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In Brief:
- Startups often make costly mistakes when accounting is deprioritized.
- Founders should understand cash flow, tax rules and entity structures.
- LLCs and multi-entity structures are rising due to pass-through tax benefits.
- CPAs advise revisiting business structure as the company grows and evolves.
Starting a business can be both exciting and daunting, and while the potential upside can seem promising, the path for a startup may be packed with pitfalls, especially those that forego strategic advice from tax professionals.
While streamlined startups are usually efficient and adaptable, they often leave their founders juggling multiple roles, which can lead to mistakes. “Entrepreneurs often find themselves managing multiple aspects of their business, from operations and marketing to finance and HR,” says Shashi Singal, a tax partner at Anchin in Uniondale. “In the midst of this multitasking, it’s common for accounting to take a back seat to other priorities, and for occasional errors and misconceptions to happen.”
Learning the basics of business accounting beforehand can help founders avoid playing catch-up later, according to Singal, who suggests becoming familiar with some key concepts, including understanding the differences between profit and cash flow, knowing what counts toward book income and what is considered taxable income, and finding appropriate tax software order to establish accurate and efficient record-keeping. “While it may seem tedious at first, setting things up correctly from the beginning can save entrepreneurs the hassle and cost of fixing and cleaning up their records later,” she says.
Startups that fall behind in record-keeping can suffer in other areas of their business. “If a business has inadequate accounting staff or software which cannot provide the reporting needed, it can negatively impact the entrepreneur’s ability to accurately budget, forecast and understand the financial performance of the business,” says Paul Becht, principal at Baker Tilly in Uniondale. “A strong accounting department possessing the right technology with the help from an experienced and robust outside accounting firm can help the business owner properly convey the company’s financial performance to banks, investors and other interested third parties.”
Recently, more owners have decoupled components of their business for more accounting leverage. “Business owners are increasingly creating multi-entity structures to separate operations, real estate and other activities in order to take advantage of pass-through entity credits and other tax benefits,” says Brittany Mayoka, CPA and chief operating officer at Harbor Accounting Group in Syosset.
This is due to the provisions of the 2017 Tax Cuts and Jobs Act being made permanent earlier this year, as well as New York State’s tax code revisions that offer alternatives to more traditional state and local tax deductions. “One of the most notable changes was the introduction of the 20-percent qualified business income deduction (QBID) for eligible pass-through entities,” Mayoka says. “At the state level, New York implemented the Pass-Through Entity Tax (PTET) in 2021, which allowed for a state and local tax (SALT) deduction work-around.”
The qualified business income deduction offers tax benefits to owners of limited liability companies (LLCs), specifically partnerships, which have become increasingly popular designations for startups. “Over the past decade, the use of the limited liability company structure has grown substantially,” Becht says. “This entity type provides tax flexibility, as business owners can elect to be taxed as a sole proprietor, partnership or corporation. At the same time, LLCs offer legal protection with less complexity than incorporated entities.”
However, forming a partnership may not always be the best choice for entrepreneurs. “C corporations may be an advantageous option for startup founders seeking to benefit from qualified small business stock provisions, which offer substantial tax savings on gains from the sale of eligible stock,” Singal suggests. But several other factors may influence a startup’s incorporation strategy. “Despite the lower corporate tax rate, many small businesses continue to favor pass-through structures to avoid double taxation and reduce administrative complexity,” she says.
Given the often complex parts of a small business, deciding which type of structure is best involves detailed planning. “Ultimately, the decision on how to structure a business is shaped by a complex mix of tax rates, deductions and long-term strategic goals,” says Singal. “Business owners must carefully evaluate these factors to select the most tax-efficient structure for their unique circumstances.”
While carefully curated data can provide a clearer choice for startup founders that are deciding on a structure, the optimal structure for any business may change with time. “I always recommend running comparative tax models for each entity type before making a decision,” Mayoka says. “The analysis often reveals that a structure that seems simpler may actually cost more in the long run. Entity choice isn’t a one-time decision—it should be revisited as the business evolves.”
Accountants can often provide valuable advice to startups, but maintaining a close relationship with a trusted CPA has helped established businesses optimize their accounting practices as they expand as well. “A few years ago, an entrepreneur operating a successful retail and distribution business wanted to branch out into real estate investment,” says Becht. “Due to the real estate venture being an entirely different line of business, it required a distinct accounting approach, as revenue would be generated from leases rather than product sales.”
The strategy paid off, according to Becht. “Years later, the client now owns several LLCs structured to efficiently hold real estate assets and maximize favorable tax treatment.”
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JARED SCOT, LIBN CONTRIBUTING WRITER
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