Tips on Starting a Business: You have a business name—now what?
Pop quiz!
See if you can answer these questions: Do you know how to properly structure your business? Will your business generate income during a limited time? Have you any experience with license applications and tax filing? And what do you do if your business has tax liabilities?
A successful start to business may begin with a great idea, but it certainly doesn’t end there. Your choice of business structure will impact day-to-day operations, taxes, and risk to your personal assets. Asking the right questions now and knowing where to look for the answers are a great way to get on the right track.
It may seem daunting and confusing at first, but the best way to uncomplicate things is to get to know information every business person or entrepreneur knows.
What You Should Know
A well-structured business involves more than just incorporation. Understand each entity and how it will affect you. Learn their differences before deciding which type to launch. Wouldn’t you like to have the ideal mix of legal benefits and protections for your business? Of course you would! Who wouldn’t? And as your business grows, it is always best to consult a professional about the next steps. But for now, we should learn the basics, and that starts with the LLC.
Understanding an LLC is not a Business Structure
Understanding how to properly set up a business starts with knowing what an LLC is. An LLC is simply a legal term for a Limited Liability Company. It is a corporate structure that separates your personal assets from those of your business. In short, if your business gets sued, you will not lose your house or the contents of your bank account. Doesn’t that sound great? With an LLC, you’ll be off to a good start.
There are a few things worth remembering when incorporating an LLC. First, there are no special tax or financial forms required. Second, you must have an Operating Agreement which details every asset that the LLC owns from day one. Third, you must keep this agreement up-to-date as your company expands. And, depending on the risk levels and tax rate, an LLC can be an excellent option for you.
Although an LLC is not a corporate entity, it can elect any entity type. Let’s discuss what these are and how to structure your business.
The four entity types are Sole-Proprietorship, Partnership, Corporation, and Sub-Corporation. These entities have different filing requirements, mainly franchise tax, and federal, state, and annual reporting. The great thing is that any business entity, other than a sole-proprietorship, can choose between fiscal and calendar year as well as choose how to account for income, be it cash or accrual basis. Before we continue, let’s get comfortable with these new terms.
Four Terms all Business Owners Should Know
Fiscal Year
Twelve months make up a fiscal year, which is the same length of time as a business’s financial reporting period. Using a fiscal year is perfect for seasonal and retail businesses, which experience a significant increase in sales volume at particular times of the year. Similarly, food trucks and online shopping commonly choose a fiscal year as this may offer a more accurate depiction of their business’ operations. Businesses that rely on contracts, like pest-control and logistics services, also benefit from choosing a fiscal year accounting period. A fiscal year can be the same as a calendar year, but not the other way around. Companies that rely on government contracts typically use a fiscal year.
Calendar Year
In business terms, a calendar year is a one-year accounting period that starts on January 1 and ends on December 31. For tax purposes, both individuals and businesses use a calendar year which is the most commonly used type of accounting period. This period corresponds to a fiscal year for individuals and corporate. It has all the financial data for the entire year, which is used to calculate the amount of income tax payable. Many businesses choose the calendar year because it is the simplest to use. Real-world businesses that follow the calendar year as their fiscal year include Alphabet and Amazon.
Cash Accounting
Cash accounting is a bookkeeping method that records income at the same time as the transaction. For instance, when selling a hotdog or grooming a dog, the customer pays you as soon as you hand them their hotdog or their pet; likewise, you record your expenses as you pay them. Businesses that use cash accounting are found at your county fair, neighborhood farmers or flea markets, and sidewalk kiosks. Traditional brick-and-mortar retail companies and small businesses also use the cash accounting method, such as hair and nail salons or corner grocery stores.
Accrual Accounting
The accrual accounting method records the revenue prior to receiving payment for product or services sold, but it records expenses as they are incurred. In other words, your statement will reflect that money has come in at the beginning of the transaction, even though the actual payment has not yet been given. We call this cash-on-delivery, and a great example would be a car repair shop or a business with custom-made products.
Common Types of Business Entities
Sole-Proprietorship
A sole-proprietor is a person who runs an unincorporated business alone. If you choose to treat a domestic limited liability company (LLC) as a corporation, and you are its only member, then you are not considered a sole-proprietor. It is important to note that, in legal terms, the sole-proprietor and the company are one and the same.
Sole-proprietorship is the easiest form of business entity. In fact, you are automatically a sole-proprietor if you do business activity and do not register as any type of business. It is perfect for low-risk businesses and entrepreneurs who want to test the waters first, such as home-based businesses; but it may also require paying a sizeable tax on your earnings.
Setting Up a Sole-Proprietorship:
- Use a calendar fiscal year.
- Attach your federal filing requirements to your 1040 tax form, which includes a Schedule C and Schedule SE.
- Your state will require you to file your personal tax return along with your business information.
Partnership
Similar to a sole-proprietorship, a partnership is also a simple business structure—the difference being that a partnership is when two or more individuals own a business together. Each person contributes money, property, labor, or skill, and shares in the profits and losses of the business.
Partnerships are a good option for businesses with several owners (like investment firms), professional organizations (like physicians, accountants, or attorneys), and those looking to test out a potential business idea (like software development) before forming a more formal company.
Setting Up a Partnership:
- The federal filing requirement is form 1065 (IRS Publication 541).
- Foreign partners will include FDAP.
- The tax return will generate a K-1, 2, or 3, which is used on each partner’s individual tax return for tax payment.
- States will require a filing as well.
- States that do not have state taxes, like Florida, require partnerships to file a state return F1065. If you are in a non-state tax state, check with your state for filing requirements.
Corporation or C Corp
A corporation, also known as a C-Corp, operates, realizes net income or loss, incurs tax obligations, and distributes earnings to shareholders.
There are two things worth noting about a corporation. When it makes a profit, it is taxed; but when dividends are paid to shareholders, the shareholders are also taxed. We know this as double taxation. Furthermore, shareholders are not permitted to deduct any corporate losses.
Although the cost to incorporate is more than other forms and requires more comprehensive record-keeping, operational processes, and auditing, corporations provide the strongest protection to their owners from personal liability. Another advantage a corporation has is its ability to raise capital through the sale of stock. Perfect examples of corporations include Walmart and Microsoft Corporation.
Setting Up a Corporation:
- The federal requirements include filing an 1120
- This may include making estimated tax payments quarterly if the tax liability is more than $1000 (Publication 542 provides IRS guidance and advice).
- The state requires the same filing requirements.
- States known not to have state taxes, such as Delaware, require a corporation tax return 1100; and for Florida it is F1120.
- If operating a business in a non-state tax state, check with your state on requirements.
Sub Corporation or S Corp
A Sub Corporation, commonly called an S-Corp, is a type of business entity designed to bypass the double taxation on a C-Corp. Federal double taxation is why S-Corps choose to “pass through” corporate revenue, expenses, deductions, and some losses to shareholders’ personal income. These shareholders are assessed on their individual income tax rates
S-Corps are responsible for tax on certain built-in gains and passive income at the entity level. The S-Corp is, unsurprisingly, the most popular business entity in the country.
Qualifications for Sub Corporation:
- Be a domestic corporation.
- Have only allowable shareholders.
- Have no greater than 100 shareholders.
- Have only one class of stock.
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
Setting Up an S-Corp:
- The federal requirements for an S-Corp include filing 2553 or 8832 to request to be this entity type.
- This includes annual filing of 1120S, which will produce a K1, 2 or 3, and sometimes a B1, to be used on shareholders’ personal tax return.
- State requirements are the same.
- Estimated tax payments must be made if tax liability is $100 or more.
- States known to be tax free, such as Delaware, require filing of 1100S.
- States such as Florida do not have a filing requirement because an S-Corp is a pass-through entity.
Conclusion
These are the most common business entities and, depending on your current and future plans, it pays to know them all.
When deciding to incorporate your business, know which will work best for you in terms of how it will affect your personal tax return, the business filing requirements on the federal and state levels, and the type of year and accounting method which will work best for your finances.
Resource
The most helpful resource for doing your own research online is to read the Tax Guide for Small Business (Publication 334) at irs.gov.
Research is definitely beneficial, but it will only get you halfway there. For this reason, it is best to consult a team of dedicated professionals who can guide you through the ins-and-outs of starting and running a business.
We are that team! We will help you make the big decisions and properly structure your business to suit your needs. From applying for licenses, to keeping you current on your tax filings and dealing with tax liabilities, we’ll take away the stress of paperwork so that you can focus on building your business. Wouldn’t you like to be updated on important announcements? We have two to share with you right now! The extended deadline for federal tax payments is on October 16. Now, that’s some good news we wouldn’t want you to miss!
Joy the Bookkeeper has helped dozens of business owners succeed in both starting a business and navigating through tax season. Our clients are our success stories. We want you to be a success story, too.
Start by calling one of our friendly consultants today. Book now if you want a FREE 30-minute consultation with Joy the Bookkeeper.