By Doug & Polly White, Contributors, USDR.
Q. Some friends and I are thinking about starting a small business, but we understand there are some legal, regulatory and tax issues we’ll need to address. Can you tell us what these issues are and how to deal with them?
A. Small business is the engine of our country’s economy and both political parties want economic growth. Therefore, you would think that starting a small business would be easy. You’d be wrong. Entrepreneurs encounter a morass of laws and regulations with which you are supposed to comply, and your efforts will be taxed at multiple levels. Worse, depending on the geography in which you operate and the industry you are in, the rules vary.
We’re not attorneys and we don’t give legal or tax advice. Further, this column isn’t long enough to cover this topic thoroughly (books have been written on the subject). However, we can make you aware of a few of the challenges you will face.
• First, decide how to structure your business (e.g., Partnership, LLC, S-Corp, C-Corp, etc.). We have addressed this issue in a previous Ask Doug & Polly, but the short answer is that you will probably want to be an LLC or an S-Corp. These structures will provide you with some protection from the liabilities of your company (e.g., lawsuits) and they have some tax advantages. We suggest that you consult an attorney for details.
• You will each have to pay personal taxes (federal and state) on any salary you receive. This means that the company will have to file both federal and state withholding taxes. This can be complex because you have to take income tax, FICA, and FUTA out of paychecks. Then the employer has to match the FICA withholding. These rules are subject to change based on pending regulation. If you use a payroll service, they will do this for you (for a fee, obviously). We use QuickBooks in our business, which will do the calculations for you. However, we had to pay an outside firm to set this up for us and we call them periodically when we have questions. It can be frustrating. We have paid this outside service $200 to help us figure out how to pay a $70 tax correctly.
• Assuming you are in Virginia, you’ll have to pay state unemployment taxes. Again, a payroll service can do this for you or QuickBooks can be set up to handle it.
• If you are an LLC, profits of the business (even if they are not paid out as dividends) will be split between the owners on a pro rata basis and each will have to pay their own portion of the taxes. However, if the business earns enough, you’ll have to file quarterly withholdings or risk a penalty at the end of the year.
• Businesses in Virginia with more than three full-time equivalent employees have to pay workers’ compensation insurance.
• If you sell a product rather than a service, you’ll have to pay sales tax. It can sometimes be unclear where the line between a product and a service is drawn. For example, if you are paid by the hour to write code for someone, that’s probably a service. However, if you are paid for developing an app that you deliver to someone, that may be considered a product.
• You’ll need to register your business with the State Corporation Commission and you’ll have to pay an annual license fee.
• Your county or city probably has some tax requirements. For example, in Chesterfield County, where we live, we have to get a business license (you can’t open a bank account without one). In addition, we have to file and pay taxes on the assets of the business.
• Most labor laws apply to companies with even one employee. There are many of them and they can be complex.
Starting an entrepreneurial venture can be exciting, rewarding and profitable. Unfortunately, our government makes it complex. We suggest seeking out competent advisors.