Starting a new business?
This a general overview of the new business startup process. For more details contact your accountant or email us:
New Business:
· Selecting the appropriate entity.
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Selecting a name for your business.
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Obtaining professional and personal insurance.
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Obtaining business licenses and permits.
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Starting the new business.
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Bookkeeping for your business.
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Providing special services.
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What new business owners should know about having employees.
Tax Issues:
· Paying taxes as an owner of a new business.
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Hiring Employees vs Independent Contractors.
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Office in the home.
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Recording business expenses.
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Planning for your retirement.
Selecting an entity for your new business
Sole proprietership
A sole proprietor is the simplest form of business organization, and the business has no existence apart from the owner. Its liabilities are your personal liabilities, and your proprietary interests end when you die. You undertake the risks of business to the extent of all assets, whether used in the business or personally owned. A sole proprietorship includes the business profits and losses on the sole proprietor's own personal income tax return.
Partnership
A partnership is the relationship existing between two or more persons who join together to carry on a trade or business. A partnership is not a taxable entity, however, it must figure its profit or loss and file a return. Partners report their share of reportable items on their own tax returns. There should be partnership agreement outlining a partner's share of income, gain, losss, deductions, or credits, among other things.
Corporations
Corporate profits normally are taxed to the corporation. When the profits are distributed as dividends, the dividends are taxed to the shareholders. No deductions for dividends are permitted to the corporation. A key benefit of incorporation is that in most cases it will shield the individual stockholders from personal liability.
S Corporations
With a limited number of shareholders, a S Corporation elects to be generally exempt from federal income tax. Its shareholders will then include in their income their share of the corporation's separately stated items of income, deduction, loss, and credit and their share of non-separately stated income or loss. Income, as in a partnership, is only subject to taxation once. Limited personal liability is also a key benefit.
Limited Liability Company
A business can also beformed as a Limited Liability Company (LLC). By forming LLC you can limit your personal liability, take advantage of the benefits of a partnership, but with more flexibility as to income allocations.
Selecting a name for your business
If the business goes by any name other than the owner's real name, a Fictitious Name Statement must be filed in the county where the business is located. Filing a Fictitious name Statement prevents any other business in the county from using the same business name. In addition to filing for the name, you will be required to publish the Fictitious Name Statement in a newspaper of general circulation in the area. You will be required to renew your fictitious name periodically, usually once every five years. Contact your County Clerk's office for specific requirements.
Obtaining professional and personal insurance
Before starting the business, professional and personal insurance needs should be thoroughly investigated. Most insurance companies offer a "business owner's package" combining many of the below coverages in one policy. In addition to the below, personal insurance for disability, life, and medical should be considered mandatory. Consult an insurance broker for proper coverage and limits. Some of the different kinds of insurance available are:
- Professional Liability Insurance - coverage for malpractice, etc..
- Basic Fire & Record Reconstruction Insurance - covers fire losses to your equipment and premises.
- Liability Insurance - pays lawsuits brought against your business because of bodily injury or damage to others' property.
- Business Interruption - if your business closes due to fire or some other insurable cause, this insurance will pay you approxiamately what you normally would have earned.
- Worker's Compensation Insurance - provides disability and death benefits to employees injured or killed on the job. Most states require employers to carry workers' compensation for all employees.
- Automobile Insurance - The same coverage available to you on your personal automobile is available on a business vehicle. If you use your personal vehicle for business, you should check with your insurance company to make sure you have coverage that includes business use.
Obtaining licenses and permits
Licenses
If applicable, the business must obtain a business license or permit from the city or county where located. The cost is usually based on size and must be renewed annually or bi-annually. Businesses operating under a fictitious name will usually not be able to get the local license until they have filed the Fictitious Name Statement. Contact City Hall or the County Clerk for specifics. The business may also be subject to an annual business registration or business tax usually due by the last day in February. Contact the County Tax Collector's office for specifics.
Permits
Every state that collects a sales tax issues "seller's permits," and every business that sells goods must have one. When you apply for your seller's permit, the state will give you a full set of sales tax rules and procedures. Service businesses that do not sell parts or inventory are generally not required to obtain a seller's permit.
When starting the new business, initial cash outlays for the startup costs should be budgeted. Basic startup costs include: equipment (desk, computer, adding machine, file cabinet, etc.), insurance premiums, deposits for telephone & electric, license & permits, fictitious name statement & publication, stationary (business cards, check printing, office stationary,etc.), and rent.
To assist in controlling expenses, a budget should be prepared on a monthly and/or annual basis and compared to actual expenses at the end of the period. In addition, to ensure adequacy of available cash, monthly cash flow projections should be developed and updated. These projections will show approximately how much cash will be on hand during the month and alert you to possible cash shortages.
Bookkeeping is an integral part of your business that is designed to record, summarize, and analyze your financial activity. For a small service business, a basic check and deposit register may be adequate to record the financial activities of the business. Over-the-counter computer software such as Quicken and Peachtree can simplify bookkeeping.
At the end of each accounting period (ususally monthly), financial statement may be prepared from the entries in your check and deposit register.
Bookkeeping procedures:
- A separate business checking account should be established. All business and personal finances should be kept separated.
- To simplify the bookkeeping process, the financial activities of the business can be recorded in a check and deposit register which is designed in a similar manner to a checkbook. To assist in income tax preparation at year-end, business expenses should be classified in a manner consistent with the applicable Internal Revenue Service (I.R.S.) Form. Of course, the number and types of accounts can be expanded as needed.
- All business disbursements should be made by check if possible. If some business expenses are paid with your personal cash, they should be recorded on a voucher, summarized on a weekly or monthly basis, and reimbursed by the business with a business check. All business expenses paid by cash should be supported by documents showing their business purpose.
- All bookkeeping entries should be supported by canceled checks, bills marked "PAID", receipts, and deposit slips. These items should be filed in an orderly manner (i.e. use of an accordion file with aphabetic tabs), and stored in a safe place for a least seven years for tax purposes.
A standard invoice for billing customers should be designed (note that preprinted forms may be purchased), and time sheets may be used to track the amount of time spent. If credit is extended to any customers, an accounts receivable ledger should be set up to track each sutomer's balance due.
To prevent disputes with customers regarding special services, a contract agreement should be signed by both parties. the purpose of a contract agreement is to avoid any misunderstanding, to create a contractual obilgation, and to set forward the legal liability of each party. The contract should contain the following items:
- Scope of services including any limitations. Be as detailed as possible.
- Fees or method of determining fees.
Whate new business owners should know about having employees
If you have employees, there are additional rules and regulations that you should be aware of:
- I.RS. Circular E - Employers Tax Guide (Publication 15) and the California Personal Income Tax Withholding Guide give you detailed instructions for complying with federal and state employer requirements (i.e. employees' withholdings).
- You must apply for Employer Identification Number (I.R.S. Form SS-4). The identification number is used for income and payroll tax reporting.
- When an employee is hired, certain forms need to be completed and signed by the employee. The I.R.S. requires a signed Form W-4 to determine the proper withholding for payroll purposes. The immigration reform legislation requires that employees hired after November 6, 1986 complete a Form i-9 to prove their United States citizenship. Once completed, these forms are to be maintained by the employer.
- Most employers are subject to the Fair Labor Standards Act. In general, this act sets a minimum wage for covered employees and set overtime pay at not less than 1.5 times the regular rate of pay.
Paying taxes as an owner of a new business
In addition to regular income tax, a self-employed individual or partners will be subject to a self-employment tax on the business income. The 1997 tax rate is 15.3% of income up to $65,400. The amount in excess of $65,400 is taxed at 2.9% (the Medicare portion of self-employment tax has no limit).
As self employed, you are personally responsible for submitting quarterly estimated taxes (by use of vouchers). Your quarterly estimated taxes should consist of 100% of prior year taxes (110% if your adjusted gross income is greater than $150,000) or 90% of current year taxes. Underpayment penalties occur if payments do not meet the 90%/100%/110% safe harbors and/or are not made timely. For corporations, quarterly estimated taxes are 100% of prior year or current year.
Tax payments are scheduled on the 15th (or the following Monday if the 15th falls on Saturday or Sunday) of each quarter:
1st Installment 4/15
2nd Installment 6/15
3rd Installment 9/15
4th Installment 1/15
Generally, each installment payment should be 25% of the required annual amount.
Hiring employees vs. Independent contractors
The main distinction between an employee vs. independent contractor is the level of control that an employer can exercise. If an employer only controls the result of the work but not the means or methods to accomplish that result, then that worker is an independent contractor. On the other hand, if an employer controls what must be done and how it is done, then it is more likely an employee relationship. The I.R.S. identified 20 common law factors by which a proper classification can be made. These 20 factors are often subject to much interpretation and, because of the resulting confusing, currently under review.
In the meantime, if you need to hire an individual to assist you in your work, you must use the 20 factors to determine whether the worker is an independent contractor or an employee. If deemed an employee then a W-2 is issued and payroll taxes must be withheld. If deemed an independent contractor then no payroll taxes are due and Form 1099 may need to be issued to that person at year end. Form 1099 are generally not required for reporting payments to corporations. You will need to file Form 1099's if certain transaction occurred. Generally, Form 1099's are required if:
- Payments is to a non-corporate entity and
- Payments is $600 or more fees, commissions, or other forms of compensation to persons not treated as your employee for services rendered in you business
If you use your home (ie. den) regularly and exclusively as your principal place of business for your trade, then a portion of certain expenses relating to the home such as rent, untilities, and telephone are deductible. The deductible portion applicable to business use is generally calculated based on square feet of space used for business to the total square feet in your home. This deduction has been subject to abuse and this is another area where the I.R.S. audits very carefully.
Car expenses
If you use your car for business purposes, you will be able to depreciate the car and deduct related car expenses. The deductible items include cost of:
- gas
- license
- lease fees
- depreciation
- insurance
- garage rent
- repairs
- parking fees
- maintenance costs
- rental fees
You must prorate the expenses if the car is used for both business and personal purposes. Business mileage and the total number of miles driven for the year should be adequately supported. Receipts of all business related expenses must be maintained. Instead of calculating actual expenses, you may used the current standard mileage rate of 31.5/cents per mile. due to alleged abuse by the taxpaying public in this area, the I.R.S. have been sensitive to these expenses. Note that the I.R.S. has a rule on purchased luxury automobiles, which limits the amount of depreciation that can be taken.
Travel & Entertainment
The Tax Reform Act of 1986 sustantially changed the rules for deducting travel and entertainment expenses. The current law has further heightened the significance of properly substantiating expenses of this nature. The new requirements can be met by maintaining a log with adequate records or sufficient evidence corroborating the taxpayer's own statement as to :
- cost - cost of expenditure
- time - date of meal, duration of trip
- place - name and address of establishment
- business purpose - business reason for the expense
- business relationship - relation between the company and person being entertained
The I.R.S. will disallow the deductions if the taxpayer fails to satisfy the substantiation requirements. In addition to the 50% limitation on the deductibility of meals, the deductions for travel and entertainment may not be "lavish or extravagant".
Expenses Elections
Under certain circumstances, annual capital expenditures up to $18,000 (for 1997) may be expensed. There are additional state income tax limitations for corporations.
There are a variety of retirement plan options for businesses. Some require mandatory contributions; some provide for optional contributions; some allow for elective employee compensation deferrals. All "qualified" plans must be nondiscriminatory. Contribution and deduction limitations vary by type of plan. Please consult your tax professional for details.
