Your Legal Dictionary to Starting a Business

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BooksYay, its #StartUpFridays! Today we are discussing the topic #GettingLegal (taxes, LLC, paperwork). Starting a business and not getting these steps of the process situated and under control is an invitation for disaster, especially multiple invitations from the IRS. EEEK!

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So I wanted to give some knowledge on this topic since it can be a tad confusing (even I’m not sure if I got it all right, so please consult a trained CPA before embarking on any start-up quest!). Recently, I’ve been considering starting up freelancing in-between applying for full-time positions, and I remembered that my uncle in Miami is a CPA. So I called him up and shot a couple of questions about the first steps of the process towards him.

According to my understanding of what he told me (I repeat, I am NOT a trained CPA!), there are different ways that you can label your business and each have their own perks and disadvantages.

Sole Proprietorship: (un-incorporated individual) an individual who is running/owning a business. An advantage of going the sole-proprietor route can be that there is very minimal upfront cost in the legal department. It might be a great option for those who are starting out, because there is limited paperwork and limited upfront cost. What can be a disadvantage towards going the sole-proprietorship route is that you as the individual can be LIABLE for any physical or monetary damages.

ex. Someone comes into your store and slips and falls, not only can they go after your BUSINESS, but now they can also come after YOU (your property, wealth, and everything else you own).

Well, for many freelancers or business owners they might not have a brick and mortar building for their business, everything they do is online. So while they don’t have to worry about physical damage, they do have to keep a close eye on monetary and reputation damages. Ex. Say I make a website for a client and in the contract I tell them that they will make $5,000 a month increased sales guaranteed because of this amazing website I made them (not that I or ANY of you should EVER do that! Don’t guarantee ANYTHING that you can not GUARANTEE! Sorry, just want to make sure you get that clear!). If they don’t make for example the $5,000 a month that was guaranteed in the contract, then you are in breach of contract and they can come after not only your BUSINESS but YOU as well. Another example can be reputation damages, if you guarantee that your client is going to get X amount of new social media followers and they actually LOSE followers because of a marketing campaign you did, you’ll be at the discretion of your client.

While a sole proprietorship might be a good way to start out when you have limited cash flow and property to lose, it’s advantageous to consult a CPA and take the next step on your business journey if only to protect your assets down the road as your company and business grows.

Corporations (LLC, C-Corporations, S-Corporations) I would like to step out and describe filing as a corporation as giving birth to a baby. You are the parent of this child, but you aren’t this child. They are their own person or entity. Corporations allow a protective shield and degree of separation from the owner and the business. So if a client decides to sue you for whatever damages (as long as any actions performed by the owner weren’t done in a fraudulent manner, then in that case they can come after both the owner and their business) they can only go after what the corporation is worth, they can not touch the owner’s personal assets.

Ex. XYZ Corporation owns $10,000 in equipment and revenue, if a disgruntled client, employee, or passerby decides to sue XYZ corporation they can only sue for $10,000 since that is what the company is worth, they can’t go after the owner who owns a $200,000 property and a $20,000 car.

A disadvantage of doing a corporation can be the fear of “double taxation.” Corporations are taxed on their profits. So when a corporation makes a profit they are taxed on it, and that money is distributed to the shareholders (those who own a share of the title to the business) and they are taxed AGAIN on the individual level.

To qualify as a C-Corporation: You must file articles of incorporation with the secretary of your state. The Articles of Incorporation is the name of the document, it’s a series of statements that are necessary for the state to allow that entity to operate as a corporation. I believe it is profits of 10 million+ that force your into the C-corporation category. Hello, double-taxation!

Disadvantage: Possible Double Taxation

Advantage: You are making 10 million + in profits, seriously, you can pay some taxes!

To qualify as an LLC or S-Corporation: First off, LLC (Limited Liability Corporations) can be owned by individuals and corporations. So companies who own other companies within their companies, and individuals. S-Corporations can only be owned by individuals. If you have profits under 10 million you can qualify as a LLC or S-Corporation. What can be advantageous about a LLC or S-Corporation is you get the liability protection that you don’t get as a sole proprietor, you don’t pay taxes on profits, but the owner will be taxed on the income made through the business.

Confusing, I know!

To avoid double taxation or being taxed on profits of the business and personal income, many business owners turn their profits into salary, so they pay taxes only on personal income. Salary is considered an expense.

As a corporation you would have to give yourself a set salary, that can be tough if your income fluctuates a lot within the year.

A word to the wise, for every dollar you make expect to put aside 10-15 cents (can get up to 20 cents or more depending on what income bracket you are in, so consult a CPA!)

Just like an employer would withhold taxes from the employees paychecks, you have to do the same for yourself as a small business owner. Paying taxes is a part of life, but fearing it isn’t.

Like my uncle said, “Paying a lot of taxes is a good thing, because on the flip side it also means you are making a lot of money, and that your business is growing. “

What else would you add to this discussion? Leave your best taxes tips, advice, and comments below:

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