This article addresses numerous questions that I have answered on other web sites about starting a small business and in particular about using that small business to invest in real estate. Also, many people who are considering retirement planning are thinking about starting a small business. In this article, I will attempt to focus on each of those areas and explain how starting a small business will benefit you regardless of your motivations.
Before we go down the road on how to start a business, keep in mind that some jurisdictions do not allow some types of businesses to be run from residential housing. Internet blogs for example will almost universally be allowed but perhaps pet sitting, day care etc. may not be permitted. Check with the local government agency to be sure before you put time and effort into a business that you cannot operate from your home.
Many small businesses get started at peoples homes and move to other locations as they grow. Look at Apple, a successful business that stared in a house.
You may want to consult the Small Business Administration website. This government organization has great resources and itself is a resource in the event you desire to apply for an SBA guaranteed loan. I will cover this later.
Assuming that you know what you want to do with your small business e.g. real estate investing, we go from there. I will not explore what your small business should do for income, that’s up to you. Other articles on my blog address some questions you should ask about this point.
Types of Business Organization
The first thing you will need to do is consider what type of legal organization you will use to conduct business. There are many available including:
- Limited Liability Company – LLC
- Sub Chapter S Corporation
- C corporation
- 501c3 Not-for-profit Corporation
- Family limited partnership
- Variations on the LLC concept for professionals
There are single person versions and multiple owner versions of how each is organized. States charter the above businesses. I will go into this later. You also have the opportunity to market your business as a “DBA”, that is “doing business as”. This works well when you have a unique name for your product or business and it’s just one avenue e.g. you can create several DBA’s.
DBA’s are owned by one of the organizations above and are not strictly legal organizations. You file a DBA statement with your local county. No one else can file the same DBA name in that county but they can file one in another county although it is unlikely unless many people offer it. There is no need to file a DBA for most businesses but I wanted you to be aware of its existence.
There are reasons for each of the types of organizations above. The following is a brief explanation of each:
- LLC – this form is very popular, it permits individual(s) to write up a simple articles of organization document that outlines how each person is viewed by the LLC e.g. a member, or managing member. Who can sign checks, how members receive compensation and any other elements that will completely spell out how the owners interact with each other. This document is created to avoid issues in the future.
- The primary reason to use an llc is to avoid liability transferring from your business activities to your personal wealth. By law, an entity suing the llc is prohibited from piercing the vail and taking personal property. Another reason for using an llc is that it is for tax purposes a partnership and all income flows into your personal tax return without first being taxed. Both of these are great benefits.
- Sub Chapter S Corporation – A popular form of organization which is very similar to the LLC except it is a corporation and under the articles of incorporation each owner is a shareholder and owns a specific number of shares with a par value. In an LLC you indicate in the articles of organization that a person owns x percent of the business. Just like an llc, the Sub chapter S Corp is not taxed, taxation takes place with the individuals income from the corporation. You can issue W2 forms for this type of organization and disburse all funds in that manner or make distributions to the owners.
- C Corporation – most small businesses do not use this type of organization because the corporation is taxed as an individual and the owners/shareholders are issued w2 forms meaning they take a pay check. This type of organization is subject to double taxation. You will recognize this type of organization because most business entities on the stock market are C corporations. When there are many shareholders this is a preferred type of business because in some cases the managers are not shareholders or are minor shareholders.
- 501c3 not-for-profit corporation – there are struct rules about forming and managing this type of corporation. You cannot own this type of business and you are subject to outsiders taking it over. People who are creating a business to manage charitable activities would chose this type of business because it will not pay income taxes. Individuals who draw funds will pay income taxes on those funds.
- Family limited partnership – this is similar to the llc in almost every way. Some people will put family assets into this type of partnership where multiple family members are involved in the business. An attorney can explain how this may benefit a new business start up over another form above e.g. llc for your specific need.
- Variations – professionals including doctors and attorneys can create other types that are called “llp” or Limited Liability Professional organizations. I will not go into that here since most who read this will have already formed this type of organization if they are currently a professional.
How Do I Get Started?
After you have decided which type of organization is best for you, the next step is to do a name search. States generally have online searches through the Secretary of State’s office. Click on this, it will take you to the Mississippi Secretary of State name search where you can enter a name and see if anyone owns it. Let’s explore the “Name”
When choosing a name, you need to consider where you will be doing business. If it is just in your state than you can expect once you have been granted a charter that no entity chartered in your state will use your name. That does not however prevent others from chartering a business in another state using your name. Unless you charter the name in all 50 states expect that your business name may be duplicated elsewhere.
If the name is unique the chances of usage by others will be smaller. Also anyone can use a DBA rather than the chartered name and that is legal even in your state but not in your county. So the name by itself for a small business is note something that should note be the most critical aspect of forming your business.
Your Business Name
About names. Changing a name by one letter is allowed. For example “Trident Capital” if it is available can be secured. If someone wants that name after you have secured it, they can use this instead “Trident Capital Services” and that name will be secured for them. So you see, you must consider fully exploiting the name from the start. If you were Trident Capital and you were making toy tridents then Trident Capital would be ok or “Trident Capital Toys” would be more descriptive.
I recommend that once you know the name is available that you immediately follow up with forming the organization. This secures the name. Some states may allow you to reserve the name for a few days but if you delay completing the transaction the name may be gone.
Remember, you can always use a DBA if your favorite name is taken. Some people could care less about the name and use the first initials of their kids e.g. “ABC Management LLC”. If you are engaged in multiple activities you may want to select a more open name such as “ABC Management LLC” which could mean anything.
Forming the Organization
With the name selected, time to follow through with forming the organization. Assuming that you have decided to select an LLC, you would follow the steps on the web site to fill in information about the LLC. The website will ask you who the designated agent is. This is the person in the organization who will receive any communication from the state or any legal notifications.
The designated agent is public information but the members of the organization are not (I believe this to be true in all states but things change). You must appoint a managing member or members and indicate this on the website if asked. Sometimes the managing members are exposed to the public as well.
About the managing members. These are individuals who can make decisions for the members. A managing member can open a checking account, sign checks, obligate the business to buy property etc. There can be more than one managing member. Typically a wife and husband LLC will list both as managing members. This must be indicated in the articles of organization and can be changed at any time.
Pay the required fees and you should receive an acknowledgement on line that you are officially a business entity.
Articles of Organization/Incorporation
Now that you have gone to the state website and formed your organization its time to get down to work. Create your articles of organization for an LLC and articles of incorporation for corporations. The articles of organization are easier to create, you can find examples all over the internet. I will not refer you to any one site since your needs will vary.
Download the basic articles that best indicate what you will be doing and modify them to suit your needs. Remember, you can change these at any time and they are not filed at the state or county recorders office. They are kept in a drawer or with an attorney.
Banks will require a copy when opening checking and other financial accounts. Lenders will require a copy when applying for a loan even if the loan is personal.
If there are multiple members, be sure if you change anything that you create a sign in sheet and state the change and have everyone sign it. Put the signed copy in the binder.
Consider using an Attorney
At this point it is prudent that I suggest the use of an attorney for creating the articles of organization. While you can do this yourself and many do, you may want to consult an attorney after you have created it.
I suggest this because the document must reflect what the members want it to say. So create it first using a template and have the attorney insure that it makes sense and has the required legal words. Doing it this way will save time and money.
There are companies that will do all of this for you selling you a package that includes creating the business and articles of organization along with a seal.
If you are creating a Sub Chapter S or C Corporation, you will need articles of incorporation and a seal. You can use a company that does all of that for you then take the articles to your attorney or have your attorney create the articles for you. Regardless, everyone uses the same templates and fills in the things that change e.g. names.
Unlike the articles of organization with an LLC, you must call a formal shareholder meeting to make changes. You have to take minutes etc. There are also requirements for annual meetings of shareholders etc. for corporations. LLC’s do not have such requirements.
FEIN/Tax Registration
You are not done just yet. You will need to obtain a FEIN, or federal employer identification number. This is used to open bank accounts and for other government and legal requirements. Without a FEIN, your business is not technically legal at least at the federal level. The purpose of the FEIN is to permit you to make tax deposits and payroll and security tax deposits.
As a small business just starting out you may not have employees and that’s ok but you still need the number and you will use that number when you file your annual tax return. Use this link to apply for your FEIN. You will have the number as soon as you go to the site and complete the documents.
If you live in a state that has an income tax as most due, you may have to file something with the state. Even your local county may require a business license depending upon what you want to do.
Finance
You should have completed the following steps before this section:
- Create a business name
- Secure that name with the Secretary of States website
- Complete requirements for filing the business entity
- Obtain certificate of organization from the Secretary of State
- Create articles of organization
- Obtain an FEIN from the IRS
Now it’s time to open a checking account to validate all of the work that you have done. There are many choices but unlike personal accounts, most financial institutions will charge you a monthly fee to open a business account. The fees are not large but your business is just starting so look around for the best deal.
You want a financial institution that is flexible and will perhaps offer you a line of credit or a loan when you need it. They should have a great website allowing you to transfer funds in and out without fees. You will need an ATM card and perhaps a business credit card. In some cases you can obtain everything from the same financial institution.
My preference is a credit union although most do not offer checking accounts to businesses. Try Navy Credit Union of you are active or former military, they have everything you need to get started.
Avoid using personal checking accounts and credit cards. Keep your business activities separate from your personal activities for many reasons not the least of which is to avoid an IRS audit. Setting up separate accounts and credit accounts without fees is a good move.
Account for Everything
You must account for every expense if you are to be profitable. That means mileage, use of your home etc. It’s too easy to buy something for your business and forget about it using your personal credit card. It has happened to me. I will go to Costco and buy pens while I am buying paper towels for the house. I use my personal card and the expense goes away.
I highly recommend that new small businesses obtain an American Express card. Why? Because the things you charge on the card are not reported to credit agencies as it is a business charge card. Further, as a charge card, you must pay the balance at the end of the month. This discipline will help to keep you profitable. They have an over time option but I have never used it. You will earn points and in my opinion the most valuable of any cards out there. And finally, there is no fixed credit limit.
One of my larger businesses used the American Express card to buy everything. On some occasions we exceeded our normal monthly purchases by more than 200% and they approved the purchase. This gave us the “float” that we needed to be paid and then pay American Express. I am not being compensated by American Express for these comments.
Accounting
Ok so you have a business and you are starting to make some income, not the same as earning a profit but transactions are being made. You need to track everything including your time if you bill by the hour. You can buy one of the on line accounting services e.g. Quicken or you can go on line and find accounting programs at no cost.
I use “Wave Financial” for one of my enterprises and it works very well. There is no cost for this software which works in the cloud. I have access to it on my iPhone and my computer as well. They even have an app that scans and records receipts and that’s free as well.
There is not need to start with an expensive option. When you business grows larger and you feel the need to move up to a paid program or even to work with a CPA, you can transfer your data over.
Tax Deductions
Be sure to read about what is deductible and what is not. Your personal car for example is not fully deductible if you use it for any personal use. For example, if you are on the road for 8 hours per day doing your business, you can deduct 100% of the car for your business less any personal use of it during the weekend etc. If you have only one car, the IRS will not let you get away with claiming 100% use.
If you have another car, then claiming 100% use make sense because you can park your business car and use your other car for personal use. If you use your personal car periodically for business, record mileage and use the IRS cost per mile deduction (changes each year). This is easy and is unlikely to spark an audit.
I use an app called MileIQ created by Microsoft on my iPhone. Its free and works great. It records every trip I make and after the trip I can swipe for business or delete for personal. I spend time on this mileage thing because it is a cause for audits. IRS looks unfavorably upon those who try to write off an entire vehicle for limited business use.
Another IRS audit issue is the office in the home deduction. This is a great deduction and not available any longer to individuals who include it on their 1040 but it is available those who file LLC’s and other business tax returns.
Read the IRS instructions for use of a home for business, it will take you through the process. Form 8829 is filed with IRS schedule C.
You need not be a CPA to work this out, the purpose of listing the forms above is to give you an idea of what is allowed. Use the categories and track the expenses inside of your accounting program. There is a way to set up Wave Financial or others to track exactly what the IRS needs. Then the CPA can transfer the data to the appropriate lines in their tax reporting software.
2018 Law Change
The tax law changes that took place for 2018 have created a win for small businesses. There is a $20,000 off the top of income allowance for small business that is a great windfall. Some small businesses lose money their first year and this may not apply since it applies to income. Losses are not a very bad thing at the start because some of the expenses benefit you. For example, if you have rental property, you can deduct depreciation and that by itself may cause your investment to show a loss.
Depreciation is not actually money out of your pocket that is why property owners who show losses may actually be making money on a straight cash flow basis. For example, you receive $1,000 per month in rental income. You are entitled to $300 in depreciation. After expenses before depreciation you earned a gross profit of $250.00. Then you apply deprecation and the profit goes away. You pay no taxes. But, you have $250 to spend.
Now this is not a permanent gift, depreciation will eventually come back to be reconciled when you sell the property but it gives you a good start like borrowing from the government. This works with the purchase of a pickup truck for you business for example. You can write off the entire amount the first year if you buy a heavy duty model e.g. 250 or greater.
Writing off a $75,000 vehicle against for example $70,000 in income means you pay no income taxes that year. Of course when you sell the truck the depreciation will come back and be calculated against future earnings. The point is that you have cash to work with in the early stages of your business.
Trademark and Patents
Most people do not have patents to protect but you may create things that you can trademark. If you are an artist and create art to be used on websites for example, you can trademark your products and restrict use. All you have to do is use the registered mark ™or the registered mark ® on your products including items on your website. See an attorney for more details.
Consider using the “copyright” symbol for documents and other work products that you want others to use but not copy. You can place the © symbol on your products as well.
Tax and Regulatory Favorable States for Businesses
While it is likely you will start your new business where you currently reside, some who are ready for retirement are more flexible regarding their geographical location. You should know that not all states are friendly to businesses. That is true of some cities as well. Years ago, I needed to open a site for my business in a city that was ideally located geographically.
I found a building that would perfectly meet our needs and I went through the process of determining what was required from the city. During the process, I was “encouraged” a the point of a dagger (not literally) to use a consultant on their favored list. At that point, I knew everything that the consultant knew but the fire department did not want to work with dummies. While I can understand that their time was often wasted by working with novices, I engaged a consultant.
After a couple of weeks of back and forth, we had our permit and leased the building and began operating there. Within another two weeks we were informed that they did not want us in the City. Turns out that the deputy fire chief had a thing with another organization and they did not want competition. They manufactured reasons for us to move.
We hired another professional who told us outright that the City in addition to this unusual “thing” also wanted to gentrify so they only wanted coffee shops and hair salons. It was a costly undertaking. This is not a story specifically about taxes but there are other issues you have to consider as well.
Some states are very hospitable to businesses with little red tape and must faster start up times. California is not one of those states and there are a number of very high cost and high tax and highly regulated states just like California. Before you consider starting your business check on the cost.
California Least Friendly Business State
For example, Calfornia charges $800 to create a business. Mississippi charges less than $50. California regulates everything and there are multiple hurdles to starting a business beginning with business licenses at the local city, county level. County environmental fees are charged to businesses by counties. Onerous state taxes on corporations and individuals. There are city, county, state and federal inspectors in California for almost all businesses. Forms and fees to be paid on an annual basis etc.
I am using California because I am very familiar with it. Nevada is a bit less intrusive, their business formation costs are half of California’s and there is less red tape although their tape supplier must be located in California. I moved to Mississippi to pay less taxes and start new businesses at lower costs as well.
Use Professionals
I know quite a bit about accountant and tax law after starting multiple businesses over a period of about 35 years. I was appointed Squadron Tax Officer while I served in the Air Force. They sent me to a school to learn how to complete tax returns so that I could help those in my squadron.
With all of this knowledge, I can do my own tax returns even the complex ones with many LLC’s and transactions. I employ the services of a CPA to check everything that I do or that my firm’s accounts do. Having another set of professional eyes is good insurance. I have not been audited in my entire business life.
My CPA Completes My Tax Returns
My CPA completes my business and tax returns every year. We have an understand that I want to deduct everything that I am entitled to. We do not operate in the gray area. I have known people who have tried to out guess the IRS and the disruption to their business even when they win is not worth the trouble to save a few dollars. So, I know that there are things that I could deduct but they are on the margins and not worth triggering an audit.
I use a corporate attorney who I consult on occasion and who has prepared legal documents for me and reviewed others. My wills and other documents have been prepared by attorneys. These people charge for their time and in my opinion it’s worth having a second opinion and someone looking out for you interest. My recommendation is that you should become familiar with the legal and accounting laws to the extent that they apply to your business but leave the professional things to professionals. In the end you will make all decisions which will be more informed.
Notes
The information provided above was not created to substitute for use of professionals nor is it considered advice since I have not charged for the information. There is much much more to starting a business and you should find additional information on this website. I will be revising this article over time and adding similar articles. Please review other blogs and FAQ;s
