We all know that lawyers live in “Legal World” and accountants live in “Tax World” – but for business lawyers, we keep our eye on what’s going on in Tax World because it could have implications for our small business clients. Some of the rules can overlap, so I’m going to lay out for you how to tell the difference between what is a “legal” issue and what is a “tax” issue.
First of all, the two Worlds have their own separate sets of rules. This is why a small business needs a really good CPA to help them navigate Tax World and a really good small business lawyer to help them navigate Legal World. But when should you go to a lawyer and when should you go to an accountant? This article is to help you understand that Legal World and Tax World are different. As a small business owner, you need to understand how all the different rules factor into your decision-making – to see the full picture.
So let’s start with a few places that are obvious:
Tax World = all issues that relate to business income, expenses, and taxes (MONEY).
Legal World = all issues that relate to how business is conducted (BEHAVIOR).
Here are four of the most common business areas where the rules for Law and the rules for Tax exist side by side:
1) Business Formation – Every business is “born” in the law. Legal World is where it all starts. If it’s a sole proprietor, partnership, LLC, or Corporation, it all starts with the law. The law provides the definition and framework for each type of business. After a business is “born” then it will be taxed – so Tax World comes in after the fact.
However, it is smart for small business owners to consider what the tax implications will be before they choose the structure of their business. That is why business accountants may be consulted for a new business. But the legal documents that create the new business are governed by the law and must be created by someone who knows the law. That is why small business attorneys actually form the new business
2) Independent Contractors – When a small business hires an independent contractor, the law considers this to be governed by contract. That is why an Independent Contractor Agreement is so important. It creates the structure for the relationship. The laws and statutes don’t do that. Whatever rights and obligations there are, they need to be spelled out in a contract. For tax purposes, the independent contractor is responsible for their own business taxes – because they are considered an independent business. Makes sense right? It’s the whole “independent” thing. In order to track payments, the IRS requires the filing of a special form (called Form 1099). But the small business does not have anything to do with the independent contractor’s taxes.
3) Employees – When a small business hires an employee, the law completely steps in and provides all the rules and regulations. The law gives employees many rights and protections. That is why it is so important for small businesses to navigate this area of Legal World. When it comes to Tax World, small businesses withhold taxes from their employee’s paychecks and submit the money directly to the government. In addition, the small business pays its portion of the taxes. The tax procedures are more complicated for employees than for independent contractors, so many small businesses prefer to hire independent contractors. But be careful! Both the Legal World rules and the Tax World rules are very specific as to who can be an independent contractor and who has to be classified as an employee.
4) Business Ownership – We’ve already stated that a business is formed in the law, so it’s not surprising that business ownership has to be legally documented. Yes, business ownership is stated on tax forms, but those forms only serve as evidence. They can be challenged. Business ownership has to be established in the legal documents that are created when a business is formed. Once the legal documents state the business ownership, then it can be reported on tax forms. It’s the horse before the cart!
The interplay between Legal World and Tax World is important for small business owners to understand. These are just four of the areas where the law and tax rules overlap. There are many others. Small business owners need to understand the rules so it’s important to get good legal guidance and good tax guidance from experienced professionals.