Setting up your own business is not that difficult and it is really not necessary to pay someone to do it for you if you are relatively computer literate and savvy. However, before proceeding, there is something you should know about incorporating; the most significant reason to incorporate is liability. If you own a store on a strip mall and a customer could walk in the front door, slip and fall, injure themselves and wind up with mountainous medical bills then yes, you have a liability issue and you need to be incorporated. But what if you are just inputting medical records on your home computer? Where is your liability? If you wanted to, you could get errors and omissions insurance for any inputting mistakes you might make. In that situation there really is no liability issue. With that said, there are other reasons you may want to incorporate. Many businesses do not want to enter into contracts for services or material with an individual, rather they want to deal with other businesses. You may be in a situation where the company you work for will not deal directly with you but they will sign a contract with your business. Then you need to be incorporated. You may have financial backing lined up for a venture but the backers will not fund a person, only a business. Then you need to be incorporated. There are other reasons to incorporate, but the fundamental issue you face is the fact that your tax situation becomes much more complicated and expensive after you have incorporated. And that complication and expense can be justified only if you do it correctly: if you incorporate correctly and conduct your business in the "proper fashion." The problem you face is summed up in the term "pierce the corporate veil." Here is what happens; you incorporate, you conduct your business in the "proper fashion," you do everything correctly, as far as you can tell, and then the unthinkable happens and a liability event occurs. The liability event is significant enough that lawyers become involved and the whole thing winds up in the courts. During the proceedings, the defense attorneys will try to "pierce the corporate veil." They will force you to prove that you conducted your business affairs in the proper, legal fashion by demanding to see 1) your Employer Identification Number (EIN) assignment letter from the IRS, 2) your Articles of Incorporation (or Articles of Organization if you are a Limited Liability Company - LLC), 3) your Form 2553 election to be considered a small business corporation by the IRS, 4) the IRS' letter approving that election, 5) all of your business tax returns, for each year the business existed, showing compensation of officers, 6) your personal tax returns for those same years showing inclusion of that business income, 7) all of your filed, state-required, yearly annual reports, 8) your county and municipal tax receipt numbers or tax registration numbers or certificates proving that you are legally registered to conduct your business at your location and 9) last but not least, your business checking account showing that all of the income from the business was deposited in to that account and all of the business expenses were withdrawn from that account.
If you fail any one of these tests, or cannot provide one or more of these documents, the defense lawyers will have done their job; they can then declare that your business is not legitimate, you did not conduct your business in the "proper fashion," the "veil" of business liability protection has been "pierced" and you are now personally liable for all of those mountainous medical expenses. That is what you face. So you have to make a decision; since you are going to go down the incorporation path, do you want to do it correctly or not? After spending all of that extra money and suffering all of that extra complication in order to be incorporated, do you want to do the job correctly or not? Sure, you will probably never need to prove it, but you have to spend the money anyway so why not do it as best as you can? If nothing else, just to know that you could prove yourself to a higher authority like a court of law.
Let's rank business categories from a tax point of view. The easiest is a Schedule C for Self-Employment Income, included right along with your tax return when you have a business. When your self-employment income is high enough, a Schedule SE is generated automatically to pay your Social Security and Medicare taxes. You do not even need an EIN. By far it is the easiest and least complicated. And a note about tax years; it is best to have a calendar year tax year. Fiscal tax years should be used only if there is an over-riding business reason. The vast majority of the tax preparation profession is geared up for calendar year tax payers and businesses, so staying in that cycle is beneficial from a business-support point of view. Second, you could just get a fictitious name from your State's Division or Department of Corporations website. You cannot protect a fictitious name, someone could come along and incorporate using that name, and force you to stop using it, but you could still conduct a fictitious name business on a Schedule C. Fictitious names usually expire and have to be renewed in three to four years.
Then we get to true incorporation with Articles of Organization for an LLC. You can file your Articles with the state but if you do not limit your liability at the federal level, you did only half the job. The IRS considers an LLC to be a "disregarded entity." An LLC is not one of the recognized business entities in the eyes of the IRS. But the IRS does recognize an S-Corporation or "Small Corporation" (although the "S" does not stand for "Small"). And liability is limited (provided you do everything correctly) at the federal level when you are an S-Corp. The way to do this is to file a Form 2553 "Election by a Small Business Corporation," see more at the step below.
Then there are Articles of Incorporation for a corporation. A not-for-profit corporation and partnerships are not considered here. This set of instructions is written for the single individual who has a need or desire to form a business entity, typically single-owner. A Form 2553 is again required for a state-registered corporation to protect from liability at the federal level.
Above that is a C-Corporation, which requires further classification at the federal level. All the big businesses are C-Corporations and incorporating to that level is well beyond the scope of what is written here.
The assumption here is that you are forming an LLC or small corporation and you do not know what to do first. The following list should NOT be considered complete, but it is a good way to start. No warranty is stated or implied, use this list and set of instructions at your own risk and remember, the list of how to do things in the "proper business manner" is endless.
Step #1: Establish a separate business checking account with a debit card. It is preferable to get a personal checking account in your name and use it strictly for the business. Later, if the balance in the account ever gets large enough to exceed the required minimum balance, you can convert it into a business account. Seed the checking account with $500. Avoid your normal financial institution, go somewhere else: a bank with a good website. More about the business checking account later.
Step #2: Pick a name for your business; consider being an LLC and if you do, be sure to add LLC at the end of your business name. Be mindful of your punctuation - use a comma before the LLC or not, but once you do, be consistent. The way to start the process to make your business name official is to visit your state's Division or Department of Corporations website. In Florida it is www dot sunbiz dot org; each state will have a different Universal Resource Locator (URL) but each state website will have a way to look up or search by business name. Look up your candidate business name and see if it is taken or not. If it is, keep trying variations of the business name that you like until you find one that is not taken. Then, DO NOT do anything else in that website. Record the business name (like in a small text file), bail out of that website and then go to the IRS' website, www dot irs dot gov and get your EIN for your chosen, unused business name.
Step #3: At the IRS website, type "apply for EIN" in the top search window and click on SEARCH. Click on the top choice; "Employer ID Numbers (EINs)" and then on "Apply for an EIN Online." Follow the instructions and apply for an EIN using the business name you recorded in Step #2. It is free to acquire an EIN. IMPORTANT - at the end of the process there will be a letter generated by the IRS computer that lists your business name and its assigned EIN. BE SURE TO SAVE THE PDF FILE OF THAT LETTER. You can also record the EIN but the letter is important because it links the EIN with the business name as filed with the federal government.
Step #4: Go back to your state's Division or Department of Corporations website and follow the instructions to create a new LLC or corporation. Timing - do it all in one evening. Use the business name from Step #2. IMPORTANT - USE THE EIN FROM STEP #3 FOR ALL ID NUMBERS - NEVER USE YOUR SOCIAL SECURITY NUMBER - SSN. The business records on a state's Division of Corporations website are public knowledge, discoverable on the web, so your SSN should NEVER appear there. ALWAYS use your EIN. And use your business checking account from Step #1 to pay the fee to register your business name.
Step #5: Acquire a county tax registration or tax receipt number (otherwise known as a business license or an occupational license or a business occupational license). Businesses are categorized and there may be different requirements per category. Investigate your county website. Google the full name of your county appended with the words "tax collector," "occupational license application," "business license," "business tax" and "businesses." Click on the hyperlinks provided by Google and take some time drilling around each website to see what is offered. You may be able to find and download the business application, print it, fill it out and mail it in. Do not expect an online application process; the signed application may require notarizing and being mailed in, but the yearly renewals can usually be done online. And acquiring a tax receipt / registration number from the county you live in is only half the battle; you may also need a tax receipt / registration number from your municipality (city, town, village) where you live, check your municipality's website. More on counties and municipalities below.
Step #6: Go back to the IRS website, download the PDF version of Form 2553, fill it in, save it, print it, sign it and mail it in. Use the date of your Articles of Organization / Incorporation as the date you started doing business. Form 2553 should be filled out, signed and mailed within two months and fifteen days from the date you started doing business.
Step #7: Enroll in EFTPS - Electronic Federal Tax Payment System. You can pay all of your federal taxes online nowadays. The EFTPS website does not receive the same support as the IRS' website and it shows because enrollment using Internet Explorer (IE) 9 does not work; after inputting my information on the Step 2 "Enroll" screen, a blank "Review" screen always came up. Re-entering the information produced the same error. Phone tech support verified that they had a problem with IE 9. They suggested using Mozilla Firefox. On the EFTPS home page, it says that they support IE for Windows and Mozilla Firefox. I dislike having two different browsers installed on my computer. Many people do not mind at all, even prefer having more than one available to them. It is a matter of personal preference. But I can move around in IE just a little bit faster than I can in other browsers and that is enough for me. I even like IE 9 because it has more streamlined download functionality and more multi-webpage versatility per window. So it is distressing that the government cannot handle the latest Microsoft product and with reluctance I went to www dot cnet dot com and downloaded and installed Mozilla Firefox. Sure enough, EFTPS enrollment completed without a problem using Mozilla Firefox. IMPORTANT - at the Step 4 "Complete" screen there is a large "Download PDF" button directly below a "Print" button. BE SURE TO DOWNLOAD AND SAVE THE PDF FILE. It contains your eighteen-digit long enrollment number. Within seven days you will receive in the mail your Personal Identification Number (PIN) and instructions on how to obtain a password to use EFTPS dot gov. Before you ask why please know that you have not "paid yourself a paycheck" until you have paid ALL of your required income taxes.
You are probably asking why? What good does enrolling with EFTPS do me? Here is what happens. At tax time, the "books" of the business have to be balanced. If there is net business income after expenses and that income is not reflected as cash in the business checking account, then typically, one or more distributions were taken. Money was taken out of the business. Happens all the time. As part of balancing the books for tax purposes, the final distribution amount can be accounted for and that final distribution amount does wind up on the Schedule K-1's flowing out to the business officers. And I am here to tell you that if that distribution does show up on the Schedule K-1 and the Schedule K-1 is included as income on each officer's personal tax return, then you bet by golly that those officers will pay federal income taxes on it. But who did they not pay? They did NOT pay their Social Security and Medicare taxes. This problem is pervasive and endemic. At last year's IRS Nationwide Tax Forum in July in Orlando, at the "Pitfalls of Subchapter S-Corps" seminar, the speaker said that for the last year they had data (probably 2009), 35,000 single-owner S-Corps filed business tax returns with income over $100,000 and did not pay themselves any compensation. At that forum it was also mentioned that just two weeks previous, the wording in a bill before Congress to empower the IRS to go after those S-Corps who are not paying officer compensation was gutted. So those S-Corps escaped for another year. But do not think that will last for long. Congress will eventually plug that loophole. In order to be completely legal, you have to "pay yourself a paycheck" each pay period by deciding how much you can take from the business, go to the EFTPS website, login and pay your Federal Insurance Corporation of America - FICA - taxes - Social Security and Medicare. You can also 'withhold' your federal estimated tax payments each pay period or wait and pay them at the required due dates of the 15th of April, June, September and January of the following year.
Timing the creation of your business is important. Most first-time business owners have no clue about Step #6 above. It is not until tax time that the issue comes up. For that reason and to establish the business as soon as possible by filing both a federal and state business tax return, it is best to create your business late in the year; a good starting date is 01 DEC. You can get your checking account setup ahead of that date, and even check the availability of your candidate business name on your state, county and municipal websites, but do not pull the trigger until 01 DEC. Be mindful of your time constraint - as soon as you have found the business name you want, acquire the EIN and then file your state Articles of Incorporation / Organization, preferably all within the same evening from your home computer; and remember, you have to pay for it online that evening so your checking account has to have already been setup. Granted, it is unlikely that someone will also find your preferred business name and incorporate under it before you do, but why take the chance? Minimize the amount of time between filing for your EIN and filing your Articles with the state. Also, if you can do it, if you can arrange it, try to setup some serious income-producing activities for December; try to maximize your potential for profit in December. The flip side of that is to minimize your business expenses for December; you have no choice but to spend the fees listed here in order to establish your business, but try to make those fees your only expenses for the month, if you can. Schedule other required business expense activities before 01 DEC, if you can. If you do this, then you stand a much better chance of showing a net profit for the year (by taking advantage of the "short" first tax year of business). And the reason why has everything to do with showing a profit in your first year of business and the tax benefits available to you in subsequent, net-loss years, if they happen. The IRS will not let you continue to conduct a failing business venture that incurs significant losses every single year. Having an initial, non-loss year of business may help dissuade them from pulling the plug during your lean years and disallowing all of those prior year business loss deductions. When that happens, the tax bill is so large that you will be forced to mortgage your home or declare bankruptcy. As bad as all that is, the primal reason to show a profit is to exercise your ability to pay your FICA taxes. This sounds bizarre because no one else recognizes it, but it all has to do with Social Security, see below. And you will be able to show a net profit only if you have set it all up correctly at the end of the year. It is unlikely or unheard of that someone starts a business correctly, please remember that; if you failed at one or more of these steps, you are one of many who have done so. It is an extraordinary event, to create a business from a position of strength, by showing a profit in its first year.
Before starting this process, it is wise to investigate the county and municipal websites. If the websites do not provide answers to the following questions, pay a visit to the county courthouse and to the town hall or municipal office complex during business hours, wait in line if you have to, and then specifically ask what the fee is to apply for and also renew a business tax receipt / registration number, but most importantly, ask if they have a category for your home-based business. I am assuming that you will be able to conduct your business out of your home and you have to be sure that the county and municipality permit your type of business. A good example of this problem is the Handyman. He knows a lot of clients; they call him to fix windows, doors, plumbing, roof leaks, etc. But in many counties, you have to be a General Contractor to conduct that type of business without oversight. The costs to apply for, study and take the exam, and then renew the license year after year for a General Contractor are prohibitive for the typical, single-owner-operator Handyman business. There are other business types that the county or municipality will not allow to be home-based. There may be zoning issues. Condominiums have their own sets of rules. Checking out the possibility of establishing your business from the ground up (municipality, then county, then state and finally, then the government) is a prudent step before you outlay any money.
Try to do everything you can online to minimize expenses (like fuel costs). Whenever you are acquiring business information online or any online information you want to save, be sure to capture an electronic version of it. There is PDF printer software like PDF995 that loads itself onto your computer just like another printer. Anything you can print to paper you can print to a PDF file, the software just asks you where you want to store the file and what name you want to give it. "Printing to PDF" is bundled with other big-name software you may have on your computer and as a last resort, you can start a blank document file and with your cursor sitting on whatever active window you want to save, you can press ALT-CTRL-PRT SCR to capture that window and then paste it into your document file. Collect the "window capture images" on successive pages of that document file to constitute a record of your activities.
In addition to the above information, please note the following. In Florida, there is a requirement to file a $150 Annual Report by May 1st of each year or else there is an additional $400 penalty. It is likely that many (if not all) other states have similar requirements. And are you ready for this? The Annual Report contains only the name and address of the business, the business agent and the business officers. That is all. Do not think that any kind of financial data is required, because it is not. The best part about registering your email address in your state's Division of Corporations website is that they will send you automatic reminder emails that your Annual Report is coming due.
You are preparing yourself for an unlikely possibility, but one that you must protect yourself from: the liability event. In its extremely remote occurrence, as part of Legal Proceedings, you will be forced to reveal everything about your business, if you want any hope of defending yourself at all. So when your lawyer asks you to provide all of the documents described here, you will have no choice but to do so, and heaven help you if you do not have them.
It is likely that the first piece of evidence that any defense attorney will ask for is the business checking account. Besides the check register and bank statements, you will have to provide the business accounting summaries or books. There should be a listing showing all of the income and expenses. Far too many business owners are not religious enough about keeping their business finances separate. Far too many treat their business like a personal piggy bank, make indiscriminate withdrawals, and reconciliation at tax time is nearly impossible. An attorney who can put together the fact that the business net profit per the books does not match the income reported on the business tax return will be able to pin more offenses on you, tax offenses, like lodestones around your neck.
Also, about filing Form 2553 after the two month and fifteen day post-starting business filing due date; as long as you successfully transmit a timely filed tax return, by the due date, without extensions, in the year following the year you started business, then, (again,...ahem) as long as you file Form 2553 within six months of the due date of that initial year tax return, then you can seek relief from the due date requirement for a Form 2553 filed late "Pursuant to Revenue Procedure 2004-48" (which should appear above the title of the form). That is a bunch of legalese that means even if you forget to file Form 2553 when you started your business, as long as you file a tax return for that business by the initial due date, then you can file Form 2553 after-the-fact (per Rev Proc 2004-48) within six months of that due date for that initial tax return and the IRS will accept your election to be an S-Corp.
Remember that every year you have to file your business tax return first, and it is due by 15 MAR, not 15 APR. The output of the business tax return (Form 1120S for S-Corp's) is a Schedule K-1 which has to be included as income or loss on your personal income tax return; that is why the business tax return is due before your personal tax return.
Every year you will be required to have a stockholder meeting (even if you are the only stockholder) and record the meeting minutes. Everything has to be in the minutes: Articles of Incorporation, Form 2553, IRS letter approving it, minutes from all previous meetings, all distributions, all loans, compensation of officers, authorized signers, statement of accounts and everything else business related. A December meeting with your tax professional, included as part of your business / personal / state tax return preparation fee, would be prudent if you can negotiate the extra cost of conducting the meeting and recording the minutes. Put a copy of the minutes with your yearly business tax return client copy.
Be mindful of how your Social Security Retirement Benefits (SSRB) are calculated. Your benefits are calculated using something called the "rule of 40 quarters" or ten years. And those are consecutive quarters we are talking about. Your SSRB are based upon your highest earning forty consecutive quarters. If you are young, having a hole in your rule of 40 quarters is not that big of a deal because you have many more income-producing years left in you. But if you are older, putting that donut in your long string of consecutive working years can seriously reduce the amount you receive in benefits. And do not go off saying that Social Security will not be around when you retire. Of course it will. Congress will make sure of that. It may not have the same benefits as we have today and the retirement ages may not be the same, but it will still be around. If you incorporate and neglect to pay any of your FICA (specifically Social Security) taxes during a specific year, you put that donut in your rule of forty quarters without ever realizing it. When you finally do realize it, it is too late. If you are an employee during the year you start your business on 01 DEC, then you should have withholding for most of the year already and you are not at risk of the donut in your rule of forty quarters. Not even much of a reduction in benefits, since you did not quit your job and start your business until late in the year. But watch out your second year. If there is no officer compensation on your business tax return and a net loss in the second, full-year worth of business, and you have no other income, then you get the donut in your rule of forty quarters, nothing you can do about it. But if you have net business income that second year, and you do not pay your FICA taxes, then you take the donut when you could have avoided it.
This whole story has come full circle back to the beginning for one more piece of advice. Way back at the start you filled out that Form 2553 to elect to be a small corporation. In Part I of that form you have to list the name and address of each business shareholder and in column L their number of shares or percentage of ownership. I strongly recommend that you make yourself the sole owner with 100% of ownership. You may be tempted to enlist others into your enterprise, you may think others bring more to the table, make your business entity more viable, better chance to succeed. Do NOT succumb to that notion. This is a binding, legal document that you are signing and sending to the U.S. Government. There is nothing trivial about it. In the world of business, there needs to be one person in charge, where the final answers and final decisions come from. It is true in politics, it is true in business and it is true in life. You cannot predict with 100% accuracy how your business venture may pan out. It may fail, true, but it may also take off and be one of those countless American business success stories we all hear about. If that happens, one person needs to be empowered to make each of those final decisions and that person is you since it was your idea and you did all the work. Do not dilute your power over your own business by adding someone else's name to that Form 2553. You do not want to have to worry about getting someone else's approval to do something you think is necessary for the business.
Enough said, I will get off my soapbox and end with my website: www.your-tax-professional.com.
Eric
My name is Eric Jahnsen and I am an Enrolled Agent which means I am enrolled to practice before the IRS. For your tax preparation needs, acquiring your prior year reported tax information or just tax related help and suggestions, see our website at http://Your-Tax-Professional.com.
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