Laying the ground work for a new business can seem overwhelming if you are just starting out. Cathy from Absolutely Kneaded asked recently if there was any reason for a small business not to be an LLC? I thought it was a pretty good question to start a discussion on what structure your business should take and what areas you should consider as you answer this question.
There are three main areas to think about when you think of the appropriate business structure.
1) Taxes
2) Legal liabilities
3) Capital
Each type of business structure has a different use and different advantages and disadvantages in the three areas. Before we get into an in-depth discussion on all of them we probably need to define what the types of business structures are.
1) Sole Proprietorship
2) Limited Liability Corporation
3) Partnership
3a) Limited Partnership
4) Incorporated
a) S-Corp
b) C-Corp
5) Nonprofit (many business owners may feel they fit into this category but it is a specific one that applies only to those who are not motivated by profit)
6) Cooperative
Today we will cover the Sole Proprietorship
Sole Proprietorship – Sole meaning single not the bottom of your shoe. You own it. You are the business and the business is you. If you take money for services or products and you haven’t created any other type of entity, then you default into being a sole proprietorship. Cost to start it – Nada, zilch, zip, zero. Cheap and easy so to speak.
Statistics In 2003, over 19 million businesses filed taxes in this class. 68% of them had revenue of less than $25,000. The average was less than $7,000. Remember revenue is before any expenses. If you babysit, preach, mow yards, clean pools, etc, then you fall into this category. Now don’t think that all sole proprietorship businesses are small potatoes. Over 96,000 reported revenue of over $1,000,000 (that’s a million bucks to you and me). So a sole proprietorship(SP) can become a very large business. Many times it will be referred as independent contractors as well. It covers pool cleaners, babysitters, lawyers, doctors, dentists and consultants. If you get a 1099MISC issued to you for work you have done, you are the proud owner of a sole proprietorship. Even if you don’t get a 1099MISC, you may still be operating an SP if you collect money for goods or services and have not set up a separate business entity.
Taxes Since you are the business and the business is you, your taxes are pretty straightforward as well. You have to complete a Schedule C and include it with your personal tax return. Keep a good set of books to make life easier when it comes tax time. You want to keep up with all your revenue (sales) as well as all your expenses. You only pay taxes on your profit or the difference between your revenue and your expenses. A good way to do this is using a program like QuickBooks Premier Edition 2009
If you do use Quickbooks, I would suggest picking up a book called “Getting More from Quickbooks – Conquering 27 Frustrating Mistakes That Steal Your Time, Sanity and Money” by Jennifer Thieme (Read my review here)
Accurate record keeping can more than pay for the cost of the software. As a Sole proprietor, you are required to pay both income tax and self employment tax. Don’t forget that income tax comes in both state and federal flavors. Many of you may be unfamiliar with the term self employment tax. It is the tax that you normally split with your employer if you get a W-2.
Self Employment Tax is the Social Security and Medicare taxes that appear on your paycheck. You pay half and your employer pays half. Well being self employed, you get to pay both. You do get to take a deduction on half of it against your income so you don’t pay income tax on half of it. Social Security is currently 12.4% and Medicare is 2.9%. You only pay the SS portion on the first $102,000 of net income while the Medicare portion is on all your earnings. You file an SE form to show where this has been accounted for. So every dollar in expenses that you have a record of saves you a minimum of 15.3% in SE taxes. So keep good records. You owe SE tax is your net income is greater than $400 so it hits pretty early.
Tax ID Number Typically an SP files taxes under the owners social security number. You can also get an EIN (Employee Identification Number) from the IRS. It takes about 10 minutes online. I suggest everyone who runs a business get this. Even if you don’t have any employees, you can use this number as your tax ID when you fill out paperwork and reduce the chance for identity theft. It also shows that you are treating your SP as a real business.
A Business or a Hobby? Notice I said that an EIN shows you are treating your SP as a real business? Many people will have a hobby that they make some money while they engage in it. They will report a loss on their Schedule C and reduce the amount of taxes they owe from other income sources. The IRS frowns on reporting a hobby as a business. I won’t go into the specifics but you can read about more here. The easiest way to be considered a business is to make a profit 3 out of 5 years. If you aren’t able to do that, you need to be able to show you are operating a business rather than a hobby. Talk to a good tax preparation person or accountant if you have specific questions.
Disadvantages? So if it has no cost to start why don’t I want to be an SP? What are the disadvantages of being a sole proprietor? You have some disadvantages in each category. The biggest one is in the legal liability area. As a sole proprietor, you are personally responsible for any claims against your company. There is no difference in the court’s eyes between your home, your personal assets and your business assets.
Tax Disadvantages You are limited in some of the deductions you can take as a sole proprietor. Spend some time discussing the different possible deductions with a good accountant or tax preparation professional. Make sure to ask them if they have experience in different types of business structures. You also have a greater likelihood of being audited. While the chance of being audited is small, an audit of a sole proprietorship also can include the rest of your return.
Capital Disadvantage SPs are limited in how they can obtain capital. Since you are the sole owner, everything is a personal loan. You cannot sell stock, partnership interest or membership interest. It all comes down to you as the owner.
So while a sole proprietorship is quick and easy, it is probably not the best one to be if you are going to be serious about building a business. We will look at Limited Liability Corporations tomorrow.
PS If you have questions you want answered, sign up for our free newsletter on the right. You can submit a question when you enter it. If you are already signed up or read us through our RSS feed at the top, jump over to the Contact Us and fire away. Leave your website address and we will give you credit when we answer it.
PSS If you are looking for a great way to become more productive, sign up for a free account here. It is one of the best tools I have used to keep myself focused. Sign up Now for a free account and tell your friends
Related Posts - My Top 8 Posts of 2009 I spent the weekend trying to fix a computer (which I am normally very good at), working on a sink (which I am normally very...
- 7 Benefits from Using a Small Business Coach Can you imagine the Baltimore Ravens without a coach? I mean could you imagine any professional team without a coach? Yet we often wonder what...
- As Seen on Bankrate.com Seven ways to Minimize your Small Business Risks [/caption] I was recently interviewed for an article at Bankrate.com on how a small business could minimize the risks associated with running their business. I...
- Do You Have Trouble Saying No? For many business owners and entrepreneurs saying No can be one of the toughest things to learn to do. When you first get started in...
- Do You Have a System for Success? <p>One of the things that separates a successful business from one that struggles is the systems they have in place. Why do you think people...
Related Websites - Weekend Links Over the past few weeks I've slacked off a bit when it comes to working...
- Weakonomics Clogged Tubes Finds #2 Welcome to another edition of "Clogged Tubes Finds". That name sucks doesn't it? I'll take...
- What Are The Different Types of Taxes? In honor of the filing date for taxes here in the US (today), I thought...
- Making Your Maximum Annual IRA Contribution at Tax Time RateLadder made a guest post on LazyMan's blog on a strategy he is using to...
- Tax Credit and Stimulus Payments for Boomers and Retirees in 2009 Yes, the 2009 Stimulus Bill contains a little something for boomers and retirees: The retiree...
