The following is an outline of steps to follow when starting your own business. It is impossible to cover every topic, but I have chosen the bare minimum of information you should consider. As always, you should consult the professionals who do this every day and have invested many hours of study in order to be current with the laws and regulations.
Choosing a name
When starting your own business, the first official move you need to make is choosing a name. It may seem simple, but there are several things to consider. You want to make sure that no one else has already chosen that name and trademarked it. You also need to make sure that no one else has reserved that name in your state. You can do a quick search on the GA Secretary of State website.
Be careful choosing something too close to another business’ name. You will not want customers mixing you up with another. The Secretary of State will allow you to reserve your name for a small fee. Once you apply for this, your choice gets checked against their records and the SOS will send you an email with approval or request for changes.
Is this a business or a hobby?
If your business is not conducted for profit, it could be considered a hobby by the IRS and the deductions will fall under certain limitations. This determination is in place to deter taxpayers from setting up “businesses” just to benefit from deductions and losses year after year.
There are nine relevant factors which help determine whether an activity is a legitimate business established for profit or conducted mainly for sport or recreation. At a later date, we will go into more depth about this issue.
Choose an entity type
The common entity types are as follows: Sole proprietor, partnership, s-corporation, and c-corporation. Here is where you really need to speak to a professional. In a separate blog, we will discuss a few benefits and drawbacks to each type, but a conversation with your attorney concerning your liability and risks is invaluable at this point.
Make applications
Do you need to be an LLC or Inc?
Limited Liability Companies and Incorporations are set up on the state level with the Secretary of State. Here is another perfect occasion to speak to a professional. Choosing one of these entities can force you into a tax situation you are not prepared for.
Example: a married couple decides to open a booth in a farmers’ market, and they set up a two-member LLC with the Secretary of State. By default, they have forced themselves into filing of a partnership return at the end of the year. Had they not applied for an LLC, they may have been able to file as a qualified joint venture on their personal 1040.
If you determine that an LLC or Inc. is the best route for your business, this application to the SOS should be done before you apply for a Federal ID Number (also called an Employer Identification Number, EIN).
Federal ID number
The application for the FEIN can be made by mail or online at the IRS website. Did you note the statement above that the application should be made after you have applied to the Secretary of State for your LLC or Inc. In my practice, most of my clients needed this number yesterday because they already started their business and don’t have two weeks to wait around for the approval from the SOS.
What would happen if you received the FEIN before you found out that the SOS didn’t approve the name you have chosen? That is going to cause you trouble and more paperwork.
If you are a sole proprietor and operate a very small business and an LLC is not a good fit for you at this time, you can still apply for a FEIN. This will keep you from having to give out your Social Security Number.
State accounts: sales tax, withholding tax, excise tax
The state applications will vary according to the type of business you have. Will you be selling goods? Will you be selling goods subject to sales tax in more than one state? Will those goods be subject to special excise tax such as tobacco products or alcohol? Will you have employees? These applications will be made at the state’s department of revenue websites.
Local permits: location approval, business license, other permits
Many cities, counties, and municipalities require permits and licenses depending on the nature of your business.
Open a bank account
The bank will need your EIN, address, usually a personal guarantee, and maybe the company operating agreement. It is imperative that business and personal funds are kept completely separate. Separate bank accounts make it easier for you to track your transactions and makes the sole proprietor tax return easier to prepare. LLC’s, partnerships, and corporations must have their own bank account.
What kind of funding will you need? Some businesses start up with minimal cost, but others require a large investment. There are rules for the deductibility of startup costs. A tax professional can help with this question. It is also imperative that each owner/partner tracks his or her own basis in the company (the contributions of money or assets they make to the company).
What is income?
Anything received in exchange for goods or services is considered income. Most of the time this means money, but the receipt of goods or services (bartering) is also considered income and is includible on your tax return and your books. Cash is considered income.
What can you deduct?
Expenses may be eligible to be deducted if they are incurred in the pursuit of income and are ordinary and necessary for the type of industry.
There are many categories of deductions and each may have its own set of rules. Here is a quick overview of a few of the categories.
Auto expenses
Two methods used to deduct vehicle expenses are: actual expenses, and standard mileage rate. Both methods require a contemporaneous log of mileage (date, destination, purpose, number of miles). A calendar may suffice but there are apps available which can even connect to your accounting software and track this expense.
Meal expenses
Meals may be deductible while traveling for business, or if provided to a client, customer, or employee. Usually, meals are only deductible at 50%. There are exceptions. Receipts are required for each meal showing the date, amount, people present, and the purpose for the meal/meeting. Entertainment expenses are no longer deductible.
Home office
An in-home office may be eligible for deduction if it passes several different tests:
- exclusive use
- regular use
- business use
- principal place of business use
To pass the exclusive use test, your business has to be the only activity carried out in that space. You cannot use the same space for business that you use for the guest room or searching the internet and watching Netflix. To pass the principal place of business test, it has to be your primary workspace. In most cases, if you have an office elsewhere, you will not pass this test.
A home office is treated differently depending on the type of entity you choose. A sole proprietor may be able to deduct his expenses on his form 8829, but a member of an s-corporation is not eligible to use this same form. Your tax professional will be able to advise you on your options. You may benefit from setting up an accountable plan if your home office is eligible.
Then, there are two different methods for deducting the expense: actual expenses and simplified method. Both methods require information about the square footage of the office and of the whole house. There are benefits, as well as drawbacks, to both methods. We will discuss this in a separate post.
Large purchases, equipment, vehicles
Some expenses are not eligible to be deducted in whole in the year they are put into service. Large items such as furniture, equipment, and vehicles must be depreciated. This means that you can take a portion of the deduction for each year until the end of the IRS class life. This usually pertains to items put into service which are useful for more than one year.
Rental property gets depreciated depending on its type, residential or commercial. Improvements are depreciated. This includes buildouts, remodels, roof replacements, etc. Goodwill is amortized in a similar way. Do some research. Check with your tax professional. More detailed information will be available in a future post.
Employee vs. Contractor
The determination of a worker as an employee or contractor depends on factors from three main categories: behavioral control, financial control, and relationship of parties. If you tell the worker what needs to be done, how it is to be done, when it is to be done, and you provide the tools to get the job done, that person is probably an employee.
This is a crucial determination to make. Check out this IRS publication 1779 concerning this issue. If you determine that those working for you are indeed employees, there are payroll requirements and quarterly tax obligations to fulfill. As well, if your business is an s-corporation, you have a payroll requirement to pay officers a “reasonable salary.”
Record keeping
It is important that you keep accurate records of income and expenses. Records, logs, and receipts should be kept, each having a recommended or required length of time.
Records can be kept in a variety of methods. Paper, computer spreadsheets, accounting software… Whatever you choose, keep personal and business separated, keep your receipts, be accurate, and get help if you need it. Those who are not comfortable keeping books can save a lot of money by spending a little to have professional help.
Tax returns
Your entity type will dictate which tax return needs to be filed and the due date of that return. The schedule C on your personal tax return is due April 15 following the close of the business year. The 1120 for the C-corporation is due April 15. The partnership 1065 and the S-corporation 1120S returns will be due March 15 so that the shareholders, partners, or owners have K1’s in time to prepare their personal returns by the April 15 due date.
Taxes due
Sole proprietors: once the profit of the business is determined, that income is subject to federal and state income tax at the rate for your tax bracket, and is also subject to 15.3% self-employment tax. You may be required to make estimated tax payments quarterly (April 15, June 15, September 15, January 15).
Partnerships: the 1065 is filed and taxes are paid by the partners on their personal tax returns according to the information they received from the 1065 K1. This income is subject to the regular personal tax rates and may be subject to self-employment tax.
Subchapter S corporations: the 1120S is filed and taxes are paid by the shareholders according to the information on the K1. This profit is subject to the regular personal rates and is not subject to SE tax. Shareholders who work for the company are expected to be paid a reasonable salary and will receive a W2 for this income.
C Corporations: the 1120 is filed and the corporation pays its own tax. There may be a requirement to submit quarterly estimates. Shareholders may pay tax on dividends from the corporation and may also receive a W2.
I cannot stress how much a few conversations with a professional tax preparer and an attorney can save you time, money, hassle and paperwork. I have heard it said that all successful people need an accountant, insurance guy, pastor, and attorney.
If you have questions, please contact our office. First City Income Tax & Business Services, LLC, 912-335-5404. We provide help with all the services mentioned above.
Many of these topics will be discussed in more detail in future posts. If you want to subscribe to the blog to receive future access, click here.