So, you’ve decided to take the plunge and start your own business! No more rude bosses or flaky co-workers. No more dancing to the tune of upper management’s latest ditty. No more waiting on other departments! No more performance evaluations! Now YOU get to call the shots. YOU get to be responsible for your own decisions and reap all the benefits of your ideas and hard work. And YOU get to answer to the government! Or, if you’re able, to hire someone who will. Let’s face it, one way or another, every good business is an accountable business, operating within the acceptable practices and laws of its state, nation, even the entire world.
Trial by Fire
If you are like the typical start-up business owner, you know much more about your product or service than you do about structuring a business entity or paying related taxes. To help get you through this fiery ordeal with only minor smoke damage, here are the highlights of selecting the legal form of your business, registration and licensing requirements, tax liabilities, and insurance considerations.
Not to be overlooked is the assistance of an attorney or accountant. You will almost certainly require the services of one of these over the life of your business – an accountant, for sure, when filing your federal taxes – so it will be good to find one you can grow with. The Yellow Pages and the local Chamber of Commerce are good sources for leads, as well as word-of-mouth. An accountant need not be in a firm, or even be a Certified Public Accountant (CPA) to be just what you need, although a CPA will have had extensive education and experience with the foundational aspects of business ventures. At the least, conduct phone interviews with a couple of prospects, asking such things as their business education and experience, types of businesses in their clientele, their availability and fees. On the practical side, make sure this is someone you can talk with, who can answer your questions without making you feel like you wish you hadn’t asked.
Big Legal Decision #1
What form will your business take? There is no perfect answer to that, as each of the options has advantages and disadvantages. The major considerations will be among the trade-offs in personal liability, taxes, control, profits and losses.
Every business is some type of legal entity: either it is defined separately from its owner or it is not. A sole proprietorship is identified entirely with its owner, who has complete control over all management and operational decisions. If it prospers, so does its owner; if it has debt, so does its owner; if it is sued, so is its owner; if its owner dies, so does it. A sole proprietorship can be in the owner’s name, or can conduct business under a fictitious name, the familiar “Doing Business As” (dba) designation.
A fictitious name is usually registered on-line with the state’s Business and Corporation website, for a small fee. A sole proprietorship doesn’t face double taxation as a corporation does, because the owner pays personal income taxes on the profits made, making accounting much simpler. A sole proprietor is considered to be self-employed and is therefore required to make quarterly estimated tax payments, usually a minimum of 15% of estimated taxable income. A sole proprietor can also have employees with certain tax liabilities. This is discussed in the “Tax Liability” section.
One disadvantage of a sole proprietorship is that it can have a harder time raising capital, since it tends to be perceived as less solid than a corporation, partnership, or limited liability company. It has no shares to sell to raise capital as a corporation does. Potential investors are, in effect, investing in the owner himself. Another disadvantage of a sole proprietorship is that as a business becomes successful, the risks associated with conducting business tend to grow, such as taxes on higher income, employee liabilities, production costs, risk of lawsuits, and changing marketing considerations. At this time, a sole proprietor can decide to trade off some independence for protection by forming a corporation or limited liability company.
Legally, a corporation is a person – not a human being, but a distinct entity separate from any human being associated with it, including you. You may own all the stock, but the corporation still ”lives on” even if you die. You are not liable for a corporation’s debts, and if it is sued, you are not, unlike a sole proprietor. Incorporation may require the involvement of an attorney or accountant, but you can accomplish it on your own through your state’s business website. The fee is considerably more than for a sole proprietorship, usually several hundred dollars, and there is an annual recertification fee.
You will need to select a name, keeping in mind how important a good name is in the marketplace. Refer to the post “Choosing a Successful Name” for some solid advice. You might even want to trademark the name, and you would be well advised to search the US Patent and Trademark Office’s database at www.uspto.gov, as well as your state’s database, to make sure the name is not already in use. You may choose to name your corporation one thing and do business as another, in which case you would register the dba as a fictitious name through your state’s business website.
A corporation has officers, you most likely being the President, and is governed by a Board of Directors. You must hold annual shareholder meetings and document the proceedings. Corporations also have bylaws, which you will not have to write from scratch, but will tailor with the help of your attorney or accountant. Software programs are available, such as Quicken Legal Business Pro 2011, to help create the necessary documentation.
Corporate profits are taxed at the corporate rate and are usually distributed to the shareholders as dividends, which then are taxed as personal income. A special type of corporation, the S Corporation, does not face this double taxation, since profits are not taxed, but are divided among shareholders according to percentage of ownership and become part of personal income. Likewise, S corporation losses become part of the personal income tax return.
As it sounds, in this business entity, control is shared by agreement among the partners. Although not necessary, it’s best to draw up a partnership agreement, detailing who is responsible for what and to what extent. Quicken Legal Business Pro 2011 offers a template for creating a Partnership Agreement. Each partner is always accountable for their own business-related actions, as well as those of the other partner(s.) In other words, if one partner’s actions result in a lawsuit, all other partners are equally liable. All partners are personally liable for the partnership’s debts. The income (or loss) of the partnership is allocated to the partners according to their agreed-upon percentages and are taxed as personal income. Capital gains (or losses) of the partnership are capital gains (or losses) of the partners and are allocated according to agreement.
In a Limited Partnership, there are also limited partners (LP) in addition to the general partners (GP). The GPs have management control, share in the profits proportionate to the agreement, and are liable for the limited partnership’s debts. The LPs have no management authority and are liable for debt only to the extent of their investment.
In a Limited Liability Partnership (LLP), the partners each have management authority and enjoy liability protection similar to that of a corporation, with the partnership, and not the individual partners, being responsible for obligations. Usually, LLPs are formed by professionals such as attorneys or accountants, and in some states, are limited to these. Check out your state’s business website for information pertinent to you.
On the disadvantage side, all partnership types are liable for self-employment tax, and the necessary quarterly estimated tax payments. Setting up a partnership can cost several hundred dollars, but not usually as much as a corporation.
Limited Liability Company (LLC)
An LLC provides limited personal liability to its members, similar to a corporation and a limited liability partnership, and in contrast to the personal liability for the debts and obligations of the business that are borne in the general partnership or sole proprietorship. LLCs do not have bylaws as do corporations, but you may need to write an operating agreement, spelling out the duties of the members. Some states require a written operating agreement.
An LLC can be classified as a corporation, partnership, or proprietorship for tax purposes, and its income (or loss) flows to the members’ tax returns as in an S corporation, sole proprietorship, and partnership. Quarterly tax payments of estimated self-employment tax must be made, unless the LLC is classified as a corporation. Generally, the state filing fees for an LLC are a couple hundred dollars. Quicken Legal Business Pro 2011 has a section on “Running Your LLC.” It contains a boilerplate Operating Agreement all ready for you to adapt to your needs, plus consent forms for LLC members, forms for meeting notices and a format for meeting minutes.
Making a Federal Case of It
Regardless of the type of entity you choose, you will need a Federal Employer Identification Number (FEIN or EIN). If the number is needed for identification only, it is referred to as a Tax Identification Number (TIN). This nine-digit identifier is necessary when filing tax reports, paying employee taxes, applying for credit, and opening business banking accounts. You can get one on-line by going to www.irs.gov under the Business tab. Complete and submit Form SS-4 on-line or print out, complete and mail. You can also call the IRS at 800-829-4933 and complete the process, receiving your number immediately, if you are an authorized owner of the business.
Before completing the form, you must decide the type of tax entity your business is: corporation, partnership, or sole proprietorship. Of course, if you have been working with an attorney or accountant, they will know and may even obtain one for you. Or, you can call the 800-number and the agent will help you determine this. If submitting on-line or over the phone, you will receive the number immediately; if by mail, allow a week or two. After you receive your number, the IRS will contact you about setting up online filing of your tax liabilities (discussed below.) This may prove very handy for you, but these filings can also be done through the mail.
Registering Your Business
You will most likely register your business in the state where you live. If you are incorporated in one state and open a branch operation in another state, you will need to register as a “foreign corporation” with that state. This can usually all be done online by visiting state Business websites. As a minimum, you will register the business’ name, address, physical location, and the names and addresses of owners or officers. Your city may require a business or occupational license. The licensing division is usually one of the city government offices and can be found in the government section of the phone book. Your county may also require you to register, so check with the county clerk’s office.
Business Tax Liabilities
The list of taxes levied on businesses only seems endless! As an individual, you are accustomed to paying federal income, state income, sales, property, real estate, federal withholding, Social Security, and Medicare taxes. Your business, also a legal entity, pays these plus a couple more. The ways that these are paid by your business is different from how an individual pays them in most cases. Here is a discussion of each and some suggested sources of help for you:
Income taxes for C and S corporations are due to the IRS by March 15 of the tax year, using Form 1120 or 1120S. Six-month extension requests may be made using Form 7004. Sole proprietorships file on the owner’s Form 1040. Partnerships file using Form 1065. Software application packages such as QuickBooks (http://quickbooks.intuit.com) and Peachtree Accounting (http://www.peachtree.com) can help you to keep the financial data you need in categories that make filing taxes much easier. TurboTax (http://www.TurboTax.com) also contains all the forms you need for filing. Initially, you may want your accountant to head up this process, as it can be confusing to the uninitiated, but you can grow familiar enough with the process in time to do it entirely by yourself. If your state collects income tax, it is normally filed at the same time, using the appropriate state forms, which you can locate on the state’s Business website.
When your business purchases items intended for resale, you do not pay sales tax on the purchase if you have a state tax resale number, since your customers are the ones paying the tax. You can obtain a resale certificate through your state’s Business website, or regional branch office (check out the Government offices pages in the phone book.) When you collect sales tax from your customers, this must ordinarily be reported and paid before the end the following month. As of now, internet sales are not taxed, except those sales to customers in your state of business registration. Some cities and counties also require collection of sales tax, so be sure to check with their local offices.
Taxes on equipment and machinery are usually required by county or city governments. Check with the local tax appraiser’s office or wait until they contact you, which is a part of the business registration process. They send you a form asking for a listing of equipment, its purchase price, and current value. They assess the amount of tax you then owe.
Some states require the annual payment of an intangible property tax. Common types of taxable assets are:
- Stocks & bonds
- Loans & notes
- Mutual funds, including money market funds
- Ownership interest in a limited liability company
- Interest in limited partnerships registered with the Securities and Exchange Commission
- Accounts receivable not arising from your normal course of trade or business.
Check with your state’s Business website, or your accountant, for further information.
Before we discuss taxes, let’s look at a couple of required forms you must have for each of your employees. When you hire employees, your business is required to keep on file an Immigration and Naturalization Services Form I-9, Employment Eligibility Verification. This is to show that a person is legally permitted to work in the US. The form itself contains guidelines for acceptable identification.
Each employee also fills out a Form W-4 Employee’s Withholding Allowance Certificate, which shows the number of deductions each is entitled to claim, affecting the amount of federal withholding. This is the number you use when referring to the Federal Tax Table, Circular E, to withhold the proper amount of tax from the employee’s paycheck. Each employee also has 4.2% (new rate for 2011) of the gross pay withheld for FICA (aka Social Security) and 1.45% for Medicare. You must match this 6.2% and 1.45% for each employee. Within certain dollar-amount guidelines, you deposit the sum total of all withholding and employer match monthly, using tax coupons, indicating this is for Form 941. Quarterly, you fill out Form 941, to show that your 3-month liability and the three deposits you have made during the quarter total the same amount. You can make up any difference by including a check with the report, or rolling over any overpayment into the next quarter. Form 941 must be mailed back to the Department of the Treasury by the last day of the month following the end of the quarter. (For instance, a report must be filed by April 30 for Jan-Feb-Mar.) QuickBooks (http://quickbooks.intuit.com) and Peachtree (http://www.peachtree.com) have payroll features that allow you to figure paychecks, accumulate funds, track deposits, and prepare Form 941.
By Jan. 31 following the tax year, you are required to issue Form W-2 to each of your employees, and to file Form W-3 with the Social Security Administration by Feb. 28, along with copies of the W-2s. Again, accounting software can make this an easy process.
Your business may hire some independent contractors from time to time. In order to be an independent contractor, they must truly be separate from your business and management control; otherwise you can be fined for evading employment taxes. Check out www.irs.gov for further clarification. If you pay someone as an independent, have them fill out Form W-9 Request for Taxpayer Identification Number and Certification. By Jan. 31 following the end of the tax year, you issue each a Form 1099-MISC if the amount you paid any of them exceeded $600.00, along with Form 1096 Annual Summary and Transmittal, which must be sent by Feb. 28. Quicken Legal Business Pro 2011 has a section on “Hiring Employees and Independent Contractors” which is well worth taking the time to read to ensure that your independent contractors truly are independent, in the eyes of the government.
Federal Unemployment (FUTA)
If your federal unemployment tax liability exceeds $100.00 for the tax year, you are required to make monthly deposits, indicating 940 on the tax coupon. You only pay unemployment tax on the first $7000.00 of each employee’s wages. You file Form 940 by Jan. 31 following the tax year. Either of the software packages QuickBooks (http://quickbooks.intuit.com) or Peachtree (http://www.peachtree.com) will track your liability and prepare this report for you.
State Unemployment (SUTA)
State unemployment tax reports are filed quarterly by the end of the month following the quarter. When you register with the state as an employer, you are issued a withholding multiplier. The state can change this from time-to-time, depending on several factors, and you are notified if it changes. Again, you only pay unemployment tax on the first $7000.00 of each employee’s wages. QuickBooks (http://quickbooks.intuit.com) and Peachtree (http://www.peachtree.com) have a feature that allows you to automatically calculate this, as well. Some states require that you report New Hires, so check with your state’s Business website to make sure you remain in compliance.
The amount of liability insurance you carry depends on your industry and the types of products you sell. A business selling products for children faces broader liability vulnerabilities than does one selling books. You may wish to consult an attorney for a definitive ruling on how much you need to carry, but you can also check out industry standards through trade associations and insurance companies. Some states will not license certain businesses that do not have the minimum recommended coverage. Check with local and state licensing agencies for more details. Getting quotes from several companies is quick and easy on-line: just search on ‘business liability insurance’ and take your pick. Your business may also need to carry Worker’s Compensation insurance. Again, check with your accountant or attorney, or your state’s business website for guidelines. In most instances, business owners and principals are able to file an exemption, a big financial break.
There are many legal issues facing businesses, and though they may seem overwhelming at first, most business owners manage to navigate the sea of them and survive. Attorneys and accountants can prove invaluable, but there is also a multitude of information and assistance available online and through software applications. One of the most crucial decisions, with long-term implications, is how to structure the company, which affects many of the tax and liability issues. Weighing all the options before making the decision sets a wise course.
IMPress Action Checklist
Below is a list of the steps that will help you address the legal issues you face. Check off each step as you complete it to keep track of your progress.
- Select an attorney or accountant to interview
- Review the types of business entities, deciding which is best for you
- Get with your attorney or accountant, or proceed to the next step yourself
- Visit your state’s Business website to check out business entity requirements
- Download needed Business Entity registration forms or complete online
- Select Accounting Software and begin accumulating data for tax filings
- Apply for FEIN online, by phone, or by mail
- Register your business with city and/or county offices
- Set up State Unemployment Tax account
- Contact your Property Tax Appraiser’s office, or wait for them to contact you
- Obtain Sales Tax Resale Certificate
- Set up Unemployment Account with state
- Get Federal Tax Deposit Coupon book through mail, or set up online account
- Check out Liability Insurance requirements and obtain coverage
- Make Sales Tax report by month-end to state, city, and county, as required
- Make Employment Tax deposits by the 15th online or using coupon for 941
- Make 940 deposits monthly, if accumulated liability exceeds $100.00
- File Form 941, reconciling monthly deposit total with tax liability
- File State Unemployment Tax report
- Make Quarterly Estimated Tax Deposits (if not a C or S corporation)
- File Form 940 Federal Unemployment Tax report by Jan. 31
- Prepare and Mail Employee W-2 forms and Contractor 1099-MISC by Jan. 31
- Prepare and Mail W-3 form and Form 1096 by Feb. 28; include copies of each W-2 and 1099-MISC
- File Intangible Property Tax Return with State, if applicable
When You Hire
- Have employee complete Form W-4
- Complete and File Form I-9 with photocopies of verified employee identity
- Report New Hires to state, if required