The Common Case: One or Two Founders

Most readers will never run a venture-scale company. The typical business this chapter serves is small and asset-light: one or two founders, few or no employees, and — because the costs are mostly the founders’ own time — high profit margins. Consulting practices, design and software shops, professional practices, and niche product businesses all fit the mold. For them the architecture is settled, and worth stating plainly.

A high margin works against you in one specific way: with few real expenses, you have little to deduct and a great deal of profit, and the temptation is to manufacture deductions. Resist it. The returns here derive from structure, not inflated expenses; the moves below, applied in order, do far more than another marginal write-off, and none of them invites an audit.

For a single founder, the sequence is direct: begin as a sole proprietorship or single-member LLC, and elect S-corporation status once profit clears the break-even threshold (section “Reasonable Compensation and the Break-Even Point”) — which, on high margins, happens fast. Be clear-eyed about which benefit you are buying. An asset-light business owns little qualified property, so above the IRC §199A threshold the S-corporation salary is the only thing that can unlock the Qualified Business Income (QBI) deduction — but if the business is a specified service trade, as most one-person professional practices are, the deduction phases out entirely at the income ceiling regardless. There the S-corporation still earns its keep through the self-employment-tax saving alone; just know that is the lever you are pulling.

For two founders, two things that never arise for a solo owner become essential. First, put the ownership terms in writing: an operating or partnership agreement, and a buy-sell agreement specifying what happens to a departing owner’s share on death, disability, divorce, or a plain falling-out — ideally funded with life insurance, so the surviving owner has cash to buy the share instead of being forced into business with a former partner’s heirs (section “First-to-die Policy”). Write it as a cross-purchase between the founders, not a corporate redemption: after Connelly, a policy the company owns on a founder inflates that founder’s taxable estate by the death benefit with no offset for the buyout obligation (section “Buy-Sell Agreements: Fixing Value and the Connelly Trap”). Second, if both founders work in the business, both draw reasonable salaries under an S-corporation, and the profit split and the salaries must track each founder’s actual contribution — a mismatch invites disputes with the IRS and, worse, between the founders. Any pay a founder agrees to take later — a deferred bonus, a salary deferral until the next round closes — is nonqualified deferred compensation under IRC §409A, “Inclusion in gross income of deferred compensation under nonqualified deferred compensation plans”, with a 20% additional tax on a plan that is not documented and timed to the statute’s rules (section “Compensation for Services”). Put the deferral in writing before the service is performed or do not defer.

Finally, high margins mean large quarterly estimated payments. Get the section “Safe Harbor” right from the first profitable year; a high-margin business that ignores estimated taxes merely converts a tax bill into a tax bill plus penalties.