By Jim Conroy, CEO of The Neat Company
Starting a business requires organizing that business. Whether you’re going to function as a sole proprietorship or a corporation, being in business means keeping books and reporting profits to the IRS. Here are some ways your home business can meet those challenges.
Your business is what you do that people will pay you for. Whether you design websites, work as a contractor or landscaper, run a bakery, or provide dental services, your business structure is central to how you operate and navigate challenges.
Your business structure is who owns the business, who is liable for its actions, and who pays taxes on its profits.
The following chart from the Small Business Administration lays out the basic business structures available to you for operating your business. Except for partnerships, any of these can be a one-person operation.
| Business structure | Ownership | Liability | Taxes |
|---|---|---|---|
| Sole proprietorship | One person | Unlimited personal liability | Self-employment tax
Personal tax |
| Partnerships | Two or more people | Unlimited personal liability unless structured as a limited partnership | Self-employment tax (except for limited partners)
Personal tax |
| Limited liability company (LLC) | One or more people | Owners are not personally liable | Self-employment tax
Personal tax or corporate tax |
| Corporation – C Corporation | One or more people | Owners are not personally liable | Corporate tax |
| Corporation – S Corporation | One or more people, but no more than 100, and all must be U.S. citizens | Owners are not personally liable | Personal tax |
| Corporation – B Corporation | One or more people | Owners are not personally liable | Corporate tax |
| Corporation – Nonprofit | One or more people | Owners are not personally liable | Tax-exempt, but corporate profits can’t be distributed |
Source: Small Business Administration
However your business is structured, calculating profit or loss for tax purposes is a universal requirement. While some states tax business revenue, the IRS taxes on profit — revenue less expenses. Sole proprietors, in particular, need to ensure that what they do is treated as a business, not a hobby, in order for the IRS to allow their expense deductions.
Sole Proprietorships
Sole proprietorships are often the choice for home businesses or side-hustles. The simplicity of operating as a sole proprietorship is clear-cut – you perform work, get paid, and report your profit or loss directly on your personal tax return using Schedule C and Schedule SE. You’re your own boss and can make decisions and act on them immediately.
However, sole proprietorships come with limitations. Capital may be scarce. This makes it harder to obtain loans, nor can you float an IPO. Unlike corporations, which have multiple bankruptcy options for protection, sole proprietors are personally liable for business debts.
Other Business Structures
Partnerships have the same pass-through taxation as a sole proprietorship, and can benefit from the expertise of each partner. Limited liability corporations (LLCs) can reduce liability concerns, but the tradeoff is more legal oversight and regulation. Corporations further insulate the assets of the corporation’s owners and can usually more easily secure funding. However, they are subject to double taxation: the corporation pays tax, and then the owners pay tax on any share of profits returned to owner as dividends.
Bookkeeping Challenges
Regardless of the structure, bookkeeping becomes increasingly complex as the separation of individual owners from liability increases. Sole proprietors must spend time to track revenue and allowable expenses in order to correctly file taxes. This is true whether you throw all your invoices, receipts, and bank statements on a desk at the end of the year and start organizing them, or handle them on a daily, weekly, or monthly basis. As the business grows, errors become more likely as more tasks must be accomplished and more employees may be involved in recordkeeping.
Growth Challenges
A lot of home businesses exist just to generate income that supplements their salary from working for someone else — the classic side-hustle. But many more want to grow their home-based business into a larger entity that becomes their primary source of income. If that’s you, the challenge is one of both increasing volume and complexity. A business that started on the dining room table may expand to a dedicated home office. If regularly and exclusively used for your business, you can deduct the cost of that space. Growing further to an office, warehouse, or other facility provides additional expense items to track for deductions — or the intricacy of depreciating your business assets. Adding employees involves tracking their salaries, paying taxes you must withhold to the IRS (see IRS Publication 15), and a hodgepodge of forms and deadlines, each furthering the possibility of making an error.
Growth and market changes also underscore the logic for streamlining your processes to prevent them from interfering with actual commerce.
Managing Documents
Time, cost, and accuracy are your challenge regardless of your business structure. You will have tax deadlines to meet. This is not just the IRS deadline on April 15, but local business tax deadlines, often on different dates. If you have employees, you will need to provide withheld tax to the IRS semi-weekly or monthly, accompanied by the required form (usually, but not always, Form 944). Accuracy is essential. Penalties range from 2% to 15% of the taxes you did not deposit on time, in the right amount, or in the right way. And the more your business grows, the more prone it is to blunder from lack of time or green employees.
Basic ways to handle this bookkeeping have been paper ledgers and journals, file cabinets, and spreadsheets, all of which multiply possible error or omissions. One great help for a home business is a document management system (DMS). A DMS can grab relevant data in whatever way works best for you: scanning, uploading computer files, emailing attachments, or smart phone photograph. Through optical character recognition (OCR), it converts any input into digital data. These data are then stored securely in the cloud. Then you — or anyone you provide access — can manipulate the data to track invoices, receipts, related documents, and more. You can even generate reports to gain insight on your business, such as cash flow statements or profit and loss statements.
Your Next Step
The next step in any business is to create more efficient processes that increase its profitability. Up-to-the-moment data enables you to make smart decisions and secure financing when needed. Accurate records support growth from garage to giant. Meeting the challenge of picking the right business structure enabling your business to function well, proactively move forward, and embrace change provides the means for sustained growth.
