SMB FAQs (standing for small to medium business frequently asked questions)

Assuming you have a business plan in mind, whether formally or informally planned, the following are the critical steps needed to start your business:

  1. Legally set up your business: this will require:
    1. Filing, with your state, the Articles of Incorporation (if setting up as a corporation), or Articles of Organization (if setting up as an LLC or some form of Partnership).
    2. Drafting your Bylaws and Resolutions, or internal agreement.

Tip: this can be completed by an attorney, or by an online legal service provider, such as LegalZoom or RocketLawyer. The former may be more costly upfront but may give you a better quality work product, while the latter will be more cost-effective and quicker, yet may give more problems down the line.

  1. Getting your Employer Identification Number (EIN): once the business is legally set up, this will be obtained from the IRS. This can be obtained directly from their website at https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online

Tip: This step can only be completed once step #1 above is completed, i.e. a legal entity has already been set up in at least one state.

  1. Open a bank account under the newly assigned EIN: One will need to open a bank account under the EIN assigned by the IRS. It is very important to use this account for all business transactions going forward, for both income and expenditures.

Tip: One will want to develop a relationship with a banker for banking needs going forward. This may not seem as important initially, however as your business scales, so will the need for banking products (need to open more accounts for specific purposes, credit lines, term loans and so on).

  1. Get a business license: Most cities or local municipalities will require a business license. This can be researched and obtained by jurisdictions mostly online. Generally a given jurisdiction will require completing an application detailing the business and its activities, and fees can be assessed based on industry, revenues or oftentimes a flat fee.

The most common business structures are sole proprietorships, partnerships, C-Corporations, S-Corporations and LLCs. The following is a table comparing the pros and cons of each:

Entity Type

Pros

Cons

Sole Proprietorship

1.     No legal entity set-up required.

2.     Can still obtain an EIN from the IRS if want to operate under a number that is not your social security number

3.     Can use a personal bank account to conduct business, however it is still critical to use an account exclusively for business transactions

4.     No additional set of tax returns to file at year-end. Everything can be filed with your personal tax return.

1.     No liability protection. In the event of a litigation or claim, your personal assets might be at risk.

2.     Your net earnings will be subject to self-employment tax (i.e. it is not a tax-efficient structure)

3.     You will still be required to keep a set of books, as with any other entity

Partnerships

1.     There is more versatility with tax planning with partnerships. Based on the partnership agreement, each partner can split profits, losses and capital.

2.     Partnership organization documents are often not public records, the way corporation or LLC documents can be.

1.     Depending on the role of a given partner, they can be subject to self-employment tax. This may become a more costly tax structuring to a given partner.

2.     Will require at least two partners. If there are two partners, and one partner were to leave, the entity will need to be re-organized in the future into another entity type.

3.     Depending on the type of partnership, there may be more legal liability exposure at the personal level.

C-Corporations

1.     Limited liability protection

2.     Suitable if many shareholders.

3.     No requirements on shareholders to maintain status of corporation.

4.     Can offer employees stock options as performance incentives.

1.     Double-taxed on income: Any income to corporation can only be taken out for shareholders via distribution or payroll. Either scenario will cause a 2nd taxable event to the shareholders.

2.     Cost of set-up: this entity type can be more expensive to set up given the costs to issue stock, maintain cap tables, document board meetings and so on.

S-Corporations

1.     Limited liability protection

2.     Tax-efficient: a shareholder is taxed once on earned income. Assuming there is sufficient basis in the Company, earnings can be distributed to the owner(s) without a second taxable event

 

1.     Various requirements must be met for qualification: one class of stock, no more than 100 shareholders, all shareholders must be individuals or only certain types of estates/trusts and must be US citizens or legal residents

2.     Will need to pay “reasonable compensation” to employee shareholders of the Company. 

 

LLCs

1.     Limited liability protection

2.     Can take on the form of any entity listed above.

1.     It must be noted that for tax accounting purposes, an LLC doesn’t have its own tax designation outside of what it is elected to become. More specifically, the organizer of the LLC will need to choose if it will take on the form of a sole proprietorship (single member LLC), partnership (multi-member LLC), a C-Corp or an S-Corp. Accordingly it will have its drawbacks based on the type of entity elected.

Each business will have its own needs and objectives. Most businesses owned by one person will find the S-Corp route to be the most beneficial.  Although an entity will need to be set up, it will help protect personal assets against any potential litigations or claims down the line.  Also, although a reasonable compensation will need to be paid to the owner/employee, in the aggregate it will reduce payroll taxes significantly as compared to a sole proprietorship or partnership.

Sole proprietorships are easy to set up but are generally not recommended for a scaling business.

Partnerships are used narrowly, most often when required by a governing professional body, or in various investment structures. These entity types are not as commonly used by small businesses.

C-Corporations are appropriate if there will be many shareholders, and for flexibility of transferability of ownership and corporate governance. These entities are most appropriate for an entity that would resemble a tech company: shares can owned regardless of citizenship status, greater than 100 shareholders in total, flexibility to offer multiple classes of shares and offer incentive stock options.

We are often asked what the most common tax deductions are for businesses. The Internal Revenue Code has it such that all expenses considered ordinary and necessary while engaging in a trade or business are deductible (i.e. can be used to offset gross income to arrive at taxable income).  Some of the most common such deductions are as follows:

  1. Operating Expenses: As mentioned above, businesses can deduct any ordinary and necessary expenses related to running the business, such as advertising & marketing, professional fees paid, rent, utilities, office supplies, and equipment.
  2. Salaries and Wages: Wages paid to employees, including bonuses, are deductible. This also includes contributions to employee benefits like retirement plans and health insurance.
  3. Employee Benefits: Contributions to employee benefits such as health insurance, retirement plans, and education assistance programs are deductible.
  4. Home Office Deduction: If you run your business from home, you can deduct a portion of your mortgage interest, rent, utilities, and insurance as a home office deduction.
  5. Depreciation: Businesses can deduct the depreciation of tangible assets such as vehicles, machinery, and office equipment over time. Accelerated depreciation methods, such as Section 179, allow for immediate expensing of certain assets.
  6. Professional Services: Fees paid to accountants, lawyers, and other professionals for services related to your business are deductible.
  7. Business Travel Expenses: Costs related to business travel, including airfare, hotel stays, meals, and transportation, can be deducted if they are directly related to business activities.
  8. Advertising and Marketing: Costs related to promoting your business, including advertising, social media marketing, website design, and more, are fully deductible.
  9. Interest on Business Loans: Interest paid on business loans and lines of credit is deductible, provided the borrowed funds are used for business purposes.
  10. Bad Debts: Businesses can deduct unpaid debts from clients or customers as bad debts, as long as these amounts were previously included in income and deemed uncollectible.

It must be noted that any startup or organizational expenses incurred prior to the organization, or incorporation, of your business can be added manually by your accountant to your books. However any such expenses will be limited to $5,000, with any additional expenses above that being required to be capitalized and amortized for tax purposes over a period of 180 months, or 15 years.

Each industry and business will have varying compliance requirements. The most common requirements for small businesses are as follows:

  1. Statement of Information Filings with the state (annual)
  2. Business license (generally annual)
  3. Payroll tax filings, if applicable (quarterly and annual)
  4. Sales tax return filings, if applicable (quarterly or annual)
  5. Estimated tax payments (quarterly)
  6. Income tax return filings (annual)

Most items above will require a set of books to be maintained, at least on an annual basis, and for filings and any due payments to be remitted by given deadlines.

The Corporate Transparency Act of 2021 mandates that BOI reporting to the Financial Crimes Enforcement Network (FinCEN) starting in 2024.

Beneficial owner: A beneficial owner is an individual who directly or indirectly has control over an entity or owns at least a 25% equity interest in that entity. The ownership can either be direct, or indirect (through a trust or other entity).

Applies to: The BOI reporting requirement applies to corporations, S-Corps, LLCs and most partnerships.  Sole proprietors are not subject to BOI reporting requirements.

Required Reporting: The BOI reporting requires the following for each beneficial owner:

  1. Full legal name
  2. Date of birth
  3. Resident or business address
  4. Social security number, taxpayer identification number or a passport number (for foreign individuals)
  5. Nature of ownership or control. This includes percentage of ownership, voting rights or other control indicators.

Deadlines: Entities in existence prior to January 1, 2024 have until January 1, 2025 to file.

Entities that formed in calendar year 2024 have 90 days (from the date of notice of creation of the entity) to file.

Entities that form after January 1, 2025 have 30 days to file from the date of notice of creation of the entity.

Penalties for Non-Compliance or False Reporting: Penalties for noncompliance or for false/fraudulent reporting can include:

  1. Civil penalties of $591/day for each late filing, with a maximum penalty of $10,000.
  2. Criminal penalties up to $10,000 and/or imprisonment for up to two years.
  3. Unauthorized disclosure penalty of $591/day for each violation with no maximum penalty.

What this means for your business: Your business should maintain accurate records of ownership structures and be prepared to report any changes properly. Compliance may require involve changes especially for entities with complex ownership structures.

Where to report: You can directly file your BOI on the following FinCEN website: https://boiefiling.fincen.gov/

Generally any payments made would consist of principal and interest. Only the interest portion would be tax deductible to the business. The principal portion is a paydown of a liability and as such is not a deduction against gross income in arriving at taxable income. The following template may be used to calculate the principal and interest of a loan over its life, including accounting for any extra payments made along the way: Oftentimes auto loans will include several days of interest after origination that must be taken into account. As such, the following template may be used for auto loans:

Once your business reaches $250,000 revenues or assets, it will be required to file a balance sheet on the Schedule L of the business return, assuming it does not operate as a single-member LLC. In the meantime the following is a list that can be used to organize income and expenses of your business.

Business Income & Expenses 2023

Please use the following individual income tax calculator: