Business Partners and Business Taxes

Posted on July 7, 2014 in Business Partners

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With two brothers, I was raised that I had to share. “Share and share alike,” I was told, even though at age 10, I really wanted to hoard the last few Ring-Dings for myself. When entrepreneurs get involved in business partnerships, they tend to be sharers, wanting the good for all. But when a giver meets a taker, you have a personality conflict . . . and a potentially serious tax problem on your hands. Here’s how the unpleasant scenario can play out (I’ve seen it happen.):

Anna and Barb went into business together as 50/50 partners. When business was tight, Barb often needed more than her 50 percent share. Anna had more personal financial resources and, out of friendship, she let Barb have what she needed–after all, how could Anna say, “No, Barb, you may not have the money you need to make your mortgage/car/insurance payment this month”? What kind of person would I be if I let a friend lose her house in foreclosure?”

Anna had a rude awakening when time came to file their taxes. As 50/50 partners, Anna and Barb received equal credit for the income that the business earned. However, they were also equally responsible for paying taxes on their 50 percent share of the business income–even though Barb took more cash out of the business. The net result for Anna was that she had to pay taxes on money she never actually received.

Luckily, these two entrepreneurs didn’t need to learn that lesson twice. Anna and Barb got squared away and made Anna “whole.” Barb got professional help to get a handle on her personal budget. The company hired a bookkeeper to play money gatekeeper and write the checks to the owners for their draw. Both owners agreed not to use company bankcards to withdraw cash for their personal use.

Other owners I’ve encountered had a hard time letting that lesson sink in. Partly, this is why:

  • Financial illiteracy. They didn’t truly understand the impact their actions had on the financial and tax situation for the business (and, ultimately, themselves).
  • No referee. It can be tough to tell a close associate no, especially when the need is dire and you don’t want to face having to shut down the business or kick someone out. Agreeing to abide by what a third party decrees can be an easier way to ensure that fairness prevails.
  • No proactive planning. By addressing the previous year’s taxes after the first of the year (e.g., 2008 taxes after January 1, 2009), they have left themselves no time to rectify any mistakes or problems for tax year 2008. The time to keep an eye on potential tax problems for 2008 is in 2008. With the right accountants, they could have monitored their tax situation proactively to see if any shifts in their planning were necessary.

Check in with me later this month when I discuss how to find the accountant who’s right for your business.

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