You've Got Some Important Decisions to Make
Are you really ready to start a business?
Before you go too much further, first decide exactly what you want to do and who your customers/clients will be. If you have left you present job and are now going back to work for the same company, then immediately go to step #2 below. If not, read on.
Make sure you can be disciplined and really work at and on your business. You can never have the attitude that “I will do it tomorrow and play today.” With your own business, you may be the only person generating income and if you don't work, then NO MONEY comes in.
Think of the person who wakes up in the morning and looks in the mirror and says to him/herself, I think I will call in sick today. The mirror responds to you and says “You can’t call in sick - you’re the owner, so get to work.”
Owning your own business is a lot of work, but can also be lots of fun as you will see later.
Once you have made the decision to start your own business, you need to see your accountant next and if you don’t have one, ask your friends and find one. This person should become one of your most trusted advisors. Make sure they are a “CPA” or Certified Public Accountant.
Why choose a CPA?
- A CPA can give you vital tax advice as well as important advice on how to run your business, how to make it as profitable as possible and pay the least amount of taxes (this is the American Dream).
- A CPA is required to meet very strict standards and is required to get 80 hours of continuing education every 2 years in Georgia. Most other states have similar continuing education requirements.
- In order to become a CPA, the person must meet certain College education requirements, pass an extensive and difficult test and in most states work under the supervision of another CPA for one or more years before they can become certified.
What Kind of Business Entity to Choose?
As a new business owner, one of the first decision to make with your CPA is what type of entity you want to form, for both liability and income taxes. Your choices are the following:
- Sole Proprietor (Schedule C on your personal return)
- Limited Liability Company
- More than 1 owner (Partnership - Form 1065)
- 1 owner (Schedule C)
- C Corporation
- S Corporation
Very briefly, the differences are as follows:
Sole Proprietor - Must file a “Schedule C” on their personal return. This has no upfront costs and is the simplest. The downside is that as the owner, you have personal liability for whatever work you do and 100% of your income (assuming you have profits and not losses) is subject to self-employment taxes (think - Fica and Medicare). Personal liability means that if you were to get sued, then your personal assets would be at risk for any settlement that goes against your business.
Limited Liability Company (LLC) - This today is becoming the most common form of business for most people and in my somewhat biased opinion, the most misunderstood. If there is only 1 owner, then the LLC is taxed as a “Sole Proprietor” above. The only difference, is that in most states, you have a certain amount of Liability protection. You would need to discuss how this impacts you with your Attorney (if you don’t have one yet, you might want to get the name of one).
If there is more than one owner, then you would be considered a “Partnership” which files a form 1065. Your share of the partnership income/loss will then”Flow-thru” to your personal return and you will pay the taxes on the income personally. In many cases, this 100% of this income will be subject to self-employment taxes (FICA and Medicare). Keep in mind, that as a self employed person, you will be paying both halves of the tax. As an employee, you only see your share and not the amount that the company is required to match (100% of what the employee pays).
C Corporation - Presently, C Corporations are not very popular for small businesses. As a C Corporation the corporation pays its own taxes on their net income. The tax rates range from 15% to 34%. There is then a problem of getting money out of the corporation for the owner. The only way to take money out of a C Corporation is thru Salary (employee).
For the small business owner, this can cause lots of problems so the most common choice is an “S Corporation”. If the company has a loss, then that loss can only be used to offset future income and carried over to future years and NOT to the owners personal returns.
S Corporation - This is the most common type of entity for a new and small business owner. With an S Corporation, the owner will need to get a W-2, but is also able to take additional money out as a “Distribution”. The Distributions are not directly taxable and are not subject to Self-employments taxes (FICA and Medicare).
Keep in mind that the IRS frowns on people who take little or NO payroll and everything as a Distribution. The IRS will go after companies that take the above approach and if Audited, the company (and owners) will be liable for the taxes and penalties which can be significant. You need to discuss the salary issue with your CPA. Also, if the company has a loss, then that loss can usually be deducted from the owners income as in a partnership.
As you can see, the decision of what type of company you want to be can be very complicated. Check with your CPA before doing anything to avoid making make the wrong choice. It can get expensive to undo your corporate structure and redo it the correct way.
Stay tuned for my next Blog when I will talk about Banking and Credit Card issues and what you need to think about when setting up your business bank account and credit cards. These MUST be separate from your personal accounts.
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