Stage 3: Law & Taxes
Step 12: Consider a Legal Entity
The Concept:
One of the most important decisions you'll make is the legal form for your new business, which defines potential liability regarding business activities as well as a tax structure and which parties have controlling interest.
What you need to know:
Each of the various legal business entities has its advantages and drawbacks. It is important to consult with a knowledgeable attorney and tax advisor before making your choice. Don't automatically assume you need to incorporate because this may not be the most desirable form for your venture. The basic legal structures include:
Sole Proprietorship: You are the owner and maintain complete control of the business. As such, you are totally liable with personal assets at risk in any legal case against you. Income and expenses are reported on your personal tax return. The business terminates on your death or withdrawal from the business. The business can be sold but you are no longer the proprietor.
General Partnership: You and other parties co-own the business and have authority to establish contracts and make decisions. All partners share liability for debts and report income (or loss) on their personal returns. The business itself does not pay taxes. Cash distributions to partners generally are not taxed. The partnership dissolves upon death or withdrawal of a partner.
Limited Partnership: The business is controlled by a general partnership, with limited partners liable only for the amount of their investment. Limited partners do not participate in day-to-day operations. In this legal structure, both limited and general partners report their share of income or loss on their individual tax returns. Death of a limited partner does not dissolve the business. Tax treatment is similar (but not identical) to the general partnership form.
Limited Liability Company: A relatively new form in which an owner or "member" partners run the business, although members are not liable for debts. Members (an unlimited number of individuals or business entities) report income and income tax on their individual returns in the same manner as for partnerships. Continuity regarding death or withdrawal of members is different from state to state.
Corporation: A corporation is formed by filing Articles or a Certificate of Incorporation with the relevant state office. Here, shareholders in the business name a board of directors, who in turn appoint officers to run the business. Liability falls to the corporation, with shareholders responsible for the amount of investment. The corporation survives any death or withdrawal by owners, partners and shareholders. A corporation can file an election with the IRS to be treated as an S-Corporation. If no S selection is filed, the corporation is a C-Corporation.
C-Corporation: The entity pays its own taxes while shareholders report any actual dividends on their own returns.
S-Corporation: Similar to the C-Corporation, except the business entity generally does not pay taxes on its income, which is passed through to its shareholders. Shareholders will personally report their share of the income (whether or not distributed). Distributions of cash to shareholders are generally not taxed.
Points to consider:
- How will you finance your new business?
- How can you minimize taxes?
- What risk (liabilities) are you undertaking?
- How will control of the business be shared?
- What are the costs in forming your business?
- Will you retain profits (to grow the business) or distribute them to owners?
- What entity is the best for your business given your financial, tax and liability issues?
Step 13: Identify Required Licenses
The Concept:
Your business may need to be licensed to operate within your area and for other specialty purposes.
What you need to know:
Most cities and counties require new businesses to comply with various regulations by purchasing various licenses and permits. You may need a vendor’s license, or an industry-specific license, in fields such as general contracting, cosmetology, electrical work or liquor control. Check with the Ohio 1st Stop Business Connection Center (right) to obtain a free licensing checklist for your business. Then check for all local requirements by contacting your city and county governments.
Points to consider:
- What are the costs associated with obtaining the required licenses?
- What are the timeframes associated with the approval processes?
- What licenses must I obtain? What is the total cost?
Step 14: Seek Proprietary Approvals
The Concept:
Reserve the names, technologies, graphics and documents intended for your exclusive use.
What you need to know:
It's said that a patent to "hang on the wall" is worth nothing to a business unless it is valuable in the marketplace. You'll need to evaluate patent/copyright and trademark opportunities to see if they will be secure and worth the investment. Make sure your concept (and its name) is available and that it can be protected. You can conduct a search to see if a name already exists on the Secretary of State’s web site (http://www.state.oh.us/sos/).
Which of the following proprietary approvals will you need?
Name Registration
Trade Name: A name used in business or trade to designate the business of the user and to which the user asserts a right to exclusive use.
Corporation Name: The name of a corporation can be formed only when Articles of Incorporation are filed.
Fictitious Name: A name used in business or trade that is fictitious and that the user has not registered or is entitled to register as a trade name. Any business name that is not on file as a trade name or corporation name must be reported to the Secretary of State as a fictitious name.
Product Registration
Patents: Provides the holder with the exclusive right to make, use and sell an invention throughout the U.S. during the term of a patent. There are three kinds of patents: design, utility and plant.
Copyrights: Protection for original works of authorship fixed in a tangible medium of expression. You cannot copyright an idea on the expression of the idea.
Trademark: A word, name, symbol or device (or combination of these) adopted and used by a person to identify goods made or sold by him and to distinguish them from goods made or sold by others.
Other proprietary approvals: Service mark, mark of ownership, internet domain names, web site copyright.
Points to consider:
- What are the costs associated with obtaining your proprietary approvals?
- What are the timeframes associated with the approval process?
- Are the names, trademarks, patents and copyrights that are key to the success of your business secure?
- Are you infringing on another name, copyright, patent or trademark? If so, adjust your strategy to make the needed changes.
Step 15: Review Tax Issues
The Concept:
Make sure you know which federal, state and local taxes are due from your business.
What you need to know:
Underestimating how taxes will affect your bottom line can be a deadly mistake. It's important to work with a qualified accounting professional to determine and understand how each tax may apply to your business. That way you can plan for tax obligations and deadlines, and develop a workable tax management strategy.
Listed below are many of the taxes that may be applicable to your business:
Federal
Business Taxes
• Federal Income
Payroll and Self Employment Taxes
• Federal Income
• Federal Insurance Contribution Act (FICA)
• Medicare
• Federal Unemployment Tax (FUTA)
State
Business Taxes
• State Franchise and Income
• Sales and Uses
• Inventory
Payroll and Self Employment Taxes
• State Income
• School District
• State Unemployment
• Bureau of Workers Compensation
County
Business Taxes
• Property
City
Business Taxes
• City Income
Payroll Taxes
• City Income
Points to consider:
- The location of your business may affect the percentage of property tax you pay.
- The local income tax may vary by municipality or township.
- Estimated federal, state and local taxes must be paid quarterly.
- Have all tax issues been identified and addressed?
- Do you have a secure system of monitoring the taxes due and payment deadlines?
Step 16: Choose Accounting System
The Concept:
The successful entrepreneur has accounting systems that track all money exchanges in place and operating before the business opens. Such systems are used to monitor business finances and measure the success of the business.
What you need to know:
Financial statements tell a great deal about your business and are needed to compile tax information. The statements include:
- Profit and Loss (also called P&L, Income Statement, or Income/Expense Statement). This monitors business income and expenses as well as profits or losses over a set period of time (monthly, quarterly or annually). Make a P&L budget and monitor your actual performance against it monthly.
- Balance Sheet It provides a "snapshot" of your business finances at a set point in time and shows what you have and what you owe. The difference between those is your net worth or equity.
- Cash Flow Statement A cash flow statement is designed to convert the accrual basis of accounting used to prepare the income statement and balance sheet back to a cash basis. This accounting statement tracks all cash into and out of a company. The cash flow statement is like a checkbook for the entire business. It shows the beginning balance; deposits such as loans, sales, or investments; and checks, such as all expenses, loan payments and owner draws.
- Other Managerial Systems Depending on your type of business, you may need to track inventory, labor costs or productivity. Accounting systems are available for all of these.
A qualified accounting professional can help you set up and maintain your accounting systems.
Points to consider:
- Choose an accounting system that comfortably fits your needs.
- What tasks will your accounting professional perform? (Keep your records? Review or audit your records? Calculate the taxes owed and make payments?)
- How many transactions will you process?
- Should your systems be manual or automated? (Some systems are simple ledger books that are excellent for small businesses. Automated computer systems offer quicker access to reports and certain managerial accounting functions such as inventory management and labor costs.)
- What training is needed to operate the proposed system?
- How can you use the system to make your business more successful?
- What costs are associated with your proposed accounting system?
- Does the proposed financial accounting system compile income statements and balance sheets?
- Has a cash flow monitoring system been developed?
- Are other needed managerial systems in place?
Step 17: Research Regulatory Climate
The Concept:
It's vital to know which government and industry regulations apply to your company and how those standards may impact your business.
What you need to know:
Depending on your type of business, your company may be subject to certain standards and regulations. These include:
Occupational Safety and Health Administration (OSHA) Regulations
Cover on the job safety issues such as adequate ventilation, safe use of equipment and chemicals, scaffolding requirements, ear plugs, use of hard hats and steel-toed shoes, etc.
EPA Regulations/Permits
These national and state environmental standards cover water quality, air quality and solid waste disposal. The EPA also regulates prior and potential soil contamination.
Industry Regulations
These include Weights and Measures, the local Health Department and the Department of Alcohol, Tobacco and Firearms.
Points to consider:
- Do any regulations necessitate a change in your product or service? If so, do they affect your ability to sell it in the competitive marketplace?
- In addition to knowing and understanding current regulations, it is important to stay abreast of pending legislation, political issues and lobby-group issues related to your industry.
- Have regulatory issues been identified and addressed?
- Do you have a system in place to monitor regulatory changes?
