Starting and running a business in the US:rules you have to play by

Craig Forest

Business (in the US)

• What is a business?

• Why form one?• Where should it

be based?• How to form it?• Who should be

in it?• What type of

business?

Why?

Why?

To be your own boss

To make millions

To have YOUR idea improving SOMEONE’S LIFE

To mentor people in your company

For the satisfaction of a hard fought victory

To make an impact on the world

Its fun to see your ideas come to fruition

What is a business?

• Business or hobby?– Expectation of profit– Run in a systematic, continuous and regular businesslike

manner, – Has ordinary commercial principles governing it (such as

business and accounting records).

ExampleBaseball card collector? The distinction is important for tax purposes as losses from

a business are tax-deductible, while losses generated from a hobby are not.

Business or hobby?

• Hobby: report income, can not deduct losses• Business: report income and deduct losses

If you consistently lose money in your business, the IRS could claim it is a hobby and require you to report the expenses as hobby expenses, thereby limiting their deductibility.

What do I need to start a business?

Minimum!!!!

What do I need to start a business?

Minimum!!!!

An ideaKnowledge to produce it

CashCustomersChutzpah

What do I need to start a business?

Minimum!!!!

An ideaKnowledge to produce it

CashCustomersChutzpah

What do I need to start a business?

Minimum!!!!

An ideaKnowledge to produce it

CashCustomersChutzpah

What do I need to start a business?

Minimum!!!!

An ideaKnowledge to produce it

CashCustomersChutzpah

What do I need to start a business?

Minimum!!!!

An ideaKnowledge to produce it

CashCustomersChutzpah

The credit belongs to the man who is actually in the arena; whose face is marred by dust and sweat and blood; who strives valiantly...who knows the great enthusiasms, the great devotions, and spends himself in a worthy cause; who, at best, knows the triumph of high achievement; and who, at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who know neither victory nor defeat.

-TR Roosevelt (1910)

What else should I have before starting a business?

• A prototype of the service, product, …

• Knowledge of your competition

• Knowledge of the market

• Economics of the business

• Experience (from friends? family?)

• Written business plan

• A location (in your home is ok!)

In the United States

• Luckily we have a government system that makes this easy, cheap

• Free enterprise– If you can survive, you can thrive

Compare to Europe, Africa, anywhere!

Failure

66% of new employer establishments survive at lease two years

44% survive at least four years

Brian Head, Economist with the SBA Office of Advocacy

1. You start your business for the wrong reasons 2. Poor Management 3. Insufficient Capital 4. Location, Location, Location5. Lack of Planning 6. Overexpansion

Types of businesses

• Sole Proprietorships or partnerships

• C-Corporations

• S Corporations

• Limited Liability Company (LLC)  (or LLP typical in accounting, law)

Sole proprietorship

• A sole proprietorship is you doing business as yourself, even if you use a fictions name. It is simple, but affords no asset protection. Anything you do in business as a sole proprietorship -- or an employee of yours does -- is your personal liability and this exposes your assets to liability.

Sole proprietorships

• Pass through tax structure• No liability protection

– You are exposed and personally liable for business debts that cannot be met by business funds

• Ceases to exist if owner dies or stops doing business

• Can file DBA• Can obtain EIN• Exists when you say it exists• Can hire employees• Simplest, quickest way to get going

LLC• Limited liability – separate legal entity from its shareholders

– For debts– For injury

• Continuity of existence – Can be sold, change mgt etc

• Transferability of shares – Shareholders may sell or otherwise dispose of their shares at any time (subject

to any restriction imposed in the company's constitution).  This makes a company much easier to sell or pass on to others (such as your children) than other business structures.

• Marketplace credibility – As compared to sole proprietorships

• Control by shareholders • Profit may be distributed as dividends• Cheap to operate relative to corporations• Taxes

– Pass through to shareholders

http://www.companies.govt.nz/cms/how-do-i/learn-what-a-company-is/why-form-a-company

LLC

• LLCs offer flexibility in ownership and ease of operation. • No restrictions on the ownership of an LLC. • Not subject to the formalities by which S corps must

abide. • An LLC can be member-managed, meaning that the

owners run the company; or it can be manager-managed, with responsibility delegated to managers who may or may not be owners in the LLC.

• Taxes– A single-member LLC files the same 1040 tax return and

Schedule C as a sole proprietor; partners in an LLC file the same 1065 partnership tax return as do owners of traditional partnerships.

Corporations

• The directors manage the company.

• No flexibility in how profits are split up amongst its owners. The profits must be distributed according to the ratio of stock ownership, even if the owners may otherwise feel it is more equitable to distribute the profits differently.

S-corp• Taxes

– Pass through the income of these companies are passed through to their owners and reported on the owners’ personal income tax returns, thereby eliminating the double taxation incurred by owners of a standard corporation, or C corporation.

• Must pay nominal salary (J. Edwards example)• Ownership <75 shareholders, not other corps or LLCs• Major tax advantage over LLC• A major factor that differentiates an S corporation from an LLC is the

employment tax that is paid on earnings. The owner of an LLC is considered to be self-employed and, as such, must pay a “self-employment tax” of 15.3% which goes toward social security and Medicare. The entire net income of the business is subject to self-employment tax.*

• In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining income that is paid as a distribution is not subject to employment tax under IRS rules. Therefore, there is the potential to realize substantial employment tax savings.

– have to deal with all the paperwork associated with payroll tax. The payroll tax is a pay-as-you-go tax that must be paid to the IRS regularly throughout the year--on time, or you will incur interest and penalties. The paperwork alone can be an overwhelming task for someone who is not familiar with this; and if you expect to incur losses or otherwise experience a cash flow crunch during the year that would hinder you from paying the payroll tax when due, this could present a problem.

C-corp

Taxes

With a C corporation, the net business income is subject to corporate income tax, and the monies remaining after the corporate income tax are taxed a second time when they are distributed as dividends to its owners who must then pay personal income tax.)

Advantage of a C-corp

• Shareholders of a C corporation are typically not personally responsible for the debts and liabilities of the business

• C corporations can have an unlimited number of shareholders • Ownership of a C corporation is easily transferable through the sale of

stock • C corporations have unlimited life extending beyond the illness or death of

the owners • Additional capital can be raised by selling shares of the C

corporation's stock • Potential customers may perceive a C corporation as a more professional

entity than a sole proprietorship or partnership • C corporations are generally audited less frequently than sole

proprietorships • Certain C corporation business expenses may be tax-deductible • Forming a C corporation can result in self-employment tax savings • C corporations may provide a number of income and tax savings

Examples: LLC over S-corp for flexible for profit distribution

• You and a partner own an LLC. Your partner contributed $40,000 for capital. You only contributed $10,000 but you perform 90% of the work. The two of you decide that, in the interest of fairness, you will each share the profits 50/50. As an LLC you could do that; with an S corporation, however, you could only take 20% of the profits while your partner would take the other 80%.

Example: S-corp over LLC for tax advantage

• Mary owns a print shop• In keeping with the industry standard, Mary decides that

a reasonable salary for a print shop manager is $35,000 and pays herself accordingly. Mary’s total earnings for the year are $60,000: $35,000 paid in salary and the remaining $25,000 paid as a distribution from the S corp. Mary’s total employment tax is $5,355 (15.3% of $35,000).

• If Mary were the owner of an LLC, she would have to pay employment tax on the entire $60,000, equaling $9,180. But as an S corporation, she realizes savings of $3,825 in employment tax.

Self employment tax

• The self-employment tax rate– 12.4% for social security– 2.9% for Medicare

– Only first $106,800 of total net income is subject to the social security portion of the tax. All of the the total net income is subject to the Medicare portion of the tax.

  Sole proprietorship

C corp S corp LLC

Formation costs None Must file with state, state specific filing

fee required

Must file with state,

state specific filing

fee required.

Must file with state, state specific filing fee required.

PersonalLiability

Unlimited liability. Shareholders are not typically held liable.

Shareholders are not

typically held liable.

Members are not typically held liable.

Administrative Requirements

Relatively few requirements.

Election of board of directors/officers,

annual meetings, and

annual report filing requirements.

Election of board of

directors/officers, annual meetings,

and annual report

filing requirements.

Relatively few requirements.

Management Full control. Shareholders elect directors who

manage business activities.

Shareholders elect

directors who manage business

activities.

Members can set up structure as they choose.

Term Terminated when

proprietor ceases

doing business or

upon death.

Perpetual: can extend past death or

withdrawal of shareholders.

Perpetual: can extend past

death or withdrawal of shareholders.

Perpetual, unless state requires fixed amount of time.

  Sole proprietorship

C corp S corp LLC

Taxation Entity not taxable.

Sole proprietor pays taxes.

Taxed at corporate rate and possible double taxation:

Dividends are taxed at the individual level

if distributed to shareholders.

No tax at the entity

level. Income passed

through to the shareholders.

No tax at the entity level. Income passed through to members.

Double Taxation No Yes, taxed at corporate level and

then again if distributed to

shareholders in the form of dividends.

No No

Self Employment Tax

Subject to self employment tax.

Salary subject to self employment tax.

Salary subject to self

employment tax.

Income subject to self employment tax.

Pass Through Tax Treatment

Yes No Yes Yes

Tax Forms 1040 IRS Form 1120 IRS Form 1120SShareholders get

K-1 for personal tax

returns.

1 member: sole proprietor IRS Form 1040 - Schedule C

Partnership: IRS Form 1065, Members get K-1

Transferability of Interest

No Shares of stock are easily transferred.

Yes, but must observe IRS regulations on

who can own stock.

Possibly, depending on restrictions outlined in the operating agreement.

  Sole proprietorship

C corp S corp LLC

Capital Raising Individual provides capital.

Shares of stock are sold to raise capital

(Securities laws apply).

Shares of stock are

sold to raise capital.

Limitations prevent S corp stock ownership

by corporations.

May sell interests, but subject to operating agreement

(Securities laws may also apply).

Ease of Operation

Easiest Must have annual meetings, Board of Directors meetings, corporate minutes,

and stockholder meetings.

Must have annual

meetings, Board of

Directors meetings, corporate minutes,

and stockholder meetings.

Easy, some states may require more than others.

Financing

• Starting a business can be expensive• Where is the this money to come from?

• Angel investors• Venture capitalists• Your personal network (e.g., friends family)• The public (e.g., selling shares)• Loans (e.g., bank, credit card)• Sales!

Shares and vesting

• Your company can create shares and sell them or give them in lieu of/in addition to salary

• Why would you want to do this?– Raise money for business activities– Motivate owners/employees to work hard/long

time

Peeps you may need

• CPA-accountant for your receipts, taxes, whats ok to spend on

• Attorneys-file corp documents (articles of incorporation, annual reports

• Banks-loans, credit card, checks, registers

• Advisors-wise old sages (father-in-law?, alumni?)

Who should be in the business?

• You!

• Financiers

• Inventors

• Business peeps

People with vested interest

Scale ownership appropriately based on • investment• time worked• value added

Advice

• Separate your finances

• Separate your paperwork

• Separate your office from your living space

• Find mentors

• Write down agreements and sign them

• Take risks

How it works in Georgia

http://corp.sos.state.ga.us/corp/soskb/CSearch.aspCost ~ $100

File DBA (if sole proprietorship)

• “Doing Business As”

Mary Smith doing business as Mary’s Turbine Emporium– open a bank account – checks made out ot Mary’s Turbine Emporium– mailing address

EIN

• File a form SS-4 with the federal government (like SSN for business)

File annual documents

• Annual reports

• Certificate of organization

• Articles of organization (internal rules)

• Annual meeting minutes

• …

Inspired? What you should do next:

Ideas: thinking about ideas in classes, labs, jobs, walking across campus, sleeping

People: friends, investors, mentors, business partners

GO FOR IT!