The etymology of the word “entrepreneur” is well established. Since the earliest of French times, it has meant “someone who breaks into hives when coming within 20 feet of a lawyer.”

While I’m joking regarding the word’s origins, I’m quite serious (albeit figurative) regarding the entrepreneurial response to lawyers. Most young entrepreneurs see themselves as an unrivaled visionary and the last thing they need is some old dude in a three-piece pulling on the handbrake.

Until something else does.

Nothing will grind the entrepreneurial party train to a halt faster than a big lawsuit, nasty contract dispute or some other legal circus animal that no one bothered to stop from coming on board. The lawyer-averse entrepreneur suddenly finds himself begging for a hug from the old dude.

So, before you need to beg for that hug, here are 10 pitfalls that often cause startups legal trouble. A penny of legal proactivity in each of these areas will offer a pound of protection as your business matures.

1.   Not Hiring a Startup Lawyer: There are a lot of lawyers that represent small businesses, but there are only a few that regularly represent startups–particularly when it comes to fundraising from sophisticated angels and venture capitalists. There is a “market” around angel and VC funding and if your lawyer is not immersed in that market you can get fleeced.

2.   Not Having Founders’ Agreements: How do you split the equity pie? Who contributes what? Who acts as CEO? What if a founder stops performing? There are so many questions that founders never think through because everything is going to be “awesome.” However, when cash and humans are involved, things are seldom uniformly awesome.

3.   Choosing the Wrong Corporate Entity: While this sounds mundane, it is actually quite important. Whether you want to run your business as a C Corp, S Corp, LLC, LP etc. is wholly dependent on your long-term objectives. Different structures offer different opportunities and restrictions, and changing your structure years later is administratively painful and expensive.

4.   Using Someone Else’s Trade Name: Many entrepreneurs will lock on a company name without researching whether someone else owns that name. They will put up a web site, print a bunch of advertising collateral, and then they get a letter from some Malaysian conglomerate that says, “Quit using our name and pay us $1 million in damages.”

5.   Comingling Accounts: When money first starts coming in – either from investors or sales–it is easy to mix personal and business accounts. Don’t do it. The more you do, the more that someone can pursue your personal assets for any unpaid corporate liabilities.

6.   Failing to Protect Intellectual Property: Most great ideas are supported by a product or process that should be patented. If you are telling people all about your idea without a NDA or a patent application on file, you run the risk that your great idea will soon be your competitor’s great idea. Identify your core pieces of intellectual property and patent them.

7.   Failing to Have Adequate Employee Agreements: While these are less extensive than the founders’ agreements, you need at least a standard agreement in place for all of your employees and consultants that covers confidentiality, ownership of things they develop, etc. The agreement will not feel that important early on, but it will come in handy when your first employee is hijacked by a competitor.

8.   Failing to Check for Employee Agreements: If you are hiring someone from a company that has followed step No. 7, failing to investigate their former employee agreements can cause problems – especially if you are hiring them for their technical knowhow. If their “knowhow” is owned by their former employer or is blocked by a non-competition agreement, you may be getting less value than you bargained for.

9.   Failing to Comply with Federal or State Securities Laws: If you are asking even a couple of people for money – whether it is an investment or a loan – you must make sure you are observing the various securities laws. While you may not need to “register” your securities, you may need to file for an “exemption.” An improper offering can lead to regulatory fines and, maybe even worse, unwinding of a transaction.

10. Understand Key Contracts: If a third-party is important to a core part of your business, you need a contract with that party and you need to understand the core terms of that contract. In a breach-of-contract lawsuit, ignorance is not a defense.

Uncle Sam wants small-business owners to take notice of a new health-care tax credit — one of the first provisions of the recently enacted health-reform law to go into effect.

Last week, the Internal Revenue Service announced that it’s sending postcards to more than four million small businesses urging them to check if they qualify for the tax break. It’s being offered in two phases, with the first worth up to 35% of qualifying businesses’ premium health-care costs for tax years 2010 through 2013. The rate increases to 50% in 2014. The maximum length of potential coverage for qualifying employers is six taxable years: four years under the first phase and two years under the second.

In general, to be eligible for the tax credit, businesses must cover at least 50% of the cost of health-care coverage for some of their workers, employ fewer than the equivalent of 25 full-time workers and pay average annual wages below $50,000. The IRS says the tax break is designed to encourage smaller businesses – which are not mandated by 2014 to provide health care, unlike companies with more than 50 employees – to offer health coverage to their low- and moderate-income workers.

Tammy Rostov, owner of Rostov’s Coffee & Tea in Richmond, Va., says she received the IRS’s postcard and expects her small retail business to be eligible for the credit. She offers health coverage to her five full-time employees and pays 100% of the premium, an amount that she says has increased by more than 200% over the past six years. She describes the tax credit as a welcome relief. “It’s a step in the right direction,” she says.

But other qualifying business owners are less enthusiastic, arguing that the tax break won’t make a significant impact on their bottom lines.

Pascal Helou, owner of Globotron LLC, a technology-consulting company in New York, says affording health insurance for his three employees is a non-issue given that he’s struggling these days just to stay in business. Since 2007, he says sales have declined 30% every year and his firm now has four clients, down from 15.

“For my business, this type of tax credit will not make a difference,” says Mr. Helou, adding that he has yet to receive the IRS’s postcard about it. “The real issue is the amount of business we’re getting. Nobody’s willing to spend money” on technology-consulting services.

Meanwhile, there are also some entrepreneurs who don’t believe the government should provide financial incentives for small businesses to offer health coverage to workers in the first place.

Jim Fab, owner of Fab Electric Inc., an electrical contractor business in Gaithersburg, Md., falls into this camp. Providing health insurance and other benefits to his 18 employees, he says, is “hopefully what separates me from the electrical contractor that doesn’t.”

Some small businesses appear to be left without any government aide under the new piece of health-reform legislation. These include organizations with between 25 and 50 employees and ones with less than 25 employees but payrolls that average $50,000 or more.

Tracy Betts, says her Springfield, Va., Web-design business, Balance Technology Group Inc., doesn’t qualify for the credit. While she employs the equivalent of eight full-time workers, their salaries’ average $71,000. “For me, it’s all about the programmers, and I can’t hire anyone for less than $90,000 (in annual pay),” she says.

Ms. Betts says a year and half ago she told her staff she could only afford to offer them either health-care coverage or a retirement-savings plan with a matching contribution from the company. All but one chose the latter benefit, she says.

He goes on to note that “The financing strategy is showing promise. Its small-and-medium-business division posted a 10% gain in revenue in the company’s fiscal fourth quarter ended Jan. 29 from the same period last year, versus an 11% gain for the company as a whole. Operating-profit rose 17% from the same quarter last year to $282 million, surpassing the $281 million in operating profit from Dell’s large-business unit, which posted an 8.4% rise from last year.”

You can read the entire article here, and check out Dell’s page to see if anything interests you! A market snapshot on Dell here.

Under the Act, when an employer hires a “qualified employee” the employer is excused from paying the normal Social Security match of 6.2% of the wages in 2010. What is a qualified employee you ask? A qualifying employee is one who

• is hired after Feb. 3, 2010 and before Jan. 1, 2011;
• is not hired to replace another employee;
• is not related to the employer;
• and certifies under penalty of perjury that he or she has not been employed for more than 40 hours during the 60-day period ending on the date that employment begins with the new employer.

This incentive can save the employer over $6,000 annually for each qualified employee that is hired. Under certain circumstances, the employer who hires a new employee, and retains their services for 52 weeks, may also be able to receive an additional tax credit available on the 2011 tax return equal to the lesser of $1,000 or 6.2% of the wages paid to an employee for those 52 weeks.

These tax incentives are meant to spur job creation, especially for small businesses who are undecided about whether to begin to ramp up expansion efforts in light of recent economic challenges.

Here is the press release from the Ways & Means Committee Chair describing this bill.

While there is no specific reimbursement rate provided for in the Labor Code, there is guidance on the matter in both the Opinion Letters issued by the California Department of Labor Standards Enforcement (DLSE) and Labor Code Section 2802.

The DLSE has stated in its manual and opinion letters that it in the absence of other “evidence to the contrary” it will consider the use of the IRS mileage allowance rate as satisfying the requirement that the employer reimburse the expense’s incurred in use of an employee’s car. Businesses using the IRS mileage rate for calculating reimbursements should therefore be safe from under reimbursing their employees and violating Labor Code Section 2802.

On December 23, 2009, the Internal Revenue Service (“IRS”) issued the mileage rates used to calculate the deductible costs of operating an automobile for business purposes in 2010. Beginning on January 1, 2010, the mileage rates for the use of a car (also vans, pickups or panel trucks) will be $.50 cents per mile for business miles driven.

Failing to reimburse your employees at the proper rate subjects the business to a potential lawsuit, which could seek damages for the amount not properly reimbursed, interest from the date on which the employee incurred the necessary expenditure or loss ,and the employee may also seek all reasonable costs (including attorney’s fees incurred by the employee enforcing the rights granted by Labor Code §2802).

Double check the rates you are using when reimbursing employees for use of their personal vehicle for business purposes.

Internal Revenue Service Will Conduct Thousands of Random Employer Audits Beginning in 2010 Internal Revenue Service (IRS) officials recently stated that the IRS will randomly audit approximately 6,000 U.S. employers for employment tax compliance and proper worker classification. According to reports, the audits will begin in February 2010 and are expected to be completed within three years.1

The IRS intends to audit employers of all sizes and types, including non-profit organizations. The audits are part of the IRS’ National Research Program and have a two-fold purpose, (1) to generate revenue from non-compliant employers and (2) to serve as a statistical sample of employers that are in compliance while identifying areas of non-compliance and techniques used to avoid employment taxes.

The IRS expects to test how much of the estimated $15 billion “tax gap” attributed to employment taxes actually exists and may be closed.2 Also, the IRS expects the statistical evidence will help determine whether legislative or enforcement changes are necessary to address common employment tax evasion techniques.3 As a result, the audits are expected to be exhaustive and will concentrate on five employment tax issues:

1. worker classification,
2. fringe benefits,
3. non-filers,
4. officers’ compensation and
5. employee expense reimbursements.4

While the audits will begin with the examination of federal employment tax returns (Forms 941), the process will involve many other documents that pertain to the employers’ practices in these five areas.

A major focus of the audit will be on employers that have improperly classified their workers as independent contractors instead of employees. There are many temptations to misclassify workers: (a) shifting the cost of employment taxes to workers, (b) avoiding employee benefit costs, and (c) eliminating responsibilities under employment laws, such as civil rights or wage and hour laws. However, employers who misclassify their workers as independent contractors risk significant tax liabilities upon detection by the IRS, even if the employee paid the employment taxes due.5

Other issues that may be raised include proper treatment of (i) fringe benefits and per diems as tax-free, rather than as compensation subject to income and employment taxes, (ii) employee expense reimbursements that must comply with accountable plan rules for exclusion from employees’ gross income and (iii) executive compensation as reasonable in amount. The wide-ranging audit program is part of a trend to crack down on employment tax non-compliance, which includes heightened enforcement at the federal level6 and an increasing number of states sharing information with the IRS regarding questionable tax practices.7 Employers of every size and type should realize that their compliance with federal employment tax obligations may be scrutinized, and that they should review their compliance programs with their tax advisors before the audits begin.

For the full article with footnotes, click here.

For tax withholding changes that were effective November 1st – check this post too.

For help with compliance check out this post on hiring outsourced general counsel.

For example, if state income tax withholding is currently $400 a pay period on an employee’s regular wages, come November 1st , the withholding will increase to $440.

Payroll departments should be prepared to receive employee inquires and amended w-4 forms after the effective date.

This new change was part of legislation (ABX4-17) signed by the Governor to assist in accelerating tax collection due to the budget crisis at the State level (I know,  not just at the State level).

Littler has a more exhaustive posting on the topic here if you would like more information on this tax issue.

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