Starting Your Dream Business
If your New Year’s resolution was to finally start the business you’ve been dreaming of, you may be wondering what to do next. No matter what type or size of business you plan to start, all businesses must adhere to certain state and federal regulations. Here are some key considerations before getting your business off the ground.
Select Business Entity Type
There are several different business entity types in the U.S., each with distinct impacts for taxation and legal purposes. Before deciding on entity type, consider the degree of liability protection, management power of members, federal income tax implications, ownership succession plan and potential international issues. The most common entity types are outlined below:
- Sole Proprietorship
This entity type consists of one individual who runs an unincorporated trade or business. The key advantage of this is simplicity. No separate business income tax returns are required to be filed. Net profit is computed on Schedule C and is reported as income or loss on the owner’s personal income tax return. In addition to ordinary income tax, net profits from sole proprietorships are also subject to self-employment tax (15.3%). The owner does not receive any liability protection under this entity type.
- C Corporation
A corporation carries its own legal status, separate and distinct from its owners, and pays tax on its profits. A distribution of profits to shareholders usually results in taxable dividends (double taxation). However, the C corporation’s flat 21% marginal income tax rate can be appealing when compared to the highest individual marginal tax rate of 37% (without regard for the section 199A pass-through entity deduction).
- S Corporation
A corporation or limited liability company can elect to be taxed as an S corporation by filing Form 2553. Only domestic corporations with one class of stock are eligible. Income is taxed to the shareholder whether or not income is distributed. A nonresident alien may not be a shareholder of an S corporation. Additionally, any shareholder employees must also draw a reasonable salary and cannot simply compensate themselves through distributions, which are tax free to the extent the shareholder has basis.
- Limited Liability Company (LLC)
An LLC is a liability-limiting entity formed under state law. It can be treated as a sole proprietorship, partnership, or corporation for federal income tax, depending on the numbers of owners and certain available elections.
Partnerships are a simple structure for two or more people to own a business together. Partnerships can be a good choice for businesses with multiple owners, professional groups (like attorneys), and groups who want to test their business plan before forming a more formal structure. The partnership entity structure allows for the most flexibility when it comes to allocating income amongst the partners. However, income passing through a partnership to the partners may also be subject to self-employment tax.
The U.S. Small Business Administration website is an excellent resource for more information on various entity structures. Choosing the right entity type is not usually a straightforward process; seeking analysis from a tax advisor will give you better insight into the pros and cons of each entity type for your situation.
File with State for Certificate of Assumed Name
In general, corporations, limited partnerships, and limited liability companies are required to conduct activities under their true legal name. If those entities desire to conduct activities under names other than their true legal names, certificates must be filed with the state. For Pennsylvania, go to the “Fictitious Names” section of PA Department of Revenue website for more information.
Obtain a Federal Employer Identification Number (EIN)
If you have employees, operate a corporation or a partnership, or withhold taxes on income, other than wages, paid to a non-resident alien, you will need an EIN. All EIN applications must disclose the name and taxpayer identification number (TIN) of the true principal officer, general partner, grantor, owner or trustor (responsible party). Only one EIN per responsible party per day may be requested. Go to the “Employer ID Number” section of the IRS website for more information.
File Documents with State
Each state has its own business registration process. For Pennsylvania, the “online business document filing system” is available on the Pennsylvania Department of State website. You will need a physical mailing address within the state for this process. If you don’t have a physical mailing address, you can hire a commercial registered office provider to accept correspondence on your behalf.
Register with State for Tax Purposes
Depending on your economic and physical presence in the state, you may need to register and file additional required documents and tax returns with state unemployment, sales tax authorities, and the state’s department of revenue. You will need to consult with your tax advisor on what filing requirements your entity has with each state, city, or other taxing jurisdictions.
The information on how to obtain a state tax ID number and file state unemployment and sales taxes are generally provided in each state’s department of revenue website. As for sales and use tax, since the U.S. Supreme Court’s issuance of South Dakota v. Wayfair, Inc. decision on June 21, 2018, most states have changed their sales tax rules to include certain remote sellers. As a result, even if you are an online seller without physical presence in certain states, you may be required to collect and remit sales taxes to those states. Depending on your circumstances, you may be exempt from collecting and remitting sales taxes but may still be required to obtain sales tax exemption certificates. Failure to file sales tax returns is likely to result in paying high interest and penalties to the state department of revenue in the end. Therefore, it is important to pay careful attention to not only state franchise and income taxes but also to sales and use taxes.
Obtain Required Permits
Based on your business activities, you may need to obtain certain licenses and permits for your business. For example, there are contractor licenses, trade licenses (e.g., Electrical Trade, HVAC Trade), and business licenses (e.g., Bed & Breakfast, Ticket Reselling, Trade Fair) issued by the states and cities in which you plan to do business.
For more information or questions, please contact a member of the Herbein tax team, or email us at email@example.com.
Article Prepared By: Ada Zhang