inDinero CEO Jessica Mah shares 6 of her top tax and accounting tips for startups in 2020
It’s tax time. But instead of thinking about taxes as a headache, you should consider them as an opportunity to improve the bottom line at your company, according to inDinero CEO Jessica Mah.
“Taxes are such a great opportunity lever, it can be a strategic advantage for you and your business,” Mah tells Ali at Rho. “Taxes are so critical to get right, there is so much money to be saved.”
Mah founded inDinero — a 100 employee accounting and tax firm for startups and SMBs — in 2009, as a student studying computer science at Berkeley. She’s spent the past 10 years deep in the weeds of corporate accounting building the company: “We’ve done accounting for companies like Pinterest, Slack, Doordash, and many, many others,” she says.
Here are six of Mah’s top tips to improve your tax planning strategy in 2020.
For early stage businesses, Mah’s top piece of advice is for founders to reconsider their approach to business deductions.
“If you’re still a tiny startup, you can’t really do a whole lot with tax planning as a company, unfortunately,” she says. “The best thing for those early entrepreneurs to do is just to write off more expenses.”
For a business expense to be deductible from federal taxes it must be both “ordinary and necessary,” according to the IRS. The IRS defines these terms clearly: “An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
Examples of commonly deducted business expenses include employee payroll, rent paid for the business’ office space, interest paid on business loans, and insurance. But Mah says many founders overlook some purchases which can legally be deducted as an expense for their business.
“If you’re an entrepreneur, the vast majority of your life revolves around your business,” she says, especially in the earliest years of a company. “Most of your meals and travel that you have as an entrepreneur are probably business related. That trip you made to a conference to expand your business? Absolutely write that off and don’t feel guilty about expensing true business expenses.”
As a resource, check out inDinero’s list of 92 expenses that can be deducted.
Instead of paying yourself a high salary, and using that personal income (on which you’ve already paid income taxes) to pay for things like meals, travel, conferences, and materials, Mah advises taking a lower salary and exercising more diligence in tracking and deducting expenses through the business entity.
“Pay yourself less, and expense more, and that will net cost the business less money,” she says. And, a smaller salary could likely result in lower personal income taxes.
Once the business has grown beyond an early stage company, it’s time to begin thinking about structural tax planning. The biggest mistake established businesses make is to not plan far enough in advance, according to Mah.
“If you’re a mid-stage company, you should be doing 5-year tax planning,” she says.
If your company is doing $5 million in revenue this year, but you expect it to be doing $50 million in revenue in five years, it’s important to begin laying the foundation for effective tax planning strategies today. “You have to extrapolate it out,” she explains. “The problem is it takes years to get infrastructure set up.”
The first step to preparing a tax plan is exploring your options.
“What I recommend if you’re the CEO of a mid-sized business is to call a dozen tax attorneys from all around the world, and really educate yourself on how they think about tax planning,” Mah says. “Call up tax attorneys that represent ultra high net worth clients. They will give you legal, acceptable strategies that have been used many times before by other companies.”
Once you’ve done preliminary research, consult your accountant and lawyer, and begin to put together a plan for the next five years.
The processes your employees use for daily expenses can have an impact on the accuracy of your company’s accounting. (Or, just give your bookkeeper a headache.) One tip Mah suggests is avoiding passing a single corporate card around to all of your employees.
“The biggest problem is that companies put everything on one credit card. You can’t do any great accounting, or financial planning, or modeling if you do that, because marketing has their own expenses, and engineering has their own expenses, and the sales team and the HR team, they all have their own stuff,” she explains. “If it’s all on one credit card, you don’t know what is going on. You just see 10 meals expensed here, and 5 pieces of software expensed here. It’s really hard to keep things organized that way.”
Instead, she recommends breaking out spending on corporate cards by teams. “Each department gets their own credit card, everyone there reviews it every month, and makes sure there are no wasted expenses,” she says. She also recommends canceling all of your credit cards once a year. “That’s because people will set up software expenses, and then forget to cancel them. So it’s better to cancel all of your credit cards and start from scratch once a year.”
If you’re interested in breaking out expenses by team, check out the Rho Card.
If you’re still an early stage startup, bringing on a full time CFO to handle financial planning and strategy is likely unnecessary, Mah says.
“You don’t need a CFO when you’re $3 million in revenue,” she says. “There’s no value to be had when you’re too small.”
The value add of a finance team — an accountant, bookkeeper, controller and CFO — grows as the needs of the company do.
“If it’s just you and your business partner, the way you do your accounting is to look at your bank balance and just make sure it’s not going down every month,” she says with a laugh. “Once you have two or three employees, that’s when you should probably get operations in order.”
At that point, upgrade to using a service like inDinero or another third party firm to do your taxes and accounting, Mah says, in order to access expertise you may be lacking. As Pilot points out, properly applying for programs like the Research and Development Tax Credit alone can save your company $250,000 in one fell swoop. Accounting and part time CFO services are also experienced in identifying the right talent, which you might not be, Mah says: “No one should hire their own accountant, because you don’t know how to hire your own accountant.”
When you are ready to bring those functions in-house, AirCFO founder Justin McLoughlin suggests hiring a controller first, and allowing that person to build their own team of accountants and bookkeepers. McLoughlin offers more advice on when to hire a controller — and how much it will cost — on Routable’s blog.
The primary goal is to understand your company’s financial trajectory, Mah says, whether that’s a job performed by the co-founders, a part time service, or a full time CFO.
“The essential part is that you know, month to month, what the key levers are that you have to press on for your business in order to have a great next quarter,” Mah says. “But once your numbers are big enough, and an [in-house finance team] can optimize your financials by even 2 or 5 percent, that really adds up. And it more than pays for whatever you’re paying for the CFO.”
Metrics matter. But where do you start, and what is most important to track? Mah says paying attention to three metrics will give you the clearest picture of your company’s financial health: Recurring revenue, gross margin and free cash flow.
“Notice that I did not say EBITDA or net income,” she says. “With EBITDA, you’re not counting so many expenses, like your interest and your taxes. EBITDA doesn’t reward you for tax savings. It doesn’t reward you for optimizing your cost of capital. And net income doesn’t account for how good you are at getting customers to pre-pay, or if you’re able to debt finance your business in a creative way, or postpone vendor payments or other creative things.”
“Free cash flow is really the only reliable measure,” Mah adds.
“People should get excited about taxes,” Mah says. “Look forward to it. Stop thinking about taxes as a chore. If you embrace it, if you really invest time effort and energy into tax savings strategies, you’re going to save tens of millions of dollars over the course of your career.”
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