Money Conversations: New Beginnings
The world has undergone a lot of changes in the past couple of years. The pandemic has shown a lot of people that traditional work model is not the only solution to earn a living. In fact, World Economic Forum reported that “the number of new business applications was higher during the summer of 2020 than at any time in the past 15 years, and it has remained strong ever since.”
If you have ever thought of starting your own business or were already brave to do so, then this article might offer a few helpful tips regarding the organization of your business. At times, newly baked business owners simply lack the basic know-how of business organization which can lead to unpleasant surprises in the future. First things first. To stay afloat, you must know how to: one – operate legally meaning how to properly organize, register, pay taxes and two – protect yourself from unforeseen losses.
The simplest business structure is a sole proprietorship. Any individual may operate a business under their own Social Security Number. Most of the time, they would not even have to register anywhere and can report their earnings on Schedule C of their personal tax return. The disadvantage of this type of structure is that if anyone decides to sue the owner for whatever reason and the court finds the defendant at fault, they would be liable with all their assets – both business and personal. For instance, if you mowed someone’s yard, busted their window and did not have a penny to your name to pay for it, the judge could order you to sell your home TV to pay for the repair. Limited Liability Company (LLC) is a better option in the case where you would like to separate your business from personal belongings. To start an LLC all you have to do is register with the secretary of state. It is also recommended to apply for an Employer Identification Number (EIN); however, not imperative, so you can still operate under your SSN if you would like. For sole-member LLCs or married couples owning an LLC together and filing taxes jointly, it is still possible to report their earnings on Schedule C as part of their personal tax return, which makes taxes way easier.
If you are not the only owner in the company, you can form a general partnership, Limited Liability Partnership (LLP) or a multi-member Limited Liability Company (LLC). The difference between a general partnership and an LLP is same as the difference between a sole proprietor and a sole-member LLC. General partnership can exist on an informal basis, while LLP has to be registered with the state. The difference between LLC and LLP, however, is that LLC offers personal liability protection from the company’s debts and lawsuits while with an LLP, the partners are liable to the extent of their own negligence. One partner may not be personally liable for the negligence of the other.
An Operation Agreement that spells out the percentages of ownership and rights and responsibilities of each partner/member is required in such instance. Partnerships and multi-member LLCs have to apply for an EIN and file a separate company tax return on form 1065. Each owner receives a copy of Schedule K-1 from form 1065 which contains their prorated portion of income, credits and deductions and then includes Schedule K-1 as part of their personal tax return to pay self-employment taxes. Please, note that business tax returns are due prior to personal returns, usually by March 15.
Companies owned by shareholders (usually larger businesses) are formed as corporations. While corporations offer lots of benefits including asset protection against creditors and legal claims, they are more complex in organization and management. Corporate income is also taxed twice: once on the entity level and once on shareholder level.
Once you have organized, registered with the state, received your EIN and drafted the articles and operation agreement, you have to make sure to receive all the necessary permits and licenses. For instance, if you are opening a store, you would need to apply for a Sales Permit from the Department of Revenue and a Privilege License from your municipality. Then you would have to report your sales and pay the sales tax monthly to the state and pay privilege taxes annually to your town. You have to figure out whether your business falls in the products or services category. For example, if you are an attorney or a handyman, you provide a service and do not have to apply for a sales tax. But if you sell anything in your store, restaurant, etc., you will need a sales permit. Sometimes it may be hard to figure out, so better check with your state first.
Besides having a permit to operate, you also have to have a license to do so. That way the government wants to make sure you know what you are doing a good job and ensure safety for your customers. For example, you would not want to see a doctor who does not have a license to practice medicine or live in a house built by someone without a license.
While some business structures offer a certain degree of protection for your personal assets, you might want to further consider how to protect your business assets. This is where business insurance comes in. Depending on your type of business, you may want to consider a malpractice insurance (it is offered not only to doctors) and Workers Compensation Insurance if you have employees/contractors working under you.
Each business is different. There always has to be a lot of thought put into how to organize and operate your business. Hopefully, this article could guide you into some of the basics of where to start if you decide to explore this exciting avenue.