I wrote this up several years ago but it might be of some help here on starting a business in the USA. It is weak in some areas but should be a good start for someone wanting to start a business. The information was gathered prior to the start of our first business. (Yes, we have had more that one!)
The information provided is believed to be accurate at the time of this writing and is solely my opinion. I am not an Attorney or CPA and am not offering legal or tax advice. I strongly advise consulting an Attorney, Tax Professional or CPA prior to acting on my opinions. The content provided is derived from existing business codes and published tax sources as well as from organizations mentioned.
I am not affiliated with, retained by or employed by any organization I mention. My opinions are based on a number of years of research in the area of starting and running a business and the unique challenges faced by small businesses. If any specific entity is mentioned that I have done business with a note with the relationship will be part of the text.
My philosophy on small business is for the business owner to have knowledge of tax and legal options as well as to understand aspects of the business that are not part of the core operation. Only then can a business owner make intelligent decisions from advice provided by professionals such as an Attorney or CPA. It is, after all, your business and your responsibility.
Selecting a business organization type is only the beginning. There are a number of one-time and ongoing issues that need attention to keep a business viable.
There are three basic types of business entity. The corporation, the limited liability company and the sole proprietorship. Each of these has its own qualities and sub-types for specific situations. An exhaustive review of each sub-type is beyond the scope of this document to explore but it is worth noting the high-points of each.
C-Corp: A C-Corp is the type of corporation you think of when any big corporate name is mentioned. Non-Profit organizations normally must be a C-Corp type of organization.
- Liability is limited to investment in the company via stock purchases
- Funds can be raised by issuing more stock
- Control of the company can be lost when the principles no longer hold a majority of the stock
- There are a large number of regulatory requirements that must be met and with that comes added cost to do business
S-Corp: An S-Corp uses the liability limits and funding mechanics of a C-Corp and the simplicity of operation of a Sole Proprietorship.
- Limited liability for the investors and owners
- Simpler accounting and record keeping than a C Corp
- Operates with the simplicity of a Sole Proprietorship
- Similar protections of a C Corp
- Limited number of shareholders
Limited Liability Company (LLC) and Limited Liability Partnership (LLP) are only slightly different. The LLC is a relatively new concept and has been adopted in all 50 States and the codes are fairly uniform. Some States even allow a single person to form and LLC. Some business types may not be an LLC but may be and LLP. These are typically business that operated under regulations that are found in financial institutions.
The adoption of the LLC code by all 50 States is a boon for small business and we believe it has made the S-Corp obsolete. An LLC/LLP basically allows all of the advantages of a Corporation that an S-Corp allows without all of the complications of incorporation.
- Limits liability of the principles to their investment
- Operates with the simplicity of a Sole Proprietorship
- Is relatively easy compared to a corporation to start and operate from a Registration, Tax and Accounting perspective
- Is more limited in its ability to raise capital
- Keeps income tax liability as a Sole Proprietorship would
A sole proprietorship or partnership, also known as a DBA (Doing Business As) is the easiest form of a company and has the least number of requirements to start. It normally only takes filing a fictitious name statement and registration with a local government agency.
- Easy to start
- Low start up costs
- Few regulations and restrictions
- Personal liability for the actions of the company
- Some companies will not do business with a DBA
All businesses need liability insurance at a minimum. For a small company a minimum liability insurance policy for $1 million and $2 million aggregate per year is recommended. These policies cover a range of items from your business property to lost income from covered events to liability claims against the company. A business insurance broker can offer this type of insurance. The policies are generally underwritten by major well known insurance companies.
Keeping detailed and accurate records in a business is very important. Even the most trivial items can be helpful to the company. We can generally divide business activities into several categories. Those that are done to support the business, those that are done to satisfy government regulation and those that are done for tax purposes. While only the first of those three should be relevant the fact is the last two are more important because the ramifications of not paying attention to them can be devastating to a business.
Expenses and Taxes
You will hear advertisements that claim by starting your own business you can convert your personal expenses to business expenses and thus pay less in income taxes. This is not entirely true. You are allowed to deduct from your income taxes expenses that you incur as part of your job that are not reimbursed by your employer. There are limits but it can be done. Additionally, only legitimate expenses can be claimed. Generally, your employer must request you to incur these expenses and also not reimburse you. These would show up as miscellaneous deductions on Schedule A of your income tax return. There are limitations but it can and should be done. To convert these to business expenses you must first and foremost have a profit motive. Once you establish the profit motive everything you do for the business is deductible as business expenses.
The biggest impact is having a home office. You can claim this as an employee if your employer requires it otherwise you need to have your own company to have a home office. As long as you have a dedicated space for your office and it is reasonable size in relation to the size of your house you can make the deduction. Dedicated space means just that. You must have 100% business use of the home office. The space doesnt need to have a partition but it must be dedicated. A spare bedroom can be used for your business office if that is the only use of that space. Exclude the closet space if you keep non-business items in the closet. If you claim 5% to 10% of your total house space you should not need to worry about an audit. Additionally, the IRS has relaxed rules on just what you have to do in your home office. If you do your billing, sales calls and accounting in the office but the work is in the field then you can claim a home office.
Now that you have the home office, what can you deduct? The interest on your home loan utility bills you incur by the same percent of the home office. If your home interest is $1000 and your using 5% of your home you can deduct $50 for the home office. Also you can generally deduct travel to a second work site. So if you have a home office, travel to a second work site may be deductible. This allows you to use the standard mileage rate or actual expenses for your vehicle. If your business miles are greater than 50% for your automobile then you can also depreciate the cost of your vehicle. You must use government depreciation schedules and there are limits but it is more than you would get without having a home office.
A business operates as a legal entity. It is defined and regulated by government agencies and can legally transact business like a person. You must therefore have a way to hold funds and pay bills for the company. Never mix personal and company funds for any purpose. Doing so invalidates the limits on liability enjoyed by the principles of a company. Issue checks from the company for company expenses, payroll and distribution. Deposit money into company accounts as it is received. Fill out expense reports for legitimate expenses related to business and issue expense checks. Do this even if your personal and business accounts are at the same bank. You must always be able to demonstrate that the business is a separate legal entity from your personal affairs.
Where do you open an account? All commercial banks will charge a business more for a checking account than an individual. There will be charges for opening the account, for each check, for each deposit, for each visit to the bank, for each call to the bank and periodic charges to keep the account. Consider using a Credit Union for your company banking. We have found the experience to be more pleasant and the checking account and savings account were not only free but the savings account pays interest and the first 200 checks were also free.
An advisory board is like a board of directors but without the overall power to set direction, hire and fire executives and set executive compensation. They are also not paid as much as a board of directors or may not be paid at all. An advisory board should consist of someone from at least each of the following areas: Legal, Accounting, Marketing, Financial Capital and Business Executive. Having an advisory board composed of these types of people is invaluable to your business. They bring expertise in their field to your business without the expense of full time employees. Quarterly or semi-annual meetings with the advisory board are usually enough to both keep the business on track and to get the board members to agree to serve.
Where do you find these people? The best sources are going to be the Chamber of Commerce, SCORE, Small Business Association and Trade Associations. We have included separate sections for each of these groups and more details are in those sections.
Hold the meetings in a pleasant surrounding. For example, you could hold a quarterly meeting at a local winery. The meeting could be catered with hors d’oeuvres and wine from the winery. Of course the wine is consumed after the meeting. The expense of the meeting is offset by the fact that the board members are all volunteers.
Multi-State businesses present a problem in just who has jurisdiction over the business activities. As a general rule if you establish a physical presence in a State other than where the business is based you must register with the Secretary of State of the new State as a foreign entity (Corporation, LLC, etc) and will be subject to the same fees and taxes as if you were establishing a business in that State. Additionally, the business will be governed by both jurisdictions and will be subject to laws and regulations in both States. As an example, a business in Nevada that registers in California will be subject to California labor laws for employees that reside in California even if they do not work in California for the business and the business will also be subject to Nevada labor laws. This is often overlooked by small and even large businesses that have employees in more than one State or that have multi-State operations.
Taxes and Fees
Wherever you do business there will be a government agency that wants a tax or fee for the privilege of doing business in their jurisdiction. This has increasing become the case as government budgets across the country have been squeezed and various government bodies have been taking money from those within their jurisdiction. The Federal government pays less to the State governments and the State pays less to the county and city governments. The result is long term programs instituted by State and local governments no longer have enough money to operate and the beneficiaries of those programs protest in public over cutting their programs. We only go into this here because the financial health of a government jurisdiction directly affects what you can expect for a business climate in a State, county or city.
The federal tax system is probably the easiest to deal with. There will be income taxes for the business if it is a corporation and personal income taxes for a business if it is not.
If you are a principle of a company and do not take W2 wages, and therefore do not have withholdings, you will need to make quarterly estimated tax payments. Each payment must be AT LEAST one quarter of your tax liability for the year. Failure to do so will result in penalties. You cannot make up owed taxes in the 4th quarter if you have a larger than expected income at the end of the year. There are two safe havens to this rule. The first is the 90% rule. If you have paid 90% of your tax liability and each quarterly payment was one quarter of you liability you will not have a penalty. The second is the 100% of previous year rule. If you pay 100% of your previous year liability you will not be subject to penalty. There are some additional rules that relate to income amount and consulting a tax expert is strongly recommended here.
We have enumerated a number of issues around the Federal tax system and running a business in other areas of this paper and do not repeat them here.
IRS publications may be downloaded from the IRS website, www.irs.gov. Type the publication number by itself in the publication search box and all documents relating to that publication will be listed. You will need adobe reader, which is free, to see the publications. You can then download the publications that you are interested in. We have included the publications that should be of greatest interest for a small business.
Tax law changes are detailed in IRS publication 553. This is handy for an overview of what has changed and references to other publications for more details.
Depreciation is detailed in IRS publication 946. This is written in CPA-speak but it does bring out what depreciation schedules can be used for what types of property.
Business expenses are covered in publication 463.
Each State government will expect a business to register with the Secretary of State. For foreign business, also known as out-of-State, there is a registration process that is shorter than for a domestic company to establish a presence in the State. The real interest in registration is to collect the fees and taxes that would have been paid if you had started your business in that State. For California specifically not only will a registration and fess for the business be necessary, but also State income taxes will be due from both the company if it is a corporation and from the principles of the company for any income earned in California. The State may even require forced withholdings at the maximum tax rate (9.3% at the time of this writing) or an affidavit from the principles stating that income taxes will be paid in quarterly estimates.
The type of business you are in will also dictate what additional fees will be charged. For instance there is a $1 tax for each tire sold in California and a $2 fee for each tire disposed of. There are fees on soda containers, vehicles by use type and many other proposed fees on consumable items such as diapers and alcohol. In short, the State governments today are desperate for revenue and will tax just about anything at any time. It is impossible to keep track of all of these items. It is important to belong to a trade association in your line of business. Your trade association will keep you up to date on current and proposed legislation that affects your business.
Counties in California do not require much in the way of registration and fees but checking with the county office is not a bad idea. Other States may have different regulations. Also consider that a county may defer responsibility to an incorporated city if one exists and if not may act much as a city government would in unincorporated areas. For physical presence the county may charge a property tax on non-real property. For instance, a dentist in San Bernardino County that is also in an incorporated city has to pay property tax on all capital equipment. This includes but is not limited to patient chairs, x-ray equipment (which requires additional permits and registration), computers, other furniture, etc. Any business that generates garbage, and which ones do not, may also be responsible for hazardous waste fees (just about anything may be hazardous), infectious waste fees (nail clippings from a manicurist) and fees on a variety of items that one would never think of. Check with your county for your particular type of business for regulations and fees that you will be subject to.
The city your business is located in will surely want a business license and the fee associated with it. The fees can be charged based on an unlimited number of attributes but will basically fall into one of these categories: revenue, number of employees, type of business, professional licensing required.
If you have a home office your city will generally not tolerate excess traffic caused by your business activities. A daily delivery or pick up of product by a delivery service should not be a problem but if you had your own delivery trucks you could expect a visit from your local code enforcement for your business activities in a residential district. As a general rule, commercial vehicles and traffic is not permitted in residential areas without a variance issued by the city and the requisite fee associated with the permit.
Chamber of Commerce
Not all Chambers of Commerce (COC) are created equal. You should go to several mixers that are put on for your COC. A mixer is run by the Chamber and sponsored (paid for) by a member of the COC. Mixers are a way to get to know other business people in your COC and to meet with representatives of large companies that have a presence in your local area. Normally your public utility companies, chain outfits such as business equipment retailers and government agencies will attend the mixers. These can be valuable contacts for your small business and may lead to contracts with some of these companies.
You should be aware that once you join your COC you will be asked, and expected, to participate in the events of the COC as either a chairperson or a member of a committee. After all, the Chamber is made up of its members and there are very few paid employees of the COC. The successful COC has an enthusiastic membership that participates in the activities of the Chamber. Be prepared to be a part of, rather than a spectator of your COC.
Small Business Association
The Small Business Association (SBA) is sponsored by the federal government to promote small business development. There are local chapters at the metropolitan or county level throughout the country. You do not have to use the chapter closest to you or in your county.
Trade associations are non-profit organizations that give a consolidated voice to a type of business to local, State and federal government. They generally lobby on behalf of the industry they represent and keep members informed of current and pending legislation that affect the member companies. They also may participate in or establish standards of practice for the industry.
SCORE is a nonprofit association that provides entrepreneurs with free counseling. This organization uses volunteers from business, quite often retired executives, to provide advice and help with small businesses. You local Chamber of Commerce should be able to arrange a meeting with a local representatives from SCORE or you can contact them yourself. There web site is www.score.org.
You should use this resource to review and validate your business plan, financing options and human resources policies.
Even if you are not going to hire any employees you should be aware of labor laws in your State. If you are going to be a W2 employee of your own company you will need to purchase workers compensation insurance, unemployment insurance and withhold payroll taxes, income taxes and disability payments. It is probably worth the expense to use a payroll service in your local area if you do not have the expertise to manage this part of your business. Accounting for payroll can consume countless hours of your time that should be spent on your core business.
Labor laws are something you should pay particular attention to. Most employees do not know what their rights are and will not give you any trouble even if your business is in violation of some provision of the law. This, however, is no excuse for not knowing, or worse yet for intentionally violating labor codes. Labor boards in most States are the judge, jury, executioner and represent the employee. This is often done by a single agent of the labor department and their decision is binding upon your company. You should always keep good records of all human resources activity, disciplinary actions, time cards and payroll. Having good records will go a long way in a hearing with the labor board.
Before you hire your first employee you should write a policy manual for your company. It is important to establish policy on every aspect of employee behavior. The minimum that should be covered is timekeeping, work hours, expected behavior at work and quality of work expected. It may also be important to have a dress code and policy on handling and use of company property. If your company deals with information or products that have
A patent for an invention is the grant of a property right to the inventor, issued by the United States Patent and Trademark Office. Generally, the term of a new patent is 20 years from the date on which the application for the patent was filed in the United States or, in special cases, from the date an earlier related application was filed, subject to the payment of maintenance fees. Click here for answers to common patent questions.
Copyright is a form of protection provided by the laws of the United States (title 17, U.S. Code) to the authors of original works of authorship, including literary, dramatic, musical, artistic, and certain other intellectual works. This protection is available to both published and unpublished works. Click here for answers to common copyright questions. policies in place. This will aid your business in legal matters if an employee steals confidential information from your company.
Dunn & Bradstreet, now D&B is the credit reporting agency for business. Their web site is www.dnb.com. Sign up for a DUNS credit number for free. When you are ready to establish a business credit report you can purchase that service from them. It starts at $499. You will need the credit report if you do business with a government agency and if you want to borrow money. You may also need one to attract investors or non-government business. Since signing up is free and it only takes a few minutes there is no reason not to start out with the number. You can always go back later and pay for the services.
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