By Katie Glorvigen
You're an entrepreneur with a great idea, a polished business plan and a lot of enthusiasm. Your new business is about to go viral. What are you worried about? The legal, tax and accounting side of business might be the answer. You've heard of an LLC and know there are tax requirements of some sort, but you're not sure where to start or what questions to ask. This uncertainty can be overwhelming and might be stalling your progress. Naturally you turn to Google and then realize there are seemingly millions of websites and blog posts that will help you start your business and guide you to financial success. Seriously who has time to search that many blog posts when you're busy starting your own company?
So what should an entrepreneur consider first? Here's a great place to start: determine what type of entity you will operate as. Here we outline a number of options and corresponding pros and cons to consider.
The easiest way to enter the business marketplace is to operate as a sole proprietorship. There are relatively few barriers to entry, minimal setup cost, no need to get a federal identification number and the income and expense from your business is reported directly on your individual income tax return, which you file every year anyways. The IRS does require you to keep business records of income and expense, however this can be done in a simple manner, paper and pencil will suffice or use a Google doc if you're up for a little spreadsheet work. In Minnesota, you need to register your business name with the Secretary of State. This ensures your unique business name is really unique. This can be done in five minutes and then you are up and running.
The entity you hear about most often is a limited liability company ("LLC"). This entity structure provides legal protection and limits liability for owners. As an LLC you should obtain a Federal Employer Identification Number ("EIN"), register with the Sec. of State, and set up a business checking account. If you're the only owner, you need to track income and expense and the business activity is reported on your individual tax return, so no extra tax return is required. The downfall is all of your hard earned net income is subject to income tax and self-employment tax. This can end up being as much as 45 percent of your total profit. If you have a partner, one big "pro" is that the sky is the limit for flexibility in setup. Be sure to put your partnership agreement in writing while you're both on the same page and getting along.
A more involved and sophisticated entity option is an S-corporation. As a corporation you will need to obtain an EIN, register with the Sec of State, obtain a corporate record book, setup a separate business checking account, elect "S-status" with the IRS, and file a separate tax return at year end. You will also need to up the ante when it comes to income and expense tracking, using software that can help generate a profit and loss statement and balance sheet. So why would anyone go to all this trouble? The short answer: tax benefits. A tax advisor can walk you through these benefits, including how the tax savings can outweigh the time and cost associated with this type of entity.
Once you have decided on an entity type and followed the steps to setup, you're off to a great start. You can cross it off the to do list and start operating. Be sure to track income and expense as you go. And remember to consult with your tax advisor for ongoing tax strategy.