to keep plowing
into the business.
The IRS may have something to say about whether losses will be
deductible if you fail to meet the general rule of profitability
(two-out-of-five years). It is expensive to argue your point with
the IRS if you do not meet the guidelines, so your argument had
better be valid and worth it!
Profit to support family
� With current unemployment rates, there are record numbers of home
businesses being formed. While it does provide a great opportunity
to be your own boss, you still need to treat it like any business
startup and follow sound business principles. The early stage will
be to make a profit to replace your wages.
The profits you hope to live on will sometimes be in conflict with
other expenses that the business needs to pay. This will add to the
complexity of managing cash flows as you and the business compete
for use of the same dollar. As you gain stability and success, you
can make your market wage plus make a profit on top of that.
Tax write-off business
� This is the business I recommend staying away from. You probably
heard someone on the radio telling you how you could deduct these
expenses to not pay taxes. Repeat after me, �to spend a dollar to
save 15- to 35-cents in tax is dumb!� Deduct the legitimate business
expenses you spend to produce your income, but you will never build
wealth (without cheating) unless you have taxable income AND spend
less than your after tax income to live on. I know this is not what
you want to hear, but this is how my wealthy clients did it and they
can sleep well at night not fearing an audit.
The following are some guidelines for home-based businesses to use
when you are consulting with your tax advisor. There are many other
issues to consider in choosing your entity, but these are usually at
the top of our list.
� This is by far the simplest form of doing business. The activity
is reported on your personal tax return and does not require a
separate tax return to be filed. Since �you� are the business, it
does not afford you legal liability protection that a corporation or
limited liability company (LLC) does, but many of those liability
fears can either be insured against or are so remote that it�s not
worth the additional cost.
Limited liability company
� Should you need some liability protection or you have more than
one owner, this should be your next option to consider. Most home
businesses do not have employees or may use contractors for spot
help. An LLC taxes you just like a sole proprietorship by having you
pay income tax and self-employment tax on your profits from the
business (whether you take the money out or not).
As long as your profits are less than a market-based wage for you,
it helps you not have to deal with the cost of payroll tax returns.
The downside is many LLC owners and sole proprietors build up
taxes-due before they realize it. Since nothing is being withheld
from draws they take out to live on, they often have a bad surprise
come tax day. The legal documents for an LLC are simple if you have
one owner, but they get much more complex once you add an owner that
is not a spouse.
� The main complexity with an S-corporation is the requirement by
the IRS for the owners who work in the business to make a market
based wage. The IRS does not make you take a wage if there are no
profits, but they do not want you to avoid payroll taxes by taking
low to no wages and take your profits out as distributions.
The data the IRS needs to find if you are doing this is all in the
S-corporation tax return, the only reason they have not found you
yet is their resources are limited to how many companies they can
crack down on each year. Rest assured, they are adding resources and
more will be paying back taxes and penalties for doing this wrong
(including the tax preparers who told you to do it!).
Most home-based business owners hate accounting, but this is
especially the kind of business wherein you need to keep your hand
on the cash. The smaller you are, the less likely you have any room
in your costs to pay an outside bookkeeper. QuickBooks has made many
entrepreneurs functional (i.e. �good enough�) in accounting. Take a
class in QuickBooks and take charge of your numbers to avoid
surprises. As you get bigger, then you can transition the role to a
part-time outside bookkeeper when it makes financial sense.
You need to know the 4-forces of cash flow to stay out of trouble
managing your cash. If you are not profitable, cash flow is just a
calculation of days until death. Fix profitability first, then deal
with the 4-forces:
� Set aside your tax liability as you go. If you are taking draws as
a sole proprietor or an LLC partner, you are setting aside
self-employment taxes each time you take a draw. Once a quarter, you
are setting aside income taxes and paying in based on IRS rules.
Get out of debt
� If you borrowed money to start your business, pay it off as soon
as you can.
Core capital target
� You need to have at least two-months of operating expenses in cash
with nothing in debt to be a fully capitalized business.
� Once you have paid my taxes, paid off debt and built your core
capital target, you can now take a profit distribution as the reward
of your business success.
These principles apply to all businesses, big or small and they will
help you run a successful business!
Greg Crabtree has worked in the financial industry for more than 30
years and founded Crabtree, Rowe & Berger, a CPA firm dedicated to
helping entrepreneurs build the economic engine of their business.
He is an author and leads the business consulting team, helping
clients align their financial goals with their profit model and
their core business values.