By David Ward
For any court reporter, starting up a firm can end up being more than a full-time job.
In addition to actually recruiting clients and scheduling and handling what hopefully is a steady stream of depositions and transcripts, there’s also the daunting tasks of marketing your business, hiring staff if needed, lining up freelancers willing to step up and take overflow work in a pinch, and in general making sure the checks are coming in and expenses are getting paid.
It’s no wonder many end up putting off the big step of formally incorporating their business for as long as possible.
But any accountant or financial planner worth his or her salt will recommend that decision be made sooner rather than later — and how that’s done can have huge repercussions not only on the reporter’s tax bill, but also how well-positioned the firm in the future for a possible merger or sale in the future.
In general, the consensus seems to be that once a reporter begins generating more than part-time cash flow, they need to start thinking about incorporating — and that decision usually comes down to a choice between either an S-Corporation or an LLC (Limited Liability Corporation).
Phil Liberatore, a certified public accountant based in La Mirada, Calif., who has worked with hundreds of court reporters during the past 30 years, said: “Generally I recommend the S-Corp because it’s a lot cleaner — and even if they have an LLC, I get them taxed as an S-Corp because it’s more favorable for tax purposes.” Liberatore says court reporters making less than $75,000 annually can probably still comfortably operate as an independent contractor and pay their taxes under Schedule C as a sole proprietorship. “Definitely over $75,000 I would strongly encourage an S-Corp. The IRS is targeting Schedule C filers and the court reporters that are independent contractors are more exposed to an audit than a W-2 court reporter working for a county, state or federal government. That audit exposure is greatly reduced when you incorporate,” Liberatore said. Rhonda Jensen, RDR, CRR, CMRS, founder and president of Jensen Litigation Solutions in Chicago, Ill., said that’s the exactly the advice she got when she first started her business several decades ago. “I’m the sole owner, and right from the get go my accountant suggested I set up as an S-Corp,” she explained. “The benefit is that the company pays the owner’s FICA and Medicare tax and, as an LLC, you must pay Medicare tax on all of your profit.” Jensen’s firm now has 20 employees in addition to the independent contractors who work with her companies as well as others. “We do a lot through the company,” she explained. “We have 401Ks; it’s a “Safe Harbo”, which is beneficial for the owner of the company. But we also do a 401K match for our employees, matching up to 4 percent of their contributions.”
Lori Luck, an accountant based in Portland (ore. Or Me.), has worked with a number of different small businesses, including court reporting firms, and said: “Most service businesses are pretty similar with respect to setting up a business; however, since it seems that court reporting or captioning may be less risky from a standpoint of malpractice, the legal liability issues may not be as high of a motivator for incorporating.”
Luck, who works at CLS Financial Advisors, adds that even freelance court reporters could benefit from incorporating, though she tends to recommend an LLC for those individuals.
“If they are working alone as an independent contractor, they get some liability protection as an LLC by asking their attorney to prepare this paperwork for them, but they still file a Schedule C on their own individual tax return to report their business income,” she says. “This is much more straightforward than an S Corporation. Also, they can have their own retirement plan for only themselves and choose an IRA, SEP/IRA or 401k depending on how much they want to contribute. This is very flexible if you don’t have any employees, and you would pay income taxes via quarterly estimated tax payments.”
Matthew Alley, who along with his wife, Tiffany, co-founded Atlanta-based Tiffany Alley Global Reporting and Video, has experience with both LLCs and S-Corps and suggests from his experience, most court reporting firms of any size will tend to do better as S-Corps.
“We were always structured as an S-Corp in order to enjoy the benefits of pass-through income,” explains Alley, who served as CFO of the firm before it was sold to Veritext in 2015. “We have several LLCs also, perhaps a dozen, in the real-estate markets, but I prefer the S-Corp for the type of high-cash-flow business that court-reporting firms represent.”
There are other factors that also need to be considered, Jensen says, adding her accountant pointed out that if there’s real estate involved, or if there’s foreign ownership, then an LLC is probably the best option.
Incorporating a small business, especially a court reporting firm, is generally done for tax and possible liability issues, but it can also with it other advantages, including the ability to better organize what can be a complex flow of receipts and payments.
Denise Phipps Hinxman, CRR, CRC, currently runs Reno, NV-based Captions Unlimited in Reno, Nev., and said: “I was advised over 20 years ago — way before I had a firm and was an independent freelancer — to set myself up as an S-Corporation. I followed my accountant’s advice and have been very happy with my decision.”
Hinxman notes that prior to becoming an S-Corporation, she often struggled with paying quarterly IRS payments, adding, “I don’t know about other small businesses, but I have encouraged other top-wage earners to go the route of an S-Corporation and they have seen a difference on April 15 as well.”
Hinxman says incorporating a business should only be the beginning of a regular relationship between a firm owner and their accountant. “Many people aren’t aware of some of the laws that I’ve been able to take advantage of because I use a CPA who is a very knowledgeable tax accountant,” she explains. “I was able to pay my children a salary up to X amount of dollars per year for work they did for me in my firm. Everyone should ask their accountant these questions because there are ways to pay your children through your company.”
Hinxman adds her accountant also alerted her to the tax advantages when she purchased a new SUV for business-related travel.
When it comes to state taxes, the laws can vary, making it important for firm owners with clients in multiple states to understand the tax implications and complexities of each place they work in, which once drives home the importance of finding the right accountant for your business.
But an accountant can only do so much, and Liberatore says the mistake he sees most from court reporters isn’t so much whether or not they’ve incorporated, but rather a lack of financial planning.
“A common mistake — among new court reporters especially — is they don’t set aside money for taxes,” he explains. “And once they get behind for one year, they’re playing catch-up. You don’t know how many court reporting clients we’ve had that have come in owing multiple years of taxes, and they end up on a merry-go-round they can’t get off.”
Liberatore notes one of the first court reporting clients he ever worked with who owed the IRS more than $50,000. “She was convinced she was going to be working for the IRS for the rest of her life. She was doing her own taxes and I went back and amended three years of her tax returns and reduced her tax debt in half — and within five years she was getting refunds back. So it’s very important not just how you’re doing your tax planning and your tax preparation, but also to make sure you set aside money for taxes.”
Luck agrees, adding, “Many people are used to a W-2 where their taxes are withheld from their paychecks and they don’t have to think about it very much. Sometimes people may borrow money to help get up and running, and when they finally make enough money to pay some or all of the loan back, they don’t realize that just like the cash from the loan isn’t taxable income, repaying the loan is money that can’t be deducted from their taxable income. Consequently, it is confusing to many when they have to pay taxes when they might not have much cash.”
As daunting as all that can be, especially when they’re also focused on running their day-to-day business, firm owners and reporters do need to work regularly with their accountant and financial advisor to plan for their long-term future.
That could involve the eventual sale or merger of their business, but at the very least should include some pathway to a comfortable retirement.
Alley say he and his wife, Tiffany, began preparing their firm for sale six years before it actually occurred, adding that included not only making sure the books were in order and taxes up to date, but also that an experienced management team was in place to help the new owners.
Even if you plan on keeping your business for your entire career, Luck stresses that every small business owner needs a financial plan for the long term.
“Planning for a retirement plan of some sort, figuring out how much to save both for income tax savings provided by a retirement contribution and for the future before all the money is spent –and developing lifelong good saving habits — will greatly benefit a new business owner,” she said.
One way to do that is to meet with your accountant every autumn, well before the beginning of tax season, to work on year-end planning.
“Meet in October or November and predict how much money you will make before the end of the year,” Luck says. “Once you see that number, you can plan about how much income tax you might owe, and perhaps accelerate paying some expenses you would normally be paying in early January so you get an earlier tax deduction. You can also look at your retirement plan to figure out how much tax savings a retirement contribution would provide and evaluate the various income tax consequences of the contributions.”
David Ward is a journalist in Carrboro, N.C. Comments on this article can be sent firstname.lastname@example.org.