In order to avoid such problems, specific legal steps must be taken in order to start a home-based business. From selecting a business structure, to registering your business with the state. These procedures not only fulfill necessary government regulations, but also will protect you as a home business owner.
These steps are optional but highly encouraged. I know of some home business owners who already made millions working from home and yet their businesses are not yet registered, but it pays to abide by the rules. So, if you’re serious about having a smooth-sailing home business, consider these suggestions…
Register With The Government
Registering your home business with the state begins by deciding what type of business structure your business will take. Then, filing the forms for your business with your state.
But remember, not all types of businesses are required to file with the state and not every state requires the same thing. To be sure, you should consult with a lawyer specializing with this.
Businesses register with the state for two important reasons:
Businesses may or may not be taxed differently from individuals, and it depends upon the type of business structure. For some, it may save considerable tax payments to become a registered business.
Liability is your legal responsibility to those who are injured directly or indirectly from your products or services.
It is important that you register your business so you can be protected from another person’s injuries. While the business is the one responsible, you won’t lose your home or jeopardize your family’s future.
Choose Your Business Structure
Your choice of business structure (entity) depends on your state requirements, who is legally involved in your business, and the level of personal liability you wish to assume.
There are many types of business entities for the small, home-based businesses. In North America, these include:
2. Limited Liability Company
Other options include:
2. Limited Liability Partnership
Some options are unique to their particular state that’s why it is encouraged to consult with a lawyer when deciding your business structure.
A sole proprietorship is a business that’s owned and operated by one person. Most small businesses in the U.S. are sole proprietorship. In most states in the U.S., you do not have to file papers with the state to get permission to create a sole proprietorship but here in the Philippines, it is a must.
As a business owner, management control and decision-making is your responsibility. You have the full freedom to do things your way. You can respond quickly to each of day’s needs, but if you have employees, you are legally responsible for their decisions.
As a sole proprietor, the Internal Revenue Service (IRS) does not treat you as an employee of your business. You are taxed on all your net business income. All money made by your business, even if you leave it in the business, is taxable.
In a sole proprietorship, you are personally liable for all business debts. However, you can minimize your risk of loss if you buy relevant insurance coverage. Such coverage might be for your business property losses, personal injury, or product liability.
Limited Liability Company
This option is for entrepreneurs doing business in the United States and especially those offline, brick-and-mortar, or old-type businesses. This business structure in not available in countries like the Philippines.
There are three benefits of a limited liability (LLC) company:
- Ease of initial filing and annual renewals.
- The same limitation on owner liability like as those in corporations.
- The ability to be taxed as an individual.
If you choose LLC as your business entity, you have two options:
- Your business can be run by one person just like in the setup of sole proprietorship
- You can have a centralized management structures set up according to the laws of the state.
So, it’s like sole proprietorship but with features that are similar to those you see in corporations. There are some states in the U.S. that require a board of at least a chief manager and a treasurer.
Like I said, this entity enjoys a corporate-like features although it can be run like you’re running a sole proprietorship business. You should ask the IRS to have the business income pass through to the individual owners so they can be taxed as individuals.
Also, you can elect to have your business taxed a corporation. Your accountant can help you decide, based on your operations and goals. An LLC can combine the tax flexibility of a sole proprietorship with the shareholder’s liability shield of a corporation.
What makes an LLC entity attractive is that owners are not personally liable for obligations of the business. However, this shield is destroyed when you disregard the requirements of the legal structure of if you, the owner, are personally responsible for wrong-doing.
In a general partnership, each owner or partner owns a percentage of the business. Each has a say in the management of the business and works in it. The percentage each owns is stipulated in the partnership agreement.
Compared to the entities discussed earlier, this entity is more difficult to organize. Depending on the state, you may need to register your partnership agreement using the same type of forms used in registering corporations.
All partners share equally in the rights and responsibilities to manage and control the business. Depending on the state you’re in, some might require unanimous consent for certain decisions while others might be allowed by voting.
In most states in the U.S., a partnership does not pay federal income tax. But, it is still required to file certain tax forms every year. The form it must file is Form 1065, which is the U.S. Partnership Return of Income.
I’m not expert in taxation especially in the U.S. as I am from the Philippines, so it would be your best interest to enlist the skills of a tax preparer or an accountant. Get professional advice.
Limited Liability Partnership
A Limited Liability Partnership limits the legal liabilities for business debts to which the partners are exposed.
Consequently, an LLP cannot shield a professional such as lawyer or a doctor from malpractice claims. This entity is also tightly governed by state laws and the laws vary considerably from state to state.
Most states in the U.S. require that LLP follow law that are quite similar to that of general partnership law.
In Making Decisions And Responsibilities
This depends on what has been stipulated in your partnership agreement. In the agreement, you can elect who makes the decision in the partnership.
Remember, a partnership is a fragile thing. Trust and confidence among business partners are needed. Once trust is lost, the partnership can be dissolved.
Ownership in these kinds of partnership is divided into shares. You will own the number of shares stipulated in the agreement. You will then be taxed based on your percentage of share of the partnership income.
According to state laws, an LLP is partnership that has two types of partners:
- The General Partner – liable for all partnership or business debt. This type of partner may be required to repay business debt by liquidating personal assets.
- Limited Partner – This type of partner invests a specific amount of money into the business. As a result, this type of partner is liable only for the amount of business debt that is equal to his investment.
Some home-based businesses are structured as corporations. This happens when the business is run by a group of people like a family. Corporations are complex to set up, depending upon the laws of the state you’re in.
In most states, a corporation is owned by one or more shareholders and is managed by a board of directors.
A corporation is a legal entity in its own right and is separate or distinct from its owners.
- A corporation can sue and be sued.
- It has tax reporting requirements.
- It may need to pay taxes.
- A corporation owns all money and property, the shareholders will pay to buy stock.
- It owns all assets and all the money it earns.
- It is also responsible for all corporate debts and obligations.
- A corporation must have its own records and a bank account separate from its owners.
The greatest advantage of a corporate entity is that it is protected against personal liability of corporate owners. However, owners are still liable if they commit fraud.
- C Corporation – refers to the type of corporate entity big businesses use. It pays federal taxes and the remaining profits may be distributed to shareholders as dividends.
- S Corporation – this refers to the type of entity small business particularly home-based business owners use. This gives the home business entrepreneur the personal liability protection without to act like a giant business.
- Non-profit Corporation – this is used only if you have a mission or for organizations that are charitable or community-focused. They are allowed to make profits, but they are earmarked for furthering the mission.
- Professional Corporation – this is also a type of corporation organized for a specific purpose like rendering professional service. While enjoying liability protection as those of other big corporations, professionals are still liable for professional negligence.
Those are the legal entities in which you must choose where to associate your home business in its registration.
Now, let’s move on to another important thing…
Employer Identification Number
While most home businesses that I know do not employ individuals, it pays to have this requirement secured so in case your business grow, you are ready.
The IRS assigns an employer identification number (EIN) to identify tax accounts of sole proprietors, corporations, partnership and employers.
Here in the Philippines, we are required to get a tax ID number (TIN) separately from social security number, but in the US, if you are a sole proprietor with no employees, the IRS uses your social security number as your identification number.
Don’t neglect this part of your business. Also, banks and other financial institutions will ask you for these numbers in your transactions with them.
Licenses, Permits, and Tax Collections
While a majority of home businesses like those online businesses operate in discreet, it pays to have a license. Like I said, it’s for your protection, too.
Some businesses require permits or licenses specific to the nature of the business they’re operating, like if you’re dealing with food, you will need a sanitary permit. Be sure to get the licenses that you need.
Majority of businesses have an expiration date of one year. At that time, you will need to renew the license and pay renewal fees. Along with annual renewals, your license may have additional requirements like in restaurants, they need to be inspected again by regulators.
Please do not operate in advance, like when being tempted to operate now while waiting for your permits and licenses. If you do and get caught, you will be fined or sued.
Keep a record of all your permits and licenses for random inspection by your local government.
Always follow the rules in local taxation to avoid problems.
Follow Local Zoning Regulations
For home business that produce physical products, you should be aware of your local zoning regulations.
- Make sure that your local government permits you to operate your business from home.
- Find out if your local government permits you to operate your business the way you envision it.
- Consult with your homeowners association if they allow the type of work you want to perform in the location you have chosen.
Interestingly, in most online home business, like if you’re selling digital products as an affiliate, you do not have to deal with these headaches.
But, if you intend to have your own products, especially if they are physical products being produced in the vicinity of your home, then you must deal with your local zoning regulations.
Last but not the least in this sub-topic, is dealing with the owners of the unit you’re renting if you’re just renting out. Clarify with them with their rules, and explain your side why it is safe to produce your products in their property.
You do not want to be kicked out if you are renting an apartment.
The bottom-line in business is profits. What’s the use of having you follow all these legal steps in starting a home-based business if your business idea isn’t feasible?
Follow our suggestions here, but make sure that the business you’re starting is feasible. If you already have started, do your best that the costs in registering or renewing your business licenses is just a small portion of the money you’re making.
Thanks for reading. Let me hear your questions and opinions by submitting a comment below.
Gomer Magtibay a.k.a. Coach Gom blogs about home business ideas and answers questions (free coaching) about starting or growing a home-based business. If you would like to learn more about him or connect with him, click here.