When there is more than one — a Partnership?

When there is more than one participant, you can’t be a sole proprietor.  That goes for husband and wife also, except in some special circumstances.  Like a sole proprietorship, a partnership is easy to form and without a lot of red tape.  You do need an agreement, which also makes good business sense!  The biggest downside is that you have unlimited liability not only for your actions, but for the actions of the other partners.

Partnerships are not taxed, but do have their own informational tax return — a form 1065.  The form 1065 reports the income and expenses for the partnership and divides the items among the partners based on the partnership agreement.  Each partner is given a K-1 with his/her share of the income/loss to be reported on various lines of their individual tax return.   The form 1065 can be quite complicated and should be prepared by a qualified tax preparer — another expense.  Partners pay self-employment tax on the income rather than being employees with a W-2.

Fringe benefits are generally not deductible for partners, and the options for fringe benefits and retirement plans are much the same as for sole-proprietors.

A partnership interest can be transferred and continue after the demise of a partner depending on the partnership agreement.  Also, if an LLC is comprised of more than one member, a partnership is the default entity if no other choice is made.  More about this when we get to LLCs.

Sole Proprietorship – Oldie but a Goodie

Sole proprietorship isn’t as popular as in the old days — those days before LLC’s.  But as the LLC newness has worn off, people are taking another look at sole proprietorship.  More about it when we discuss the LLC, but some states (including KY) have established annual reporting requirements and annual fees associated with LLCs, including the single member variety.

The number one advantage to a sole propietorship is the ease and low cost of establishing.  Other than state and local registrations (and an EIN if you have employees), you just start doing business.  Also, it has the lowest administrative costs.  The business income is taxed to the owner on his or her individual tax return on a schedule C or if a farm, a schedule F.  No separate return to prepare.  The business owner is not an employee, and pays self-employment tax as opposed to social security/medicare tax.

The major disadvantage to a sole proprietorship is the unlimited liability (including business and personal assets) for debts and any lawsuits brought against the business.  Some risk can be covered by insurance, but depending on your situation,  you might be wise to discuss with an attorney.

Other disadvantages include, as the same implies, it can ONLY be you.  If you have a partner, then you can not be a sole proprietor.  In addition, It is difficult to transfer interest of a business where the owner is a sole proprietor.  Fringe benefits for the owner are generally not deductible.

For low cost and minimum red tape, it’s the sole proprietorship.

Choosing the “Right” Entity

Quite frequently, clients ask me, “What type of entity should I be?”  And my answer is always the same, “It depends.”

The type of entity that you choose to be affects each of these items:

  • Ease of formation
  • Taxation of income
  • Tax filing requirements
  • Administrative and legal costs
  • Fringe benefits available to you
  • Retirement plans available to you
  • Legal liability protection
  • Ease of selling all or a portion of an entity

And your choices are (I’ll cover each of these entity types in later posts):

  • Sole Proprietorship
  • Partnership
  • Regular Corporation
  • Sub-chapter S Corporation
  • Limited Liability Company (which then brings you to choosing one of the above)

To be better able to make a decision as you explore the different entities, here are some questions to ponder:

  • Is it just me or will others be involved in ownership of the business?
  • If there are losses, do I want to be able to take them against other income that I have?
  • Is the “cost” of set up crucial to me?
  • Do I have the funds, and is it important to be able to put a large part of the profit into a retirement plan?
  • What fringe benefits are important to me?  Am I being covered under another health insurance policy?
  • Will I have employees?
  • How capable am I with paperwork, or will I be hiring expertise?
  • Is passing the business on to future generations important to me?
  • Do I have plans or dreams to sell the business?
  • What are the possibilities of legal liability that can’t be covered by insurance?

The beginning is the time to clarify some of your intentions and choose the “right” entity.  Entities can be changed, and sometimes need to be changed.  But it’s so much smoother when you get it right the first time.

e i e i N – What’s an EIN?

Employers Identification Number is commonly referred to as an EIN.  Start a new business and someone is going to be asking, “What’s your EIN?”

First, do you need one?  As the name implies, if you are an employer then you MUST have an EIN.  Anyone issuing a W2 is required to use an EIN, even household employers.  If you are starting a new business, have no employees and are a sole proprietor, then no you don’t.  You use your social security number for tax filing and bank purposes.  Separate entities, and by this I mean legally separate such as corporations, partnerships and LLCs, need an EIN.  The exception is a LLC that is a single member disregarded entity (unless they have employees).

To obtain an EIN the first thing you do is fill out an IRS form SS-4 regardless of the method used.  Then you can file:

  • Online 
  • Toll-free Telephone Service 1-800-829-4933
  • Fax (number depends on where you live)
  • Mail (address depends on where you live)

If you’re applying for an EIN, first of all, know what type of entity you are!  If you’re not sure, then don’t apply until you are certain.  If you mark corporation, then the IRS is expecting to see a form 1120 filed even if you decide that you’re really a sole proprietor.  Secondly, there is a question about employees in the next year.  If you don’t have employees and are not certain you’re going to have employees, then say zero.  Again, you put a number and the IRS is then expecting a form 941 and form 940 to be filed.

Unsure about a question on the application?  Ask your tax professional.

Sales Tax for Artists, Crafters and other Sellers

Sales tax isn’t a federal tax and each state has it’s own regulations, which makes it difficult to give hard and fast rules.  What I’m giving you are some general guidelines and a list of questions that you need to answer for yourself in regards to your state.  Google your state name and sales tax, and then a good place to look is the FAQ section.

  • What is required for registration?
  • What are the report filing requirements?
  • On what does your state impose sales tax?  Usually this is the sales of tangible property (something you can see, touch, etc.), but sometimes digital property is included.
  • What is the state sales tax rate?  Can there be additional sales tax for cities and/or counties?
  • Which sales are exempt from sales tax?  Commonly, sales of property for resale are exempt as long as you have a proper “resale certificate” from the buyer.
  • Are interstate commerce sales exempt from your state’s sales tax?
  • Does your state require sales tax to be collected on shipping and delivery?
  • Are sales required to be broken down on a receipt between sale price and sales tax?
  • If you have paid sales tax on items used to produce your property sold, do you get a credit?  Can you request a refund of these taxes paid?
  • Is there compensation/reduction for collecting and timely filing?
  • How long does your state require you to keep records?

This is my little “down and dirty” calculation to come up with sales tax from only keeping up with total sales/receipts and with those that are exempt.  Also, exempt might be shipping, if it is not taxable in your state.  If you have numerous smaller sales, it is cumbersome to keep track of each sale.  And sometimes you may sell an item without  collecting sales tax (if it applies, you are still required to pay it even if you didn’t collect it).  There are other ways of doing it, but you’re pretty much stuck with always keeping up with AT LEAST two items.  You are going to need total receipts/sales for other tax reason, so that’s a given.  Some keep up with total receipts and sales tax collected, and back into the other numbers.  The key is to come up with a method that is easy for you,  gets the state it’s due revenue and BE CONSISTENT.

Business vs. Hobby

I’m posting this topic first for two reasons.  One, it is very important in terms of taxes to a small business.  I’ll talk about the tax implications in a later post.  Let me just say that it’s really not good to have your business reclassified as a hobby.  Secondly, is the IRS’s “facts and circumstances” for determination reinforces the importance of setting up your business properly.

Make a profit (income – expenses = profit) three or more years out of five, and the IRS says (most often) — you’re a business!  It’s those pesky losses that are a problem.  Even in good times, it takes several years for a business to be in the black.  Real businesses have losses.  This is where the “facts and circumstances” come into play.

Usually in “facts and circumstances” the IRS has some mighty slippery stuff, but in this area at least some of it makes a lot of good common sense.  These are the things that the IRS looks to when deciding if you are a business.

  • The manner in which you carry on your business (This is a biggie.  Keep business-like records.  Have a separate checking account and credit card.  Obtain proper license, registration, etc.)
  • Your expertise or the advisers you use (research strategies and trends in similar businesses, seek expert advice, and keep a record of what you do)
  • Time and effort your spend in the business (use some sort of log for time spend working in the business, even if it’s just notes on a calendar)
  • Do you expect your assets to appreciate in value
  • Have you done this before with success
  • Your profit and loss history with the business (Develop a business plan and periodically re-evaluate where you are and what you can do better)
  • Amount of occasional profits
  • Your overall financial status (Yes, if you have other resources, then they are more likely to consider what you do as a hobby)
  • Is the activity pleasurable (It’s a shame they don’t think your work could be fun!)

SUMMARY:  If you’re a business — act like one!

Welcome!

Welcome to the debut of Living within your Harvest!  Currently things are rather sparse here, but it’s my plan to fill out the bones with information, tips, reviews and resources for small business owners and just about anyone else who lives in the world.  Notice the “small business checklist” tab — it’s an outline of information pertaining to small businesses (and there soon there will be a checklist for personal finance also).  As I blog about various topics, I’ll link the post to the appropriate place in the outline.  Someday it will be fleshed out into a wonderful resource.  In the meantime, read the posts and learn some accounting!  Of course, it can’t just be lesson after lesson — I love accounting, but I doubt I’m in the majority.  My fondness for office products will probably find it’s way here as “reviews”.  And we all need inspiration — as I find it, I’ll share it.  Comments, suggestions and requests from you are very welcome– after all, this blog is for you!