When starting a new business, many aspiring entrepreneurs will launch it as a side venture to their current career employment, a.k.a. their day job. So there may not be a big rush to create a complex and expensive legal entity such as a Corporation. In many situations a simple sole proprietorship is the most appropriate way to go.
KISS
Keep it simple starting out. The simplest form of entity for running your new business is a sole proprietorship. This form of ownership requires no special communication or filings to the Internal Revenue Service until you start paying employees and/or taxes.
Sole Proprietor
As a sole proprietor you are the owner of a business that might only need a business license/permit if your county or city requires it. If you are the owner of a business that sells items that require sales tax, you will need a reseller permit, and are liable to remit all state and/or city taxes on retail, and maybe wholesale, sales your business collects. Service businesses and most cross state sales are exempt from state sales tax.
Liability Insurance
If you are concerned about personal liability, then the simplest thing to do is to buy a personal liability umbrella policy. Additionally, the best way to avoid liability is to learn your trade well and keep accurate accounting records.
No Company Taxes, Just Yours
Profit from a sole proprietorship is reported on your personal tax return. The IRS won’t even know your company exists until after you file your first personal income tax return. This will include a Schedule C which reports all of the revenue and expenses your business has incurred. In most states, including California, certain state minimum taxes are not require of sole proprietorships. You will, however, have to pay any sales tax you have collected from your customers. And since sole proprietorship losses will offset income from you day job, you might even receive a tax refund. So concentrate on building your business, not communicating with the IRS
Just a Personal Bank Account Will Do, But Don’t
Although advisable as a sound business practice, you are not required to have a separate bank account which is a necessary compliance for a LLC or Corporation. As you get your business set up you could pay your startup costs out of your personal bank account, but once you’re in business and making sales, file a Fictitious Business Name Statement and use the paperwork to open a business bank account. Keep complete and accurate records so you can be sure to get the best possible tax advantage from those early-stage costs, and not get them mixed up with your personal expenses.
Simple to Start, Simple to End
Over 85% of small businesses fail or change ownership within the first five years. Plan your business to thrive but if it fails as a sole proprietorship, you simply stop doing business. No communication or special forms with the IRS, no additional taxes to get your investment returned and no high accounting fees to close out your company. Just mark the Schedule C in your next personal tax return as “final”.
Getting Paid
In a sole proprietorship you just take the money out as a draw. No payroll taxes or quarterly forms needed. Many startups lose money for the first year, and maybe longer, so keep your day job to pay your living expenses.
Evolving Beyond the Sole Proprietorship
As your business becomes profitable talk with a CPA about another entity type that might save you taxes. Just a simple bookkeeping entry transfers all of the business assets from the sole proprietorship into the new entity without any tax penalties.
