Business license or city tax certificate

Business licenses are the official-looking pieces of paper you see behind the register at brick-and-mortar businesses. Every business must have one, and depending on your local laws, you may have to have a city license or a city tax registration certificate. Yes, even if you’re running a business out of your home and have no one coming to do business at your home, you may still need this. If you don’t have one, the authorities may charge you a bunch of penalties if they ever find out. Avoiding this step isn’t worth that risk.

To save you hanging on the phone, listening to elevator music, and being transferred and disconnected ad nauseam, I supply you with the direct links for business portals for each state to apply for your licenses and permits in Table 1-1. These URLs are accurate at the time of this writing, but as everybody knows, URLs change frequently. Check the following for updates:

www.sba.gov/content/what-state-licenses-and-permits-does-your-business-need

State sales tax and resale number

If your state has a sales tax, a sales tax number (the identifying number you use when you file your sales tax statement with your state) is required before you officially sell anything. If sales tax applies, you may have to collect the appropriate sales tax for every sale that ships within the state that your business is in.

Some people also call this a resale certificate because when you want to purchase goods from a wholesaler within your state, you must produce this number (thereby certifying your legitimacy as a seller) so the dealer can sell you the merchandise without charging you sales tax.

To find the regulations for your state, if you can’t find the information on the web pages listed in Table 1-1, try the following site that supplies links to every state’s tax board, which should have the answers to your questions (look for a link to sales and excise taxes):

www.taxadmin.org/state-tax-agencies

Accessing online regulatory shortcuts

If you’re going to be paying anyone a salary (or even hire a contractor), you’ll need an employer identification number (EIN), also known as a federal tax identification number. Every business has one. It’s like a Social Security Number for a business, identifying your business on all government forms: a nine-digit number assigned to all businesses for tax filing and reporting. You may also need one for your state.

If you have employees, you need to file withholding forms to report that you collected the necessary withholding taxes. You must send these reports to the state and the IRS on behalf of your employees. You’re also expected to deposit those tax dollars with the IRS and your state on the date required, which may vary from business to business. Many enterprises go down because the owners just can’t seem to keep their fingers out of withheld taxes — which means the money isn’t available to turn in when the taxes are due. (This is another reason you should have a separate bank account for your business.)

No need to dawdle, and don’t waste your money with a third party who charges for their service. Why not get the number direct from the source, while you have the time:

1. There’s no charge to get your employer ID number (EIN).

   An employer ID number can be assigned by filing IRS form SS-4. Go to the IRS website to apply online:

   www.irs.gov/businesses/small/article/0,,id=102767,00.html

   Or if you’d rather mail in the form, the details and downloadable form are available as a PDF file.

2. State employer ID numbers for taxes may depend on your state’s requirements. Visit the following for an overview of the requirements for every state in the country:

   www.taxadmin.org/state-tax-forms

3. Register for the Federal Government Electronic Federal Tax Payment System^® (EFTPS) service where you pay any tax due to the Federal Government online without paying an extra fee to a third party. Once you have your FEIN, head over and register at

   https://www.eftps.gov/eftps/

Selecting a business format

After you’ve fulfilled all the regulatory details, you need to formally decide how you want to run your company. You need to set up a legal format and to make a merchandise plan. (For more on merchandise planning, visit Book 4, Chapter 2.)

When you have a business, any type of business, it has to have a legal format for licensing and tax purposes. Businesses come in several forms, from a sole proprietorship all the way to a corporation. A “corporation” designation isn’t as scary as it sounds. Yes, Microsoft, IBM, and eBay are corporations, but so too are many businesses run by individuals.

Each form of business has its pluses and minuses — and costs. I go over some of the fees involved in incorporating later in this chapter. For now, I detail the most common types of businesses, which I encourage you to weigh carefully.

I’m not a lawyer (I don’t even play one on TV), so be sure to consult with a professional in the legal and financial fields to get the latest legal and tax ramifications of the various business formats.

Sole proprietorship

If you’re running your business by yourself part-time or full-time, your business is a sole proprietorship. Yep, doesn’t that sound official? A sole proprietorship is the simplest form of business; you don’t need a lawyer to set it up. Nothing is easier or cheaper. Most people use this form of business when they’re starting out. Many people often graduate to a more formal type of business as things get bigger.

If a husband and wife file a joint tax return, they can run a business as a sole proprietorship (but only one of you can be the proprietor). However, if both you and your spouse work equally in the business, then running it as a partnership — with a written partnership agreement — is a much better idea. (See the next section, “Partnership,” for more information.) A partnership protects you in case of your partner’s death. In a sole proprietorship, the business ends with the death of the proprietor. If the business has been a sole proprietorship in your late spouse’s name, you may be left out in the cold.

Being in business adds a few expenses, but many things that you spend money on now (relating to your business) can be deducted from your state and federal taxes. The profits of your business are taxed directly as part of your own income tax, and the profits and expenses are reported on Schedule C of your 1040 tax package. As a sole proprietor, you’re at risk for the business liabilities. All outstanding debts are yours, and you could lose personal assets if you default. Also, as your business becomes profitable, this business format forces you to pay an additional self-employment tax.

Also, you must consider the liability of the products you sell on eBay. If you sell foodstuffs, vitamins, or nutraceuticals (new-age food supplements) that make someone ill, you may be personally liable for any court-awarded damages. If someone is hurt by something you sell, you may also be personally liable as the seller of the product.

In a sole proprietorship, as with any form of home-based business, you may be able to get an insurance rider to your homeowner’s insurance policy to cover you against some liabilities. Check with your insurance agent.

Partnership

When two or more people are involved in a business, it can be a partnership. A general partnership can be formed by an oral agreement. Each person in the partnership contributes capital or services and both share in the partnership’s profits and losses. The income of a partnership is taxed to both partners, based on the percentage of the business that they own or upon the terms of a written agreement. Any losses are also split. The partnership must file its own tax return (Form 1065) reporting the business financials to the IRS.

You’d better be sure that you can have a good working relationship with your partner: This type of business relationship has broken up many a friendship. Writing up a formal agreement when forming your business partnership is an excellent idea. This agreement is useful in solving any disputes that may occur over time.

In your agreement, be sure to outline things such as

• How to divide the profits and losses
• Compensation to each partner
• Duties and responsibilities of each partner
• Restrictions of authority and spending
• How disputes should be settled
• What happens if the partnership dissolves
• What happens to the partnership in case of death or disability

One more important thing to remember: As a partner, you’re jointly and severally responsible for the business liabilities and actions of the other person or people in your partnership — as well as for your own. Again, this is a personal liability arrangement. You are both personally open to any lawsuits that come your way through the business.

The partnership has to file an informational return with the IRS and the state, but the profits of the partnership are taxed to the partners on their personal individual returns.

LLC (limited liability company)

A limited liability company, or LLC, is similar to a sole proprietor or partnership but also has many of the characteristics of a corporation. An LLC differs mainly in that the liabilities of the company are not passed on to the members (owners). Unless you sign a personal guarantee for debt incurred, the members are responsible only to the extent of the total amount they have invested in the company. But all members do have liability for the company’s taxes.

A limited liability company doesn’t require as much of the legal red tape and obsessive-compulsive bureaucracy as a regular corporation requires. For example, while a corporation will require a board of directors, board meetings, an annual stockholders’ meeting, and meeting minutes of all these events, a limited liability company won’t.

You’ll need to put together an operating agreement, similar to the partnership agreement. Doing so also helps establish which members own what percentage of the company for tax purposes. Most states will require you to file Articles of Organization forms to start this type of business.

An LLC is taxed like a sole proprietorship, with the profits and losses passed on to the members’ personal tax returns. An LLC may opt to pay taxes like a corporation and keep some of the profits in the company, thereby reducing the tax burden to individual members. Although members pay the LLC’s taxes, the LLC must still file Form 1065 (just like a partnership) with the IRS at the end of the year. This gives the IRS extra data to be sure that the individual members properly report their income.

Some states levy additional special or minimum taxes on an LLC. Be sure to check with your state’s business department.

Corporation

A corporation has a life of its own: its own name, its own bank account, and its own tax return. A corporation is a legal entity created for the sole purpose of doing business. If you’re a sole proprietor and you’re incorporating, one of the main problems you face is realizing that you can’t just help yourself to the assets of the business. Yes, a corporation can have only one owner — but that owner is the shareholder(s). If you can’t accept that you can’t write yourself a check from your corporation — unless it’s for a specified salary or for the reimbursement of legitimate expenses — then you may not be cut out to face the responsibility of running your own corporation.

There are two types of corporations; it’s best that you consult your accountant or lawyer to decide which is best for you.

• C corporations are what we normally consider as corporations. This is the business format of the big guys, although depending on your sources of income, it might work for you. It is taxed as a separate entity and is subject to corporate income tax.
• S corporations are corporations that have filed a special election with the IRS. They are not subject to corporate income tax, but are treated similarly (not identically) to partnerships for tax purposes.

The state in which you run your business sets up the rules for the corporations operating within its borders. You must apply to the Secretary of State of the state in which you want to incorporate. Federal taxes for corporations presently range from 15 to 35 percent, and they’re generally based on your net profits.

Employee owners of C corporations can use the company to shelter income from being taxed by dividing the income between their personal and corporate tax returns. This is frequently called income splitting; it involves setting salaries and bonuses so that any profits left in the company at the end of its tax year will be taxed at only the 15 percent rate.

Be sure to check the current corporate taxes and compare what you pay and how much you’d pay in taxes if you left profits in a small corporation — important to know if you’re going that route.

Considering that the individual Federal tax-rate percentages for incomes up to $75,000 annually can go as high as 28 percent, the trouble of keeping a corporation for your business may be a huge money-saver.

The Tax Foundation (http://taxfoundation.org/) offers its annual State Business Tax Climate Index that lists the ten highest- and ten lowest-ranked states:

• Ten best states in this year’s Index are Wyoming, South Dakota, Alaska, Florida, Nevada, Montana, New Hampshire, Utah, Indiana, and Oregon. Many of these states do not have one or more of the major taxes, and thus do not have the associated complexity and distortions.
• Ten lowest-ranked, or worst, states from highest taxes to lowest are New Jersey, New York, California, Vermont, Minnesota, Ohio, Rhode Island, Connecticut, Maryland, and Louisiana.

The full index report and state-by-state ranking can be found at

https://taxfoundation.org/2017-state-business-tax-climate-index

Most states also have their own taxes for corporations. In Table 1-2, you see the basic tax for C Corporations (assuming your corporation makes money after payroll and other expenses). Please check with your tax professional; many states have franchise taxes, inventory taxes — and goodness knows what else — as well.

Often, in small corporations, most of the profits are paid out in tax-deductible salaries and benefits. The most important benefit for a business is that any liabilities belong to the corporation. Your personal assets remain your own, because they have no part in the corporation.