FAQ's - Starting a New Business
What Organization Structure Should I Choose when Starting a New Business?
There are many ways a business venture can be structured; however, the law distinguishes each business into one of five categories; sole proprietorship, partnership, corporation, the small business "S" corporation and finally the limited liability company. The type of structure chosen will have a variety of ramifications on the future of the company, tax implications, and the owner's personal liability. Before making a final decision about the structure of the business, one should understand all of the implications each structure will have on the owners. An attorney and an accountant can provide the best information to make that decision. [Show More]
When an individual forms a business and operates it in his or her own name, or a trade name, that person runs the risk of having all of his or her own personal assets exposed to the creditors of the business. That may mean that in the event of business failure, not only could the business be lost, but there could also be a loss of personal assets to pay for debt acquired by the business. All income and losses pass through to the individuals' personal income tax return and is then taxed only once.
In a general partnership each partner is personally liable for all of the business debts. All income and losses pass through to the partners creating no partnership tax. Through the partnership agreement, the partners can determine disproportionate allocations of these pass-through items among the partners. The partnership is terminated when any of the partners withdraws, dies, or becomes bankrupt. A new partnership can then be formed with the remaining partners. There is no legal form which needs to be completed to form a partnership; however, it is strongly suggested that an agreement be set up before business is to commence. It is also possible to establish a limited partnership which protects the personal assets of the limited partners.
The "S" Corporation
Unlike a regular "C" corporation, which is in effect a separate entity for tax purposes, the "S" corporation eludes double taxation of income to its shareholders. An "S" corporation more closely resembles a "partnership" for tax purposes because revenue, expenses, gains and losses flow to the shareholders' individual tax return pro-rata to their ownership interest. Thus, there is no corporate level tax on the earnings of an "S" corporation. However, an "S" corporation still provides limited personal liability to its shareholders. In short an "S" corporation has some of the important advantages of a regular corporation and partnership included in one business structure. A corporation can elect to be an "S" corporation by filing the IRS Form 2553, Election By A Small Business Corporation. The election must be applied for by the 15th day of the 3rd month of the tax year in which the election is to apply. If the election is made after this date it will automatically apply to the next year. Some important requirements must be followed to obtain and retain the "S" corporation status. If at any time an "S" corporation fails to meet these requirements the election is revoked and the structure of the company will revert to the "regular corporation" status and the corporation is prohibited from electing "S" status for five years. The requirements are as follows:
- All shareholders must consent to the "S" corporation status
- There may be no more than 35 non-spousal shareholders at any time
- The company must be a domestic corporation set up in the United States or organized under federal or state law
- There can only be one class of stock
- Only, individuals, estates and certain trusts are eligible as shareholders Those who are shareholders must be citizens or residents of the United States
Limited Liability Company
The limited liability company (LLC), like an "S" corporation, is a hybrid form of organization with the limited liability of a corporation and the income tax treatment of a partnership. Owners of an LLC are not held personally liable for the claims of the company. Also, when the assets or ownership interest in an LLC is transferred, there is a step-up in basis and no gain recognized. This is what distinguishes it from an "S" corporation. Such an event in an "S" corporation is taxable to the shareholder and may trigger tax to the "S" corporation. However, the formation of the limited liability company is more difficult. To be classified as an LLC, the entity must lack at least two of the following four corporation characteristics:
- Limited liability
- Centralized management
- Continuity of life
- Free transferability of ownership interest
What Numbers Do I Need When Starting a New Business?Federal Employer Identification Number
Companies which are structured as a corporation or a partnership are required to have a federal employer identification number. Sole proprietorships are required to obtain a number if they will be paying wages to other family members. This number can be obtained by filing a Form SS-4. The number should be obtained before the business is required to make their first federal tax deposit. An accountant is able to provide the correct forms and to assist in filing them properly.
Indiana Identification Number
Companies that withhold Indiana income tax from their employees and or collect sales tax from their customers must apply for a state number by filing Form BT-1. An accountant can also assist in the filing of this form.
Why Should I Develop a Business Plan and Budget?Many business failures can be traced back to a lack of planning. A business plan helps to identify your customers, product demand, capital requirements, and human resource needs. With this information, an operating budget can be constructed along with a cash flow statement to forecast the company's borrowing needs. Business plans and budgets, along with personal financial information, are basic elements required by financial institutions considering a company's request for financing. If outside financing is required, the business owner should be prepared to provide personal guarantees. An accountant can assist the business owner in the preparation of these documents.
How do I Develop an Effective Record-Keeping System?
When starting a business it is important that thought and consideration be given to designing a record-keeping or accounting information system which will meet the needs of the business. The system which is implemented should provide information which assists in making current and future business decisions to accomplish the organizational goals. [Show More]
Whether the business requires computer applications or simple manual accounting records, it is important to set up an organized and efficient manner of dealing with the wide variety of information involved in running the company. The first step in actually creating a record-keeping system is to sit down with a service representative from a financial institution and find a checking account that will meet the company's needs. A checking account is the basic source of recording the cash inflows and outflows of the business. While developing a record-keeping system, the business may have a variety of other issues to address before it can open its doors for operation. Here is a very short list of questions most small businesses have or should consider when first starting out:
- What kind of accounting method should my business implement cash, accrual, etc.
- What internal control measures should be implemented to safeguard the assets of the company?
- How and where should I store my business records?
- Which records am I required to keep, and for what length of time?
What Information do I Need From New Employees?W-4 Form
Each employee of the company must complete a W-4 Form, Employees' Withholding Allowance Certificate, so that the employer withholds the proper amount of federal income tax based on the employee's designation, from the employee's pay. Once an employee completes the W-4, it generally remains valid until the employee completes a new form. Employees claiming an exemption from withholding must prepare a new Form W-4 each year and submit it to the employer by February 15. The employer is required to begin withholding immediately if an employee who previously claimed exemption from withholding does not submit a new W-4 for the current year. The employer should withhold as if the employee is single with zero withholdings.
This form is to be completed by each employee to meet requirements of the Immigration Reform Act of 1986. The law prohibits an employer from hiring illegal immigrants. To be in compliance with this act, employers are required to verify the identity and employment eligibility of all employees hired after the effective date of the Immigration Reform Act (November 6, 1986). An employer must have the new employee complete the I-9 and sign the form. The employee must provide proof of identity within three days of employment. These forms should be retained for three years after the date of hire or one year after the date of an employee's termination, whichever comes first. Social Security Number All employees should have obtained a Social Security Number to identify themselves from others in filing their individual income tax returns. This number enables the IRS to match all income reports received for an individual to that person's individual file.