Embarking on a new business venture brings excitement and challenges. In this guide, we will walk you through the legal process of starting a new business. Key considerations include choosing a business structure, managing taxes, and recordkeeping for success.

Choosing the Right Business Structure

Selecting the appropriate structure impacts your taxes, legal liabilities, and operational flexibility. The most common business structures include:

  • Sole Proprietorship: Simple, no formal setup. The owner handles all liabilities and operations. Profits and losses go on the owner’s tax return (Schedule C).
  • Partnership: For two or more co-owners sharing everything. It doesn’t pay taxes itself. Instead, profits and losses flow to partners’ tax returns (Schedule K-1).
  • Corporation (C Corp): Offers liability protection, taxes profits, and dividends. Requires Form 1120. Shareholders list dividends on their returns.
  • S Corporation: Avoids double taxation. Profits and losses go directly to shareholders’ returns. Files Form 1120S. Shareholders include their share on personal returns.
  • Limited Liability Company (LLC): A mix offering liability protection and partnership tax benefits. Can choose its tax filing status.

Starting a new business requires obtaining various permits and licenses, which vary based on the business type, location, and industry. Initially, you must register your business with the state, a step that include filing for the entity structure you chose. Following this, you’ll likely need a general business license from your local city or county.

Additionally, specific industries require specialized permits. For example, restaurants need health permits, liquor licenses, and signage permits. Retail businesses, on the other hand, may require sales tax licenses. Furthermore, if you’re planning to operate from home, a home occupation permit might be necessary. It’s crucial to research both state and local regulations to ensure you meet all legal requirements. This proactive approach prevents future legal issues and fosters a smooth business operation.

Tax Identification Number

An Employer Identification Number (EIN) is essential for businesses as it serves as a federal tax identification number used to identify a business entity. It’s necessary for hiring employees, opening business bank accounts, and filing tax returns. Sole proprietors without employees may not need an EIN but obtaining one can help separate personal and business finances. To obtain an EIN, businesses can apply online at the IRS website, mail or fax a completed Form SS-4, or call the IRS.

Beneficial Ownership Information

Recently implemented law requires LLC, corporations, and other entities to file beneficial ownership information (BOI). Beneficial ownership information refers to the details of individuals who ultimately own or control a legal entity such as a company or trust. This information includes the identities of the individuals who directly or indirectly benefit from the entity’s assets, income, or other resources. It helps to prevent financial crimes such as money laundering, terrorism financing, and tax evasion by enhancing transparency and accountability in corporate structures.

Filing is done online through fincen.gov at no cost. Companies must file their reports by the following deadlines:

  • Existing companies: Companies created or registered to do business in the United States before January 1,2024 must file by January 1, 2025.
  • Newly created or registered companies: Companies created or registered to do business in the United States in 2024 have 90 calendar days upon inception.

Navigating Business Taxes

Businesses must navigate a complex landscape of taxes, each with its own rules and implications.

  • Income Tax: All businesses except partnerships are required to file an annual income tax return. Partnerships, on the other hand, file an information return. The structure of your business (sole proprietorship, partnership, corporation, etc.) significantly influences your income tax obligations.
  • Self-Employment Tax: This tax consists of Social Security and Medicare taxes primarily for individuals who work for themselves. It’s crucial for self-employed individuals, as it contributes to their coverage under the social security system, which provides retirement, disability, survivor benefits, and Medicare benefits.
  • Employment Taxes: Businesses with employees must handle employment taxes, which include Social Security and Medicare taxes, federal income tax withholding, and Federal Unemployment (FUTA) tax. These taxes are essential for ensuring that employees are covered under the Federal Insurance Contributions Act (FICA).
  • Excise Taxes: These taxes apply to specific businesses that manufacture or sell certain products, operate particular kinds of businesses, use various types of equipment, facilities, or products, or receive payment for certain services. Excise taxes are reported differently depending on the activities of the business.

Selecting a Tax Year

A tax year is the annual accounting period a business uses to report its income and expenses. There are two main types.

  • Calendar Tax Year: This is the most straightforward option, running from January 1 to December 31. It aligns with the calendar year and is suitable for businesses that operate on a standard yearly schedule.
  • Fiscal Tax Year: A fiscal tax year consists of 12 consecutive months ending on the last day of any month other than December. This option offers flexibility for businesses whose operational or financial cycles do not align with the calendar year.

Choosing an Accounting Method

The comparison between cash and accrual accounting methods based on the document is as follows:

  • Cash Method: Cash method accounting records revenue and expenses when cash actually changes hands. It simplifies tracking but may not show real-time financial health.
  • Accrual Method: Accrual method accounting records revenue when earned and expenses when incurred, offering a more accurate picture of financial health, regardless of cash flow.

Choosing between these accounting methods determines the reporting of income and expenses, influencing financial statements and tax liabilities. The cash method simplifies tracking by concentrating on cash flow. Meanwhile, the accrual method offers a clearer view of a company’s financial health by acknowledging revenues and expenses at their occurrence, beyond mere cash transactions.

Maintaining Accurate Records

Detailed business records are essential for:

  • Monitoring Progress: Tracking your business’s growth, successful products or services, and improvement areas.
  • Preparing Financial Statements: Essential documents like profit and loss statements and balance sheets depend on accurate records for effective management, loan applications, and creditor dealings.
  • Identifying Income Sources: Distinguish between business/non-business and taxable/non-taxable receipts.
  • Tracking Expenses: Document expenses promptly to ensure all tax deductions are claimed.
  • Tax Return Preparation: Accurate records are crucial for correct tax return filings, supporting reported income, expenses, and credits.
  • Supporting Tax Items: In IRS audits, comprehensive records quickly substantiate tax return entries.

Types of Records to Keep:

  • Daily Business Transactions: Record summaries of daily transactions, like sales and expenses.
  • Receipts and Invoices: Keep documentation for income and expenses, such as receipts, invoices, and bank statements.
  • Employment Records: For businesses with employees, hold onto all employment tax records for at least four years post the tax due or payment date.
  • Asset Records: Maintain records on property purchases, depreciation, amortization, and sales to calculate depreciation and figure out the gain or loss upon selling.

Retention Period: Generally keep records for three years after filing your return or two years after paying the tax, choosing the later date. If you miss reporting income over 25% of your return’s gross income, extend the period to six years. Keep employment tax records for at least four years following the due date or payment date, whichever comes later. Following these guidelines guarantees a robust recordkeeping base, bolstering your business’s financial integrity and tax law adherence.

Leveraging Deductions

Minimize taxable income by understanding deductions for start-up costs, depreciation, home office, and vehicle expenses.

  • Start-Up and Organizational Costs: Deduct up to $5,000 each for start-up and organizational costs, reducing if total costs exceed $50,000. Amortize any excess costs.
  • Depreciation: Spread the cost of business property over its useful life. You can take a section 179 deduction for certain properties in the acquisition year.
  • Home Office: Deduct home office expenses if the space is used exclusively, regularly, and for your business. It must be your principal business location or a place for client interactions.
  • Vehicle Expenses: Deduct operating and maintenance costs for business use of a car or truck. Choose between actual expenses or the standard mileage rate. Divide expenses by purpose if also used personally.

Conclusion

Starting and managing a business requires understanding tax duties and maintaining accurate records for success. This guide shows how crucial navigating business structures, tax obligations, and record-keeping is for legal and financial health. Regular updates on tax laws and thorough record management boost growth by ensuring clarity and compliance. Consult the IRS or tax professionals for new regulations. In complex cases, seek expert advice to avoid mistakes and save time. Recognizing the importance of tax responsibilities and recordkeeping is vital for entrepreneurs aiming for lasting success.

 

Source: IRS Publication 583, IRS Publication 535

Erik Garay

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