After you have decided what type of home based business you want to have, you will then want to determine it's structure. You actually want to legalize your home business even before you get your credit card and checking account. The only reason I went into depth about organizing your finances for your home business is because that's what people are usually most concerned with.
When organizing your home business, you need to determine what type of legal entity it's going to be. There are many types of entities to consider when running a business. I'm not going to list them all, only the ones that are easy and least expensive to form. Since, we are discussing legalizing home based businesses, cost is an important factor to keep in mind. Here are some business structures to consider:
- Sole Proprietorship
- Limited Liability Company
- S Corporation
- General Partnership
As for Sole Proprietorships, Limited Liability Companies, S Corporations and General Partnerships, consider the following Pros and Cons of each entity:
Sole Proprietorship - Pros: Inexpensive and easy to create and operate. You can report your profits/losses on your personal income tax return. Cons: You are personally liable for all business debts
Limited Liability Company - Pros: Limited personal liability for business debts; One person can own 100% of interest; Profit and loss can be allocated differently than ownership interests; IRS rules allow LLCs to choose between being taxed as partnership or a corporation; You aren't required to hold meetings and keep minutes. Cons: More expensive to create than sole proprietorships and partnerships
S Corporation - Pros: You have limited personal liability for business debts; You can report your share of profit/loss on your personal income tax returns; You can use corporate loss to offset income you may have from other sources. Cons: More expensive to create than partnerships and sole proprietorships; This entity has tedious paperwork than that that of a limited liability company which offers similar advantages; Income must be allocated to owners according to ownership interests; if you own more than 2% of shares in the corporation, benefits may be limited
General Partnership - Pros: Inexpensive and easy to form and operate; All partners can report their share of profit/loss on their personal tax returns. Cons: You are personally liable for all business debts
Another important thing to get to establish your business is an EIN # (Employer Identification Number). This is also known as a Federal Tax Identification Number, and is used to identify a business entity. You will need an EIN # to open a business banking account, applying for business licenses, and filing a tax return by mail. The good news is you can apply online and it takes only about two weeks for it to be inputted into the IRS' system.
My home based business is established as a Limited Liability Company. I chose this entity because of the benefit of limited liability. My personal assets are protected in the event that I (God forbid) I am sued. However, now that I look back I wish I had operated as a Sole Proprietorship for a while and then became a Limited Liability Company. The cost for establishing my LLC in NY state was over $500. Fortunately, the laws have changed where tax reporting is concerned. Back in 2008, it cost $350 just to file a federal tax return for an LLC. Now, it's only $25 to file.
As you can see, there are so many choices available for legalizing your home business and this is not a decision to be taken lightly. Evaluate the pros and cons and determine what's best for you and your business. After you have decided on a business entity to legalize your home business, chosen a name for your business and obtained your EIN#, have a professional take care of the paperwork. In some cases you can do it yourself but to avoid mistakes and save yourself time, let the professionals take care of it. There are some online sites that can take care of it for you. I have dealt with two that I recommend Legal Zoom and AmeriLawyer.com
