Some General Rules for Closely-Held Businesses

I don’t know about you but I’m tired of hearing “It depends” to almost any business question. Early in my career, when I would ask someone a tax question, I’d get an answer. Now the typical response I get to a tax question is, “I would approach it this way…” That’s not an answer!

The lawyers are worst about this. I know our legal system has gotten us to the point where there is virtually no certainty as to outcome or amount. But can’t someone just tell me what the rules are supposed to be, generally speaking? I know the facts and circumstances can change the general rules but at least give me the basics. Maybe that’s why America has developed a legal system that is so expensive and so uncertain of outcome that the best thing to do with our legal system is avoid it. But I digress.

For closely-held businesses, there are, I believe, some best practices that can be stated. Yes, circumstances may change but there are some general rules that are true for most cases.

 

Choice of Entity

Most small businesses should be a pass-through entity. That is, avoid double taxation by being a proprietorship, partnership, limited liability company or an S Corporation. The best choice is almost always an LLC. An LLC provides limited liability to the owners and is less expensive to administer when compared to a corporation.

Any pass-through entity pays no taxes as the taxes are all paid at the individual owner level. When individual owners’ share of income gets to be over $100,000, it is wise to think about electing to be taxed as an S Corporation. This is a strategy for saving payroll taxes. Yes, there are reasons to be a C Corporation and there are times when an S Corporation makes no sense. But generally speaking, being a LLC for legal purposes and being taxed as an S Corporation is the best situation for most small businesses.

Domicile

If you’re based in Washington State, the legal entity should be a Washington State entity. I have experience with companies that incorporate in Delaware because Delaware has the best laws for publicly-traded companies. Perhaps, but your company is never going to be a publicly-traded company. And if you sell your small company to a big company, it will be an asset sale and the form of your business is unlikely to matter.

Meanwhile, if you incorporate in Delaware you’ll have a nasty franchise tax to pay along with all the usual Washington State taxes to pay. Plus a bunch of administrative headaches. It just doesn’t make sense.

Accounting System

Most closely-held businesses should use QuickBooks. It is inexpensive, powerful and easy to get staff that knows the software. Many business owners want to use industry-specific software. Or they think their business is too big for QuickBooks. This is almost always misguided and works out poorly.

If QuickBooks isn’t doing what it needs to for your business, there is usually an easy solution. First, get someone knowledgeable to set up QuickBooks for your circumstances. For example, QuickBooks is terrific for job costing but only if it is set up correctly. Second, get an add-on if it really is a QuickBooks weakness. For example, QuickBooks’ inventory system isn’t always up to the task. But adding on Fishbowl or ACCTivate will handle any inventory challenges.

If you want to have a cloud-based accounting system, I agree that’s a good idea. But don’t use QuickBooks Online, which is inferior to the other QuickBooks products. Instead, get a cloud-hosting company to host your copy of QuickBooks, preferably QuickBooks Enterprise, their top offering. The best hosting service for this purpose is Right Networks.

Cash vs. Accrual

For running your business, use the accrual basis of accounting. It is the only way to measure profitability accurately. For paying taxes, with rare exception, use the cash basis of accounting. That goes for income and state excise taxes.

There you have my unequivocal suggestions for closely-held businesses. Isn’t that better than “It Depends?”

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