DTC POD #345 - Financial Foundations for DTC Success: What E-commerce Founders Need to Know About Tax and Accounting
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What is going on? DTC Pod Today we are joined by Christian Rivera who is an expert ECOM accountants. So Christian, I'll let you kick us off.
Christian Rivera 00:01:31 - 00:01:32
Why don't you tell us a little.
Bit about your background, your business, how you work with different brands and then we can jump into it.
Christian Rivera 00:01:37 - 00:01:59
Sure. So first of all, thanks for having me. I own a firm called the E Commerce Accountants name kind of says it all. We work with E commerce entrepreneurs. We do accounting, taxes, sales taxes, you know, tax planning, tax compliance. Basically an accounting firm catered to E commerce businesses specifically.
Sweet. And so how'd you get your start there? Like how did, how did you end up in the ecom world? And I'm excited to kind of unpack. Like you know what this stuff looks like specifically in the consumer, brand and commerce world.
Christian Rivera 00:02:11 - 00:02:50
Yeah, so it depends how far back you want to go, but basically I'm a corporate America guy. I used to work for Ernst and Young, which is a big four accounting firm. And when I was there I got a ton of experience. My background's in tax, so I was a tax guy there. My clients were some of the Biggest companies in the world, you know, Hess Corp, Barnes and Noble, Squarespace, these massive, massive corporations. And basically one day I decided to quit my job and start a business. And surprise, surprise, I decided to start an accounting firm. You know, it's the skill set I learned and new in a business I kind of knew how to operate within.
Christian Rivera 00:02:51 - 00:03:46
I studied accounting in school, all that good stuff. When I first started my accounting firm, basically I was an accountant to any type of business. I really struggled in the beginning because you know, there's a lot of different types of accounts out there. And then I stumbled upon this idea of niching down into a specific space and really specializing who your clients are so you can fully understand their business and compete a little bit more effectively with other accounting firms. I stumbled into the ride sharing space. I try to be the Uber accountant and do accounting and taxes for Uber drivers. And I found out kind of the hard way that although they are truly entrepreneurs, they don't really make a ton of money and they don't really have a lot of budget for accounting and tax planning. And you know, it's just not a complex business model.
Christian Rivera 00:03:47 - 00:04:23
So I had to go back to the drawing board and around that time I stumbled across my first E Com entrepreneur client and this guy was killing it, doing really well. And I started looking into the space because as an entrepreneur I was like maybe I should be doing ecom, you know. And I was, I started looking into it and that's when I discovered that there was a lot of accounting and tax related issues with e commerce businesses. And when I started looking into accounting firms at service E Comm entrepreneurs, there really wasn't any out there at the time. So we rebranded and, and kind of the rest is history. Sweet.
So I definitely want to cover, you know, the way we can structure this conversation. We can kind of talk about it from like the basics up, like what brands need to know from like an accounting and like cash flow management sort of perspective. I think that would be really awesome as well as some stuff on like tax optimization, ways to save, ways to like be smart. But you know, maybe before we just like kick off with the basics, could you just give us a quick high level overview of like what's the difference from like a tax and accounting point of view? Like what's the difference between like a commerce or consumer brand versus like you know, any other sort of businesses?
Christian Rivera 00:04:58 - 00:04:59
Right.
Like so as you niche down as you think about this, like what are some of the things that are unique about this particular space?
Christian Rivera 00:05:04 - 00:06:04
Yeah. So from an accounting and tax standpoint, some of the things that stick out specifically are one sale, sales tax compliance. Sales tax is a complex issue for online sellers because you touch a lot of different states. So you can be an entrepreneur in Florida like yourself that ships to places all over the country, really all over the world. The issue with sales taxes is it's not like you walk into a store, like let's take an example, you walk into a Macy's, you buy a t shirt for 20 bucks, you as the customer are paying sales taxes on that transaction. Depending on your state, that business will collect sales taxes and remit those sales taxes to the state. But that's a very really easy place to determine where their sales tax risk. Because if you're walking into a Macy's in New Jersey and buying a shirt in New Jersey, it might be taxable there, right? For a business that's online, that's shipping to customers, sales taxes is a destination based tax.
Christian Rivera 00:06:04 - 00:07:11
So if you're an entrepreneur that's marketing all over the US and shipping products all over the US you have tax risk all over the US So although you're a small business in terms of headcount, you have a really wide risk in terms of tax from a sales tax standpoint. So there's a lot of places that you could have sales tax risk. So that I would say is number one. And then the other two are really accounting related. Revenue recognition is a major one. It's one of the main ways that we win clients. The way I could boil it down simply is, you know, if you have $10,000 in sales and Shopify today, do you get $10,000 in your bank account tomorrow? And the answer is no, right? Because there's refunds, there's chargebacks, there's merchant fees, there's all kinds of stuff that goes into that, those transactions before you get that net payout. So from an accounting standpoint, what happens is all we see as accountants are these deposits that come from the payment processor, Shop5 Payments, PayPal, third party payment processors, you name it.
Christian Rivera 00:07:12 - 00:07:52
And what happens is if you don't do the accounting correctly to back out those fees or those refunds or all that stuff, you know, you can have a big issue from a revenue recognition standpoint. And it's, it's one of the number one areas that the IRS flags e commerce entrepreneurs. And then the second one from an accounting standpoint is inventory. Accounting inventory is, you know, it, it's its own beast. You know, your, your inventory is not tax deductible until you sell it so if you buy $10,000 worth of inventory, you have to sell, start selling through that inventory to be able to deduct it. And that's just, you know, surface level. There's a lot of other issues that come from that. It's just complicated.
Christian Rivera 00:07:52 - 00:08:01
So I would say those are the three main areas where, where, where. I'd say it's a very specialized space from an account tax standpoint. Yeah.
And I'm super excited to dive into each one of those. But maybe we start with the first. Right. Like sales tax. So how does it work for a business that's just getting up and started? Like, what do I need to know? Should I charge my, you know, is this something I can handle through Shopify? Like, how would you approach it? What do I owe? How do I do it for? Call it like your first, you know, 10 grand, 20 grand in sales.
Christian Rivera 00:08:22 - 00:09:21
Yeah. So it's a complicated issue, but I'll make it super, super simple and I'll give the non popular accounting answer where it's like, hey, this is technical rule, but here's what you do. In practice, it's a little bit easier because I'm very, you know, I'm pro entrepreneur, especially the beginners that it's just like your money is better served like hustling and growing and putting money into your ads than instead of paying an accountant to do sales tax, you know, when you don't really have a lot of sales tax risk. So let's first start off with how sales tax works. I gave you the example of you walk into a Macy's, you buy a shirt, you, the customer is the one that pays the sales tax. Right. So if it's a $20 shirt, the customer is not paying $20 or paying, let's say 2150 store collects the money, $20 is revenues, part of their profits, subject to income taxes, et cetera, but that $50 they collect and they're obligated to take that money then paid into the state. Okay.
Christian Rivera 00:09:21 - 00:09:47
Now that is how it works for an in person transaction. For online sellers, how it works is depending on where you ship to, that's where it's potentially taxable. Potentially taxable. Okay. So the question becomes, okay, I sell to all 50 states. Do I have to do sales taxes in all 50 states? And the answer is it depends. There's a couple of texts that you have to look at. The easiest one is testing for physical presence.
Christian Rivera 00:09:47 - 00:10:19
So where do you live? You live in Florida, right? So in Florida, that is a physical presence state. So that's a state you should worry about. From a sales tax standpoint, where do you have employees? Not contractors, not agencies. I mean actual people who receive a W2, which is pretty rare for new entrepreneurs. That's most likely a non issue. And the third thing is, where do you have inventory sitting? Okay, again, for beginners, many beginners are drop shipping. Right. Or doing print on demand or something like that.
Christian Rivera 00:10:19 - 00:10:47
So again, usually not an issue. So in the beginning, it really should be centered around where you are physically living. That's where you should do sales tax compliance. So what does that mean in practice? That means in the back end of Shopify, sales tax should be turned off everywhere. You determine what states you have to do. So in your situation, let's say it's Florida, you register for the state of Florida for sales taxes. It's a pain in the ass. It's annoying.
Christian Rivera 00:10:47 - 00:11:22
It's kind of like getting a driver's license. You know, you need a driver's license to drive. You need a sales tax permit to charge sales taxes. You get that permit. Once you get the permit, you turn on sales taxes in Shopify, only in Florida. And what happens is every time a customer checks out ships to Florida, you collect that sales tax from them. Then every month or every quarter, you take that money, pay it into the state, and that's it at the end of the day. You know, my recommendation with newer entrepreneurs is always don't stress about the sales taxes.
Christian Rivera 00:11:22 - 00:11:59
Just focus on hustling, growing, and then eventually you'll get to the point where you can hire an accountant to do it. But if you do kind of jump the gun and get an accountant at those earlier stages only do, only focus on where you have a physical presence and ignore what Shopify says in terms of you have nexus in these 10 states or 15 states or whatever. So just focus on where you have physical presence in the beginning. Then once you can afford to work with an accountant that specializes in doing sales taxes, then you can start to look at, you know, doing sales tax compliance in other states.
Yeah, and I think that's, that's such a great point because I know the first time that someone opens up Shopify, like one of the prompts they give you, it's like, okay, now register for all these different states. And you're like, oh my God, like, what do I even do here? Right? So I think, you know, that's super helpful in terms of knowing that, hey, this is something that you definitely need to take care of. But first things first, get your business off the ground. Be Compliant in the state that you're operating. And then you can obviously go in, you know, work with an accountant as like your revenue sort of scale up and you can, you know, figure out that, that scalability.
Christian Rivera 00:12:33 - 00:12:57
Yeah, and I wanted to touch on that too. Shopify notifies you not to be nice or anything like that. Not because they're required to or anything like that. Shopify actually doesn't report your sales to states. If you really think about it. How does Shopify make most of their money? It's from processing, right. Whenever a customer pays with a credit card, they get a percentage of that transaction. If you turn on that sales tax button, right.
Christian Rivera 00:12:57 - 00:13:24
What winds up happening is that customer is getting charged more money. They're paying the whatever your order value is plus sales taxes. That credit card is ran. So Shopify is making more money on transactions for which they're charging sales taxes up. So that's why they're real pushy with entrepreneurs to do sales tax compliance, in my opinion. I don't know if that's entirely the truth. It might sound like conspiracy theory, but.
No, I mean, I mean it makes sense like that, that's, that's, that's percentage points on, you know, on real volume across the board. So it makes sense, right, for, for them to be able to, you know, process those fees. So cool. So moving forward, let's talk a little bit about, you know, your an entrepreneur. Like how should you think about, you know, capitalizing and like getting started with your business, right? Like, you know, you've got a factor in inventory. We're talking about ads. Like you're trying to get a team cobble together, you know, so, so maybe the people that you see do it the most successful, like what do you recommend for, for people who are just getting started out, like how do you set things up?
Christian Rivera 00:14:06 - 00:14:41
Yeah, so I love this question because we primarily work with super established brands. But what we see is they all have a lot of patterns in terms of where they came from. Right. Not like geography wise. We have clients all over the world that come from different races, ethnicities, countries, you name it. But the one thing that's consistent is they have a similar journey to getting to that super established eight or even nine figure brand. So typically what we see is there's two main areas where they come from. There's direct to consumer or Amazon, most of them are direct to consumers.
Christian Rivera 00:14:41 - 00:15:10
They come up through like Shopify, they have their own website and they're driving traffic through paid ads or something. So typically what we see from a fulfillment Standpoint is we see a lot of dropshippers in the beginning. Why? Because it doesn't, it's not very capital intensive. It's very low risk. It doesn't have to be a branded product in the beginning. It just has to be something that you think is value valuable. And you got to test it. You don't know.
Christian Rivera 00:15:10 - 00:16:05
Nobody has a crystal ball, nobody knows what's going to sell profitably. So you kind of have to test around and find your winner, right? So consistently what we see is that people come up through that, you know, shopify dropshipping scene and what happens is they find some track shit and then what happens is they get copycats. People that are ripping their, their ads or ripping their landing pages or you name it, all kinds of things. You get a lot of copycats. So then what happens is they'll brand the product, then they'll either store it in China, usually they'll start storing in China in the beginning and then eventually transitioning that inventory to the US to get that, you know, super quick fulfillment cycle. Then it's very hard for, you know, knockoffs to compete with you. Why? Because you're gonna have a much better customer experience. People are getting better quality products branded, you know, faster.
Christian Rivera 00:16:05 - 00:16:43
They're gonna get their products faster. And that's typically the journey we see entrepreneurs go from in terms of like the beginning all the way up through becoming more established. So, so that's definitely the fulfillment side. In terms of the team usually starts with VAS from the Philippines. It's very common and even we see very established businesses still working with their VAs from, from day one, you know, so, you know, having. Being smart about where you hire people because human capital is, you know, it could be the most expensive part of your business if you don't, if you don't spend it correctly. So yeah, that's what I would say. I would.
Christian Rivera 00:16:43 - 00:16:44
I typically see.
Well actually this is a great question because you get to see it, right? Like what do you, you know, obviously vas. Working with VAS is a huge unlock for a lot of, for any sort of business owner. Especially like if they're in commerce. You, you know, you see it a lot where cogs sort of make a really big difference. But yeah, what are the team structures sort of look like, you know, is it typically like one or two founders and like a couple VAs or like, you know, are they working with, you know, are they outsourcing the stuff to like marketing agencies in the early on? Are they the ones like running theirselves like so from a, from like a capex perspective, like why don't you just paint that picture?
Christian Rivera 00:17:22 - 00:18:02
Yeah. So in the beginning it's usually just one founder with maybe a handful of vascular. Um, in the very, very beginning, I would imagine it's just like one person or if there's partners, two people doing literally everything. But pretty quickly, you know, people figure out at scale, you know, you can't answer all support emails. So it's just too, it's just too much. Um, so typically what I see is the first step is getting, you know, VAs to help with things like order fulfillment, customer support, things like that. As far as agencies, I love agencies. I have clients that, that own agencies.
Christian Rivera 00:18:03 - 00:18:45
Typically, in my opinion, the most successful entrepreneurs usually have multiple advertising channels. So like think like Facebook and then a Google. Right? But what happens is Facebook represents like 80 to 90% of their traffic, let's say. And then maybe Google makes up 10 to 15%. Right. And then maybe emails make up, you know, like a percentage of the sales. So you capture customer data, follow up on email and then you close out that. Typically when I see people work with agencies in the most successful way, it's typically on that second or third tier of advertising.
Christian Rivera 00:18:45 - 00:19:33
Usually they're number one. Like their lifeline, their, their most important source of paid traffic. The entrepreneur usually is handling it themselves or have a media buyer that reports to them directly. I've seen countless entrepreneurs try to go the agency route and transition all of their, all of their paid traffic to the agency. But it's, it's hard to, you know, the vision of you and your business. Like I'm the owner of the E Commerce accountants. For me to just turn over our entire marketing, you know, channel to some agency and have them really fully understand what's up here in this like stupid looking bald head, you know, like it's very hard to transplant that vision to someone else. So I think that might typically be the issue.
Christian Rivera 00:19:33 - 00:19:45
But you know, working with an agency on that second or third tier of marketing channel, I do see it's actually pretty common like on emails and texts or Google Ad agencies or things like that.
Definitely, definitely. And then moving forward. So, you know, we've got people who are starting a brand, they've brought In a couple VAs, they're starting to scale up. Like they're seeing some traction in terms of driving traffic now. Like, let's talk about inventory, right? Like what are, you know, how do you approach it? How do you invest the right amount without being stocked out? Like, how do You. And then even from, from your perspective, from just like a financial and accounting perspective, like, what do you recommend? The best way is for consumer brand owners to like, think about, you know, inventory as it pertains to their business.
Christian Rivera 00:20:21 - 00:20:52
Yeah, it's, it's hard. It's very hard because like I said, no one has a crystal ball. There's a lot of unforeseen. The most successful people who do it forecast. So understanding a couple of things. One, what does your year look like? So, for example, everyone says, like, oh, Q4 this and Q4 that, you know, that's the busiest time of the year for most businesses. That's true. And understanding your business and if Q4 is super heavy, you need to.
Christian Rivera 00:20:52 - 00:21:55
It sounds stupid, but, you know, not a lot of people understand this. Maybe you need to stock up more in preparation for that time period. We're going to have more sales, right? What is last year look like? You know, could you have done better last year? If so, is it because you didn't have enough money to spend for ads? If you do, then what are those, what is that additional ad spend going to equate towards in terms of additional inventory, how do you make sure that one, you don't run out of inventory, but also how do you make sure you don't get stuck with too much inventory that you're not going to sell through? Right. So understanding that in addition to Q4, there are other businesses that have seasonality. Like we have businesses that, for example, are really hot around Mother's Day or Father's Day. Right. So they have a similar issue where, you know, maybe Q4 is just doing business as usual, but around Mother's Day or Father's Day, they're really pumping out, you know, the large volumes. So, you know, just being smart about when your business is busiest, you know, forecasting.
Christian Rivera 00:21:55 - 00:22:21
Maybe taking a look at what you did last year where you came up short, is it going to go the same this year? Is it going to go slightly better and kind of plan accordingly? The most successful people who do it forecast, it's. It's hard because the thing is with inventory, it's a cash. So it sucks up a lot of cash. You tie up a lot of inventory, a lot of money into. Into inventory that just sits there until you sell it. So it's very risky from a cash standpoint if you get it wrong.
We are really excited to announce that DTCPOD is officially part of the HubSpot Podcast Network. The HubSpot Podcast Network is the audio destination for business professionals and we're really excited about being part of the network because we're going to be able to keep growing the show, bringing you guys amazing guests and obviously helping you guys learn from the best founders, marketers and builders of the most successful consumer brands. So anyway, keep listening to DTC POD and more shows like us on the HubSpot podcast network@HubSpot. Definitely. And, and how do you, you know, I know there were a bunch of like, different, like inventory financing options that were like popping up and you know, then the cost of capital sort started to go up and that became even more expensive. Is that something that you see, you know, working for people or do you just, or do they just buy the inventory outright? Like, what do you, what do you see for the businesses that you're working with that, that do a good job of managing their inventory and their cash?
Christian Rivera 00:23:22 - 00:24:16
So I see many clients borrowing to acquire inventory, even if they have cash, sometimes against our wishes. Because I don't love debt, to be honest with you. As an accountant, one of the things we do for our CFO clients is we will look at their balance sheet every month and let them know kind of what their, their net asset position looks like. And the problem with debt is that it's not free. It comes with an associated cost through interest. So with interest rates so high, it can be quite substantial, you know, over, over time, especially if you don't pay it off quickly. You know, if that balance sits there, then not only are you paying interest, but you're paying the interest on interest. If you think about it, it compounds.
Christian Rivera 00:24:16 - 00:25:04
So and we even see that in entrepreneurs that are super established, that have plenty of cash and maybe aren't as educated on like, here's the impact of how debt works, here's how interest works, here's how interest compounding works. So yes, I have seen many businesses borrow it. If you need to borrow because you need the inventory, do it. Obviously, you know, it's because at the end of the day you need to be able to get the inventory to sell. Right. But at the same time, don't be scared to pump some of that cash that you have on hand back into the business through inventory, especially if you're really, really comfortable that you're going to be able to sell through it and get that cash back out.
So yeah, yeah, that makes a bunch of sense. You don't want to, you don't want to take on too much debt if you can't, if you can't handle it. That leads me to sort of my Next question. In terms of like efficiency and stuff, as you're scaling, like, what can, what can you do from a tax perspective? Like, how should business like commerce business operators be thinking about, you know, their taxes, like are. If you're making money and you're trying to save on profits or are there other ways to like optimize your business to, you know, be more profitable from a tax point of view?
Christian Rivera 00:25:43 - 00:26:10
Yeah. So you asked me a super low question because it depends on a lot of different things. We've recently opened our doors to work, to working with foreign e commerce entrepreneurs. That means non U.S. citizens that live outside the U.S. people that aren't America at all. Um, and with the foreign people, we could do a lot of cool shit with that. You know, we have a lot of clients that are living in Dubai, have tax structures going through Dubai.
Christian Rivera 00:26:10 - 00:26:59
They'll set up a US LLC and they still won't have to pay taxes in the U.S. right. So for the foreign guys, we can do some really, really cool stuff with them. And I love to geek out on those because back in my ey days we used to do these complex org structures with like a holding company with subsidiaries, and this is how the cash goes. And this company has a management agreement with this company and we could do a lot of cool stuff with that. For the Americans, it's a lot simpler and not as cool like the IRS gets you. If you're an American, there is some tax planning things you could do to reduce the taxes substantially, but it's, it's simpler. And unfortunately you don't get as much return on investment as the foreign guys do.
Christian Rivera 00:26:59 - 00:27:28
So it kind of depends. But let's just assume, for example, on the foreign side, very specialized consult with a professional. There's no one size fits all. It literally depends on where you live, what you sell, do you have inventory in the US There's a whole slew of issues that come up. For the Americans, it's really easy. It depends basically on how many owners there are. So like, do you have investors? Do. If you have any investors, then you should use most likely a C corporation entity.
Christian Rivera 00:27:29 - 00:27:57
If you don't have any investors and it's just you as the owner or you have like maybe one or two partners or something like that. An LLC tax as an S Corp makes the most amount of sense that could, you know, the tax planning benefits are substantial there and they're really well documented. So it's really easy to find those answers, really easy to find an accountant to implement tax strategies around an S Corp. So yeah, that, that's the way I could simplify it best.
Yeah, well let's, let's, let's go into some of these things. So first let's talk about LLC taxed as an S corp. Like what is, what does that mean? Does that mean you are like how do you, how do you have an LLC that is taxed as an S corp?
Christian Rivera 00:28:14 - 00:28:56
Yeah, it's. So basically when you have an llc, I'll describe the tax benefit and then it'll kind of, the rest of it will kind of fall into place. The, that you need to take kind of makes sense once you understand how it's supposed to work. When you have an llc, the IRS considers you self employed, right? When you are self employed by the irs, they're literally going to double tax you. You're going to pay income taxes and you're going to pay what are called self employment taxes is literally a double tax. Now when you have an S corp, you are no longer considered self employed. So you no longer have to pay that double tax. You only pay income taxes.
Christian Rivera 00:28:56 - 00:29:44
You do not pay self employment taxes. Now there's a catch to that. Just like anything else, it's not like they're just going to give you something for free, right? You have to actually structure things appropriately. So the catch is when you were considered an S corp, you are no longer self employed. Now you have to treat yourself partially as the employee of a corporation, as ridiculous as it sounds, because you're the owner, you also have to be the employee of a corporation which you just so happen to own. Now the reason why that's important to understand is because when you're the employee of any company, you work for Nike, you work for Chipotle, it doesn't matter. You pay into employment taxes. Not a lot of people know this, but if you have a W2 job, you're getting double tax.
Christian Rivera 00:29:45 - 00:30:10
That same double tax. I was talking about self employed people. You're paying through your, your regular job. Whenever you see fica, Medicare, Social Security, that's that double tax. If you look at your paychecks, you'll see multiple tax line items. That's what we're talking about here. So the idea is if you have an S corp, you need to split your income. The employee earnings are double taxed.
Christian Rivera 00:30:11 - 00:30:48
You pay income taxes and you pay employee taxes, right? So that's, it's a double tax. Whatever your salary is, it's going to get taxed ugly, for lack of a better way to describe it. The rest of your profits are not subject to employment taxes. They only get hit with income taxes. So if you think about it, you're taking the same business, nothing changes. You're taking that same business that you own, and you're splitting your income into two categories. One is salaries, one is profits. And if you think about it, it sounds like kind of simple, but if you have $100 that your business made, right, you need to split that $30 a salary.
Christian Rivera 00:30:48 - 00:31:29
Well, if you paid a salary in your business, your profits went down. So now that's $70 in profits, right? So you're literally splitting your business into two ways to compensate yourself. And you can optimize, obviously, between salary and profits. So to answer your question, now that you kind of understand the benefits, right, if you have an llc, you just file a piece of paperwork in with the IRS. It's called Form 2553 that basically says, hey, IRS, I know I have an LLC, I know I'm self employed. But now I want you to tax my LLC as an S corporation. I've never once seen one rejected. As long as it's filled out correctly, it's a really easy form to do.
Christian Rivera 00:31:29 - 00:32:08
I would always recommend having the accountant do it. But once it's filed, the IRS automatically approves you to have S corp status. Then once you have an S corp, you need to set up payroll so that you keep in mind you as the owner, you have profits that you already have set up, but now you have to also pay yourself a salary. So you need the W2s with the direct deposit, the pay stubs. It sounds hard, but they have tools like Gusto out there that makes it very easy. And that's pretty much it. You file an election with the irs, they'll treat you as an S corp. Then you set up a payroll system like a Gusto or an ADP or QuickBooks, and then that's pretty much it.
Christian Rivera 00:32:08 - 00:32:10
It's pretty simple to do.
What was that form again?
Christian Rivera 00:32:13 - 00:32:14
Form 2553.
Form 2553. And one question, why or what's the difference between doing that and just being an LLC where you split your income into, you know, into like you just had profits versus just salary.
Christian Rivera 00:32:30 - 00:32:52
Yeah. So the difference is with an llc, the IRS considers you self employed. Right. So when you're self employed, all of that income is double taxed. Okay. When you set up an S corp, when you split it up, the salary gets hit with that double tax. Right. But your profits are no longer subject to employment taxes.
Christian Rivera 00:32:52 - 00:32:53
They're not double tax.
Got it, Got it. And is that. Is that for. Do you need to create your own S Corp or is this just. This form allows you to file as an S Corp. Kind of the second.
Christian Rivera 00:33:04 - 00:33:29
One, the technical way to describe it is legally you will always own an llc. So if you have Blaine E Commerce LLC and you do an S Corp election, your business is still going to be Blaine E Commerce llc. It's a tax election. So the IRS treats taxes and treats your LLC as an escort for tax purposes. It's, it's just an attack. That's all.
Cool. Okay, so that's a, that's a big one. Just so you know, you're getting taxed and not double taxed the right way. That's how you do it. And then let's talk a little bit about, you know, some of the foreign stuff. I think it's, that's a really interesting topic because, like, you see it all the time. All these guys on, you know, social media who are like killing it in E Com or whatever, they're, you know, overseas, they're in Dubai, they're in these different places, they have these complex structures. So obviously it's going to depend on your own personal, you know, circumstance and what you're doing.
But like, why don't we just kind of zoom out for a second and talk about, let's just talk about, like what's possible and what are some of the best ways that are available now and why are people doing it and what are they doing?
Christian Rivera 00:34:13 - 00:34:53
Yeah, so when I say foreign, I'm talking about non citizens. Because a lot of, a lot of times we get Americans that are like, hey, I want to move to dubai, have a 0% tax rate. As, as much as I'd love to say, yeah, do it, the problem is, at least as of now, Americans, if you're a U.S. citizen, you are subject to income tax on your worldwide income. So what that means is if you move to Dubai and you make money through, even through a Dubai corporation, let's say the US will to some extent still tax that income. Okay. Depending on the tax structure. So they don't let you out of peg income taxes just because you're living outside of the U.S.
Christian Rivera 00:34:53 - 00:35:37
there's other tax benefits to living outside of the U.S. but it's in the long run, when you're really scaled up, it doesn't really equate to very much. However, if you're a foreign E commerce entrepreneur, meaning you're not a U.S. citizen and you do not live in the U.S. that's where we could do some really cool stuff. So here in the U.S. if you have an LLC, that doesn't necessarily mean you have to pay income taxes as a foreign entrepreneur. So what you can literally do is in the US if you do not have what's called effectively connected income, then you can set up an LLC in the US you could have US payment processors, you could have US bank accounts, US Credit cards, everything.
Christian Rivera 00:35:37 - 00:36:13
You could even move money from the US back to your home country and not have to pay US Income taxes. Typically how it works is you're paying income taxes in your home country. Okay? So if you have no ECI, you could set up a tax structure in the U.S. and have a 0% tax rate in the U.S. but if you're sitting in the UK, they're going to tax that income, all the profits in the uk. Now what's really cool is I have E commerce entrepreneurs sitting in Dubai, right, that they have a US llc. They don't have what's called permanent establishment. They do not have ECI.
Christian Rivera 00:36:13 - 00:36:49
They are drop shipping into the US and basically what happens is they have a 0% tax rate in the US then that income flows up to Dubai where they are an individual. When they file their individual taxes in Dubai, they have to report that income, but again, zero percent tax rate there. So we literally have E commerce entrepreneurs that are making a ton of money that pay $0 in taxes, which is really cool, but kind of unfortunate. I wish we could get our American entrepreneurs to zero percent, but that things like that are possible if you structure things correctly.
Oh, that's really cool. My next question was going to be about, you know, we're both in Florida and we hear about Puerto Rico all the time. So what's the deal with Puerto Rico and taxes? And why are so many ecom founders and entrepreneurs there?
Christian Rivera 00:37:04 - 00:37:32
Yeah, yeah. So Puerto Rico is a really, really great option for the American entrepreneurs. So remember I said if you are a US citizen, they're going to want to tax your income no matter where you are. The one exception to that rule is Puerto Rico. So there's an exclusion. You can exclude your income that comes from what's called an Act 60 Corporation. So it's very technical. But I'll boil down the simple parts of it.
Christian Rivera 00:37:33 - 00:38:10
If you are exporting products or services, this works really, really great for E commerce entrepreneurs. Also people who sell, you know, courses or do mentorship or things like that. If you export services or products out of Puerto Rico, okay. Out of a, out of an Act 60 Puerto Rican corporation. And you are what's called a bona Fide resident, which means you live in Puerto Rico 100. I think it's 180 days or more. I don't remember the exact number. If you have the combination of those two things, then you do not have to pay US Income taxes.
Christian Rivera 00:38:10 - 00:38:54
Instead, you will pay the Puerto Rican income tax under Act 60, which is 4%, which is great, because if you compare it to the US Tax rate, let's say you're scaled up all the way to the maximum tax rate, that's 37% plus what you pay in state income tax. And so if you live in New York state, that's another 8% right there. So like in Puerto Rico, you could get all the way down to 4%. But this is what's really cool. Let's fast forward. Let's say you've been in Puerto Rico for three years, you've established your brand, you're killing it, and you decide it's time to sell your business. Well, here in the US you're subject to capital gains tax, right. And that's somewhere between 15 to 20%, depending on how much you sell your business for.
Christian Rivera 00:38:54 - 00:39:11
In Puerto Rico, the capital gains tax rate is 0%. So if you sell your business for $100 million in Puerto Rico, right. And it. And it goes through capital gains tax, you're Talking about a 0% tax rate on that transaction. Wow.
And is that for. You said you have to be there three years in order to do that?
Christian Rivera 00:39:17 - 00:39:30
No, I don't know the specific requirement, I think actually you do have to sign on for a certain period. The requirement that I'm aware of is that you have to spend 180 days or more per year to be considered a bona fide resident.
Awesome.
Christian Rivera 00:39:31 - 00:39:32
So this has been super helpful just.
In terms of, like, what's available to you and all the different ways you can think about optimizing. But back to brands that just might be scaling and optimizing. Are there any things in terms of like, carrying the amount of, like, you know, the amount of profits or reinvesting to the business and like, doing things to optimize maybe the, you know, taxes from, from that point of view?
Christian Rivera 00:39:56 - 00:40:59
Yeah, I mean, there's a lot of little things that you could do. You know, I really like retirement plans, specifically Roth retirement plans, because in terms of return on investment and tax savings that substantial, if you have a, if you have a Roth IRA or Roth SEP IRA or something like that backdoor Roth for higher earners, the tax savings could be substantial on that front. So what I want to say is Consult with a professional. Because the number one way that you're going to save money, taxes. In terms of simplicity and in my opinion, return on investment in terms of your efforts and money, it's really through a good tax structure. So an LLC taxes an S corp or C corporation, either one of those will get you the best bang for your buck in terms of saving money in taxes. Beyond that, there are other. There are other opportunities, but most of them require tying up your money somewhere.
Christian Rivera 00:40:59 - 00:41:34
Spending money on something, you know, it's things that are uncomfortable. You can't get benefit without doing something that's detrimental as well. So what I will say is that paying taxes is not as bad as you think. If you're doing it correctly. If you have a good pulse on your profits and you're paying quarterly estimated taxes, it's not as bad as you think. I'll give you a very simple example. Let's say your tax rate is 24% and you make $100,000. Okay? That's a bad example, because that's not in the 24% tax rate.
Christian Rivera 00:41:34 - 00:42:08
Let's say, let's say your tax rate's at 12% there, okay? So $12,000 in taxes. If I tell you, hey, Blaine, you got to pay $12,000 in taxes tomorrow, you might be pissed. You might be like, that frickin sucks. I hate paying taxes. Whatever. But if every three months I say you'll Blaine, pay 3,000 three months later, pay 3,000, pay 3,000. If your tax payments align with your cash flows and your profits, it doesn't suck as bad as when you're ripping off that band aid and paying it in one shot. So the timing of the payments.
Christian Rivera 00:42:08 - 00:42:56
What we find with entrepreneurs is if they know that they have to pay it and they do pay it, it's not as, not as bad to deal with the other thing. People say this all the time to us, hey, what do I have to spend money on to not have to pay taxes? Here's the problem with that. If you were to buy, let's say you have $1 million in profits and you buy a $200,000 car, right? Let's just say for argument's sake, that $200,000 car is fully deductible, okay? And it's not. That's not the way deducting a car works. But let's just say it is. You spent $200,000 in a car to bring your profits down. Now how much are you saving in taxes? You're not saving $200,000, so you just spent $200,000 on a car. That is money out the door.
Christian Rivera 00:42:56 - 00:43:34
On top of that, you do get the tax benefit. Let's say it's 30%. So that's 60,000 in tax savings. So you spent 200,000 to save 60,000. Like, that doesn't really make sense. And then when you go and sell that car again, by the way, it goes the other way, where you might have to pay taxes for the depreciation you got. So, you know, this whole spending money to drop your taxes thing is, in my opinion, not a smart tax spending strategy. There are other things that are a little bit more structured that make sense, but I just want to, you know, demystify taxes, because if people understand it, it's a lot less scary.
Yeah. And I think what you just said about, like, you know, making sure the payments are, like, split up. I know for us, and like, one of our businesses that, you know, we scaled up that first year we had, we paid lump sum for, like, we were like, okay, let's just get sprinting, get off the ground, make a bunch of money, and then figure out what to do. So we did that, and then year two was like, okay, now let's figure out how to, like, break it down into installments. But it really sucked because it was almost like, you know, in April, we were paying for all of the previous year and then catching up on the next year. So that second year really sucked. And it was like, oh, man, I'm, like, spending more in taxes than I'm making. You know what I mean?
Christian Rivera 00:44:15 - 00:44:34
Yeah, you got hit with it twice. That's. That's common with entrepreneurs that are just starting out. So, yeah, it makes a lot of sense. It's hard in the beginning. Look, here's the deal. What you. What you just described, I actually agree with for the beginning of entrepreneurship, because you don't.
Christian Rivera 00:44:34 - 00:45:07
It's hard to just say, oh, pay your taxes. Right. You don't know if you're going to be profitable through the whole year. It's hard to project what you're going to do if you've never done it before. Right. So in the first year, it's not horrible if you're like, hey, let me defer the taxes and figure it out later. As long as you have in the back of your mind the idea that, okay, you know, anywhere between 10 and 37% of this money is going to have to be paid towards taxes, let me put some money aside, and I know it's there, that I do have to pay it, and I Have to pay it later. Right.
Christian Rivera 00:45:07 - 00:45:22
So in the first year I completely understand. But once you get past that beginning stage like you described, I think it's very important to figure out a plan for how to pay taxes as you go because it sucks a lot less when you don't have to pay it twice in the same year.
Definitely. Definitely. Christian, as we wrap up here, any other like, you know, final pieces of parting advice for brand founders? Anything that you see that you're like, this is something I constantly see people messing up with. Not just from a tax planning point of view, but even just from a, you know, cash flow and operating point of view. Yeah. What are some of the biggest lessons that I guess you'd see that you'd want to point out that you'd advise people if there's a couple of things just to like think about when it comes to running your brand to get right.
Christian Rivera 00:45:52 - 00:46:30
Yeah. I might be biased because I'm an accountant, but I'm a firm believer that if you're not an expert in something, do try to learn it. You know, I'll give you a very simple example that you guys might understand as like e-commerce entrepreneurs. I'm an accounting firm owner. If I were to get into the back end of the Facebook ad account, I know generally how it works. Now am I an expert in terms of media buying? No, definitely not. But I could go in and I can set up an account and run ads. Why? Because I've done it before with agencies for us to park lines.
Christian Rivera 00:46:31 - 00:47:13
Now I know enough to make me deadly, but I know I'm not an expert if you flip that around. As an e commerce entrepreneur, I do encourage you to educate yourself as much as possible on accounting. Are you going to be an expert? No. Are you going to be a tax expert? No. But understand what your accountant is doing because a lot of times if you know what you need, it's easier to find the right expert to guide you to where you need to be. Right. You know, just like for me if I was to go to market and find a media buyer, I would be able to tell the difference between a guy that took a course last week and I'm his first client versus someone who's been doing it for years. Right.
Christian Rivera 00:47:14 - 00:47:30
Why? Because I have a little bit of experience to make me deadly. So that would be my biggest piece of advice. Don't sleep on your learning accounting and tax. Although it may be daunting, any self education you could do in the area would will pay dividends in your in your journey for sure. Sweet.
Well, Christian, want to thank you for coming on. It was fun jamming on all these topics around, like, you know, business, finances, tax planning, ways to optimize your capital. As we kind of wrap up here, where can we connect with you? Where do we, you know, are you on socials? You know, is there a place that we can find you? Just why don't you shout out your info?
Christian Rivera 00:47:53 - 00:48:06
Yeah. So on all social channels. Instagram, TikTok, YouTube, Facebook. You can find us at ecommerce Accountants. Right. E. Com Accountants, plural. My personal account on Instagram is ecommerce.
Christian Rivera 00:48:06 - 00:48:25
So Namekind says it all. It's really easy to remember. If you're interested in being a client of ours, you can apply for a free consultation on our website. It's the E Commerce accountants dot com. Obviously, if you just Google E Commerce Accountants Chris Rivera, you'll be able to find us very quickly. So, yeah, those are the best places to find us.
Sweet, man. Well, thanks for coming on the show. It was a blast.
Christian Rivera 00:48:27 - 00:48:29
Likewise. Thanks for having me.
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