Before the start of a new business, the entrepreneur must meet several federal requirements. This includes establishing the corporate structure of their new business, obtaining an EIN, acquiring the required permits and licenses that are necessary for daily business operations, and acknowledging the responsibility to pay different taxes. A new business owner is obliged to follow these federal regulations, and failure to comply can result in heavy penalties. The following information provides the relevant steps needed for a new business owner to properly fulfill his/her company’s federal requirements.
Determine business structure
Establishing the corporate structure for a new business is a major federal requirement. The most common forms of corporate entities that a new business owner may consider include Sole Proprietorship, Partnership, C-Corporation, S-Corporation, and Limited Liability Company (LLC). When determining the legal entity of a company, one should take into account both legal liability (the protection of a company’s assets in the event of debt) and the issue of taxation (the most suitable tax prospect for a company).
A. Sole proprietorship
This is the most basic type of the legal structures available for new businesses. It only applies to a new business whose owners plan to run the company themselves without any hired staff. In other words, when one is a sole proprietor, one will be going into business on their own. Rather than pay corporate taxes, sole proprietors are obliged to pay taxes on the profits made from their new business and are liable for their own business’ debt.
B. Partnership (general and limited)
When a new business is designated as a general partnership, two or more individuals equally invest in a company and willingly share in the profits and losses of their enterprise throughout the development of their company. This arrangement is made possible by a partnership agreement contract, outlining the responsibilities of each partner, the duration of partnership, and any management and financial arrangements acknowledged by all existing partners. Rather than pay corporate income taxes, each individual partner reports only their share of the total business income or losses on their tax return. However, they do not have any liability protection, and they are all equally responsible for any debt their business accrues. A common problem of general partnerships is that one partner often does more work than the others, leading to conflicts in the workforce.
In a limited partnership, there are general partners and limited partners involved. The general partner(s) often assumes the main duties of the company on a daily basis. The limited partners, on the other hand, have a more limited role- one with no managed control of the company. Limited partnerships have special regulations and will often require special state licensing. One disadvantage of limited partnerships is that general partners do not have any liability protection.
C. Corporation (C and S)
There are two types of corporations that exist. The C-Corporation comprises of shareholders who have voting rights and share in the wealth and losses of their company. A new business with a C-Corporation structure pays two types of taxes: the corporation, as a whole, is responsible for corporate taxes, and shareholders are taxed separately for dividends paid. Within this hierarchy establishment, stockholders have unlimited liability protection and other fringe benefits, including the option to have different kinds of stock.
An S-corporation is similar to the traditional C-Corporation; however, they are exempt from paying corporate taxes. Instead, the shareholders of an S-corporation must report their income on federal tax returns. Stockholders have limited liability protection but have only one class of stock. S-Corporation guidelines are considered strict. A company must first file for a C-Corporation structure and then apply for an S-Corporation status, an opportunity that is only available every five years.
D. Limited Liability Company (LLC)
One of the most promising legal structures for a new business is the Limited Liability Company. An LLC is organized in such a way that it combines several features of corporation and partnership structures. Another advantage of the Limited Liability Company structure is that the owner of the new business can select varying forms of distribution of profits. Unlike a common partnership where the split is 50-50, an LLC has much more flexibility.
Obtain an EIN
Federal requirements for a new business also include obtaining an Employer Identification Number (EIN) for the company. This is usually issued by the IRS when a business owner registers their establishment. An EIN functions in a similar way to a social security number; but rather than be used to identify an individual person, it identifies the company as a whole. If a new business owner plans on hiring paid employees, as in a partnership, corporation, or limited liability, they must register with the IRS to obtain their EIN. This federal requirement also applies to new business owners who plan to sell firearms, tobacco, or alcohol. In addition, existing companies who wish to change their corporate structure must also apply for a new EIN. New businesses that have a sole proprietor organization (no hired employees) need to apply for an EIN only if they plan to distribute firearms, tobacco, or alcohol. Otherwise, sole proprietors can simply use their own social security number when filing their taxes.
Attain necessary business licenses
Obtaining essential business licenses is another federal requirement for a new enterprise. Based on the type of business and the products and services offered to consumers, an entrepreneur may need to obtain several different licenses before their business can legally operate and move forward. For example, if new business owners plan to start a public transportation and trucking company, they need to obtain a license from the Federal Motor Carrier Safety Administration. If an entrepreneur plans on becoming involved in the food industry and wants to open a restaurant, they need to register the company with the Food and Drug Administration as well as the Bureau of Alcohol, Tobacco and Firearms if they intend on serving alcohol to customers. Likewise, an entrepreneur may need the approval from the Environmental Protection Agency if their business entails working with or using chemicals or toxic products.
Apart from these federal agencies, an entrepreneur also needs to get the approval of several state organizations before setting up their new business. This includes the city council, the water and sanitation department, and the fire department.
Tax obligations for a new business owner
A new business must also comply with federal requirements of taxation. It is often based on a new business’s corporate structure and the type of products and services offered.
A. Self-employment tax
This type of tax only applies to sole proprietors. It is a social security and Medicare tax the federal government withholds from the salary.
B. Federal income tax
Business establishments that designate themselves as sole proprietorships, partnerships, S-corporations, and limited liability companies (LLC) are all responsible to pay income taxes. Each of the mentioned entities is obliged to report their company earnings and expenses to the Internal Revenue Service (IRS), filing estimated and personal income taxes.
Corporations, on the other hand, are expected to report their company earnings and expenditures to the IRS using a corporate tax return form. Corporate tax payments are also made through estimated tax filings.
C. Franchise Tax
This tax only applies to corporations, whereby they are obliged by state and federal law to file a franchise tax report and pay a franchise tax annually. This tax is usually based upon location of the company, their corporate assets, and the number of stock shares they issue to their employees.
Federal requirements must be met before any new business owner can establish their startup. After deciding upon the organizational structure of their company, new business owners must obtain an Employer Identification Number. An EIN specifically pertains to the company’s unique identification number (similar to a social security number) that is granted for tax purposes. In addition, depending on the industry sector of the company, the new business owner must also obtain necessary licensure and permits from federal agencies to ensure the public health and safety for their prospective customers. In addition, they are also obliged to pay certain taxes depending on their corporate structure. For more information regarding the licenses and permits for a new business, please refer to new business licesing article