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Definitions and discussion of Forms of Business

Hints and tips to help you to more effectively manage your business. In order to get the maximum value from this document, read it and apply those tips which directly affect you and your business. A telling sign on a new business owner's desk read:

"Yesterday I didn't even know how to spell ENTREPRENEUR and now I am one!"

Now that you have decided to open a home-based business, all decisions will be your responsibility, not just those you previously enjoyed because they involved your area of expertise.

Of course, as a day-care operator, you already knew how to soothe an upset child, but as the owner of that business, do you know when to file your taxes? As a consultant, you have over 20 years' experience advising organizations on personnel matters, but do you know if it's to your advantage to incorporate? You are an expert at word processing, but do you know how to develop an efficient record keeping and billing system? You are the boss now and the good health of your business depends on your management skills.

Choosing a Form of Business Organization

One of the most important decisions you will make is how to set up the business as a

1) sole proprietorship,
2) partnership, or
3) corporation
4) Limited Liability Corporation (LLC)

Remember, the small business owner risks it all, no matter what form of organization.
The forming of a business organization depends on the following factors:

- Legal restrictions
- Need for capital
- Liabilities assumed
- Number of people associated in the venture
- Kind of business or operation
- Tax advantages or disadvantages
- Intended division of earnings
- Perpetuation of the business

Most home-based businesses are sole proprietorships or partnerships, but a comparison of the advantages and disadvantages of each type of organization follows:

A sole proprietorship is the least costly way of starting a business. You can form a sole proprietorship by finding a location and opening the door for business. There are the usual fees for registering your business name and for legal work in changing zoning restrictions and obtaining necessary licenses. Attorney's fees for starting your business will be less than for the other forms because less document preparation is required.

Sole Proprietorship

Advantages / Disadvantages

- Easiest to get started / Unlimited liability
- Greatest freedom of action / Death or illness endanger business
- Maximum authority / Growth limited to personal energies
- Income tax advantages in very small firms / Personal affairs easily mixed with business
- Social Security advantage to owner

Simply making an oral agreement between two or more persons can form a partnership, but such informality is not recommended. Legal fees for drawing up a partnership agreement are higher than those for a sole proprietorship, but may be lower than incorporating. You would be wise, however, to consult an attorney to have a partnership agreement drawn up to help resolve future disputes.

Partnership

Advantages / Disadvantages

- Two heads better than one / Death, withdrawal, or bankruptcy of one partner endangers business
- Additional sources of venture capital
- Better credit rating than corporation of similar size / Difficult to get rid of bad partner
- Hazy line of authority

You can incorporate without an attorney, but you would be unwise to do so. You may think a small family corporation does not need an attorney, but an attorney can save members of a family corporation from hard feelings and family squabbles. Attorney's fees may run high if organization problems are complex. The corporate form is usually the most costly to organize.

Corporation

Advantages / Disadvantages

- Limited liability for stockholders (while true for big business, may not be for small business / Gives owner a false sense of security
- Heavier taxes
- Continuity / Power limited by Charter
- Transfer of shares / Less freedom of activity
- Easier to raise capital / Legal formalities
- Possible to separate / Expensive to launch business functions into different corporations

Record keeping

Keeping accurate and up-to-date business records is, for many people, the most difficult and uninteresting aspect of operating a home-based business. If this area of business management is one that you anticipate will be hard for you, plan now how you will cope. Don't wait until tax time or until you are totally confused. Take a course at the local community college, ask a volunteer from SCORE (Service Corps of Retired Executives) or a representative from the SBA (Small Business Administration) to help you in the beginning, or hire an accountant to advise you on setting up and maintaining a record keeping system.

Your records will be used to prepare tax returns, make business decisions, and apply for loans. Set aside a special time each day to update your records. It will pay off in the long run with more deductions and fewer headaches.

If your business is small or related to an activity that is usually considered a hobby, it's even more important that you keep good records. The IRS may decide that what you are doing is only a hobby, and you won't be allowed to deduct expenses or losses from your home-produced income at tax time. So keep records of all transactions in which you spend or bring in money. Pick a name for your business and register it with local or state regulatory authorities. Call your city hall or county courthouse to find out how.

Your records should tell you these three facts:
- How much cash you owe,
- How much cash you are due, and
- How much cash you have on hand.

You should keep five basic journals:
1. Check register-Shows each check disbursed, the date of disbursement, number of the check, to whom it was made out (payee), the amount of money disbursed, and for what purpose.
2. Cash receipts-Shows the amount of money received, from whom, and for what.
3. Sales journal-Shows the business transaction, date, for whom it was performed, the amount of the invoice, and the sales tax, if applicable. It may be divided to indicate labor and goods.
4. Voucher register-A record of bills, money owed, the date of the bill, to whom it is owed, the amount, and the service.
5. General journal-A means of adjusting some entries in the other four journals.

Choosing a Record keeping System

Set up your records to reflect the amount and type of activity in your particular business.

Even though you may be small and just beginning, it is probably wise to consult an accountant to help you decide which record keeping system is best for your business. Once it is set up, you can record the daily transactions or periodically have a bookkeeper post your daily transactions in your General Ledger and prepare your financial statements.

Be sure to establish a separate bank account for your business even before the first sale. Then you will have a complete and distinct record of your income and expenditures for tax purposes, and you won't have to remember which expenses were business and which were personal.

It is important to choose a record keeping system that you understand and will use. It will help you see how well the business is doing and is the first step in responsible financial management.

Tax Obligations and Benefits

Significant tax savings are available to the home-based business owner in the form of deductions, credits, and depreciation allowances. The time, money, and energy you put into keeping good records and keeping current on tax laws will be worthwhile and ensure that you operate within the law. You will need to plan for income tax, social security (all self-employed persons must pay a federal self-employment tax), employees' taxes (if you hire anyone), property tax on your home and business-related taxes, such as sales tax, gross-receipts or inventory tax (in some states and localities), and excise or individual item taxes (on certain commodities).

The Internal Revenue Service supplies the following free booklets (and runs free workshops) to give you details on your specific obligations:

- Your Federal Income Tax (Publication 17)
- Tax Guide for Small Business (Publication 334)
- Business Use of Your Home (Publication 587)
- Employer's Tax Guide (Circular E)
- Self-Employment Tax (Publication 533)
- Tax Information on Retirement Plans for the Self-Employed (Publication 560)
- Tax Information on Depreciation (Publication 534)
- Information on Excise Taxes (Publication 510)
- Tax Withholding and Estimated Tax (Publication 505)

There are various federal and state forms you will need to fill out to start a small business. The federal government requires you to fill out several forms including the following:

- Application for Employer Identification Number (Form SS-4) (If you have employees or are subject to excise tax)
- Employer's Annual Unemployment Tax Return (Form 940)
- Employer's Quarterly Federal Tax Return (Form 941)
- Employee's Withholding Allowance Certificate (W-4)
- Employer's Wage and Tax Statement (W-2)
- Reconciliation/Transmittal of Income and Tax Statements (W-3)

As a home-based business owner you should be aware that every business decision-each purchase and transaction you make-has tax implications or built-in tax advantages or disadvantages. Deductions may be available for home maintenance and improvements; automobile expenses; telephone expenses; office and work space; inventory space; major purchases, such as a computer; and a wide variety of other items such as uniforms, coffee service, trademarks, a safe deposit box, credit bureau fees, and business cards.

Each business situation is different and tax laws change, so consult up-to-date references, a trusted attorney, and an accountant who can advise you on your particular obligations and benefits.

Insurance

Insurance helps to safeguard your business against losses from fire, illness, and injury. You cannot operate without it. Talk with an insurance representative about your business needs. Check with the insurance carriers on your home policy and make Sure business use of your home is compatible with your homeowner's policy. In addition to a homeowner's policy (personal plan), now that you have a business, you will need a commercial policy for full protection. Discuss these other possible needs with your agent:

- Product Liability Coverage-to protect you in case your product causes injury to the user
- Auto Liability and "Non-owned" Auto Liability Insurance-if a car is ever used to support the business in any way
- Medical Payments Insurance-payable if Someone is injured in your home whether or not it was your fault
- Worker's Compensation-if you have employees
- Business Interruption Insurance or Earnings Insurance-in case your business is damaged by fire or some other cause and you must totally Or partially suspend operations
- Disability Income Protection-a form of health insurance in case you become disabled
- Business Life Insurance-to provide funds for transition if you die

Be sure to keep all your insurance records and policies in a safe place-either with your accountant or in a safe deposit box. If you keep them at home for convenience sake, then give your policy numbers and insurance company names to your accountant or lawyer or put it in your safe deposit box.

Final advice for the wise business person is to read and understand the fine print in all policies and to reevaluate business insurance needs about every six months.

Other Considerations

Another aspect of planning is sheltering tax dollars through a Keogh Plan or corporate pension and profit-sharing plans, if your business is incorporated, or a retirement plan,

If you have a partnership, consider making a Buy and Sell Agreement with your partner(s). This agreement requires the surviving partner(s) to buy, and the heirs to sell, the deceased partner's interest. The surviving partner(s) then becomes the sole owner(s) and the heirs receive cash for their share of the business.

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