1) Choose an entity type
You have several options for an entity type, and you want to make sure to pick the one that is best for your business. The following are your options:
- Sole Proprietorship – This entity-type does not require a separate election. You are naturally considered to operate as a sole proprietorship unless you choose otherwise. When you choose this entity type, your business income and expenses will be reported on the Schedule C of your individual tax return, which will be taxed at your personal tax rate.
- Limited Liability Company (LLC) – An LLC is a state entity designation that is often used by small business owners to provide them legal protection in the case of a lawsuit. The purpose of an LLC is to limit the liability of an owner to the business assets, while protecting the personal assets. An LLC has default tax return types, but you may choose any of the other entity types for your tax return treatment, including Sole Proprietorship, Partnership (only if you have more than one member in the LLC), or Corporation. The default tax return treatment for a single-member LLC is a sole proprietorship and for a multiple-member LLC is a partnership.
- Partnership – You may choose a General Partnership or a Limited Partnership. A partnership must have more than one owner and is a flow-through entity, where your portion of the income and expense items are reported on your personal return. As a result, your net ordinary income and net investment income will taxed at your personal tax rate. A General Partnership is made up of only general partners, meaning every owner has unlimited legal liability. A Limited Partnership is made up of at least one general partner and many limited partners. The limited partners have liability limited to the amount of their investment in the partnership.
- Corporation – You may choose a C-Corporation or an S-Corporation. A C-Corporation pays taxes at the corporate level and then an owner must pay taxes at the individual level for any dividends received. This is why C-Corporations are considered to have ‘double taxation.’ A C-Corporation may deduct employee medical expenses, while an S-Corporation cannot. An S-Corporation is a flow-through entity, whose distributions to the owners are taxed on their personal return. There are several limitations of S-Corporations, which should be reviewed before you choose the entity type. They include a limitation in the number of owners and type of owners.
2) Open a Business Bank Account and Maintain Your Books
It is very important to open a separate business account. One of the biggest mistakes we see owners make is co-mingling their personal and business funds in one account. You should have a separate business account and credit card, where your income and expenses are separated. This will help you maintain accurate books and limits a potential audit on your business to just your business account, otherwise the IRS will be able to bring your personal account and tax return into the scope of the audit.
The following are choices in software with which you can maintain your business records:
- QuickBooks (Desktop Version) – Our firm most often recommends the QuickBooks Pro Desktop version. It has all the functionality needed for a growing business. If the owner needs to have their QuickBooks accessible from the cloud, either for themselves or for their accountant to have access, then we recommend using InsynQ, which is a QuickBooks hosting site.
- QuickBooks Online – This is the option we see most commonly used by business owners when they first come to our firm. The online version of QuickBooks does not have anywhere near the functionality of the desktop versions. However, QuickBooks online can be a good option for a business owner with a low budget, simple bookkeeping, and without plans to expand to maintaining the books of a second business.
- Other, often less expensive, software including Xero or Peachtree – We do not usually recommend these options as they have limited functionality and are not as conducive to a growing business. However, if you are on a very limited budget and plan to stay small going forward, you may want to consider researching them as an option.
3) Talk with Professionals you Trust. We recommend talking to a Certified Public Accountant (CPA), Lawyer, and Insurance Agent. It is crucial that you find professionals who are responsive and who you believe have your best interests in mind.
Below are the items we recommend discussing with a professional while you’re in the beginning stages of starting your new business:
- Certified Public Accountant
- Entity type and tax type
- Strategic tax planning, for example, payroll, acceleration and deferral of income and expenses, and retirement plans
- Plan for bookkeeping and your needs in maintaining up-to-date and accurate books
- Obtaining an Employer Identification Number, Payroll Tax ID Number, and Texas Sales Tax ID Number, if applicable.
- General Business Lawyer
- Articles of Incorporation, especially if you have multiple owners
- Industry specific information in organizational documents
- Need for a buy-sell agreement
- Financial Planner – discuss if you need the following types of insurance:
- Health Insurance
- General Liability Insurance
- Life Insurance