In my last post I wrote about how to get started on building a business. My main point was this: until you have a product to sell and customers to buy the product, nothing else matters. Anything else that may intimidate you about running a business doesn’t matter until you start selling a product to a customer.
Offering a product that customers are willing to spend money on is the hard part about running business. Comparatively, the other details are a piece of cake. They should not hold you back from starting a business.
One the most intimidating aspects of starting a business is the fear of failing to meet government requirements. No one wants to get in trouble with the IRS (or equivalent) or other government agencies.
In this post I’ll hopefully put your mind at ease by briefly describing the 3 main ways to keep the government happy as you start your business. The timing depends on the nature and complexity of your business, but in most cases these actions don't matter much until you actually start soliciting sales.
1. Decide on a legal structure
Businesses can operate under several different legal structures. The terminology and details may vary by country, but the main ideas should be the same anywhere in the world. Two of the simplest structures in the United States are sole proprietorship and LLC.
Sole proprietorship. This is the simplest way to get started. You don’t even need to take any action besides accept payment for a product or service. If someone pays you to mow their lawn, you’re a sole proprietor.
The disadvantage of a sole proprietorship is that you are fully liable for all debts and obligations of the business, including actions of employees. Your personal assets are at risk. This may not be a big deal at first, but it’s something to be aware of as you grow.
Limited Liability Companies (LLC). In the US, many small businesses use this structure. LLC's are simple and inexpensive to form (for example, $70 in Utah if you file the one required form yourself), and they provide some liability protection from your business.
2. Complete necessary registrations, licenses, and permits
Once you decide on your legal structure, you need to obtain the necessary government licenses and permits. Typically, your local government will require a business license and your state will require registration to do business (including reserving your business name). Some industries require permits, such as food services.
State and local governments desperately want businesses in their jurisdictions, and they try (as best as governments can) to make it easy for you to start. Why? Among other altruistic reasons, they want to collect more tax revenue!
All state and local governments that I’m aware of have sections on their websites dedicated to doing business in their area. They should outline exactly what you need to do to register your business and meet other legal requirements.
3. Understand your tax obligations
Getting behind on taxes is one of the best ways to get in trouble with governments. They will make your life miserable.
Understanding and keeping up on your tax obligations is not difficult, but it’s incredibly important. I recommend finding a good CPA to do your annual tax return, and this CPA can also advise you on other tax obligations. The details I mention are specific to the United States, but the same principles apply to most countries.
All businesses have to deal with income tax, which I’ll focus on here. Some businesses also have sales tax, property tax, payroll tax, and industry-specific taxes.
Employees don’t have to think much about taxes. Their payroll and estimated income tax is withheld from their paycheck, and after they file their tax returns they pay or get refunded the difference based on their actual tax owed.
In contrast, business owners must pay 1/4 of their estimated annual taxes each quarter (usually 15 days after the end of each quarter). In addition to regular income tax, you must pay self-employment tax (Social Security and Medicare). The 2014 rate was 15.3% (I know - it’s a lot).
Your CPA can help you estimate your quarterly taxes, but a good rule of thumb for many small businesses is 25% of net income (15% for self-employment tax and 10% for income tax). Until you build some history and have a CPA help you with better estimates, I recommend you transfer 25% of your estimated net income into a separate bank account as often as practical.
For example, if you're a freelance programmer with limited expenses, immediately move 25% of every client payment into your savings account.
When it comes time to submit your quarterly estimates to the IRS, you can simply transfer the funds from your savings account rather than scrambling to come up with the money.
I did not intend to make this a detailed guide. You can find more detail on any of these topics from many sources. The SBA, for example, has many great resources, including this section on starting a business.
My goal is to focus you on the most important tasks required to keep the government happy while you get your business going. Hopefully this puts your mind at ease by making government requirements seem less intimidating.
Question: What are other ways to make sure the government is happy as you start a business?