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Frugal Small Business Start-up Tips: Step 7- Setting Up a Legal Business Entity

Starting a new business often involves numerous decisions and details- especially when it comes to its legal set up. If your time and money are limited then you want to do what you can to get your business going on the right foot and save yourself some headaches down the road.

Though I have made this topic of setting up a legal business entity one section, really it involves several steps and areas of consideration. Like the other articles in this small business start-up series, I will introduce each step, provide you with a few frugal business tips, and then point you to some outside resources which will cover the topic more in depth.

Here is a rundown of the steps involved at this point of your small business start-up process:

  • Decide on the Legal Structure of Your Business
  • Register Your Business Name
  • Apply for an Employer Identification Number (EIN)
  • Register Your Business for State and Local Taxation
  • Apply for Licenses and Permits and Abide by Local Zoning Laws

Choosing the Right Business Structure for Your Start-up

As you go through the start-up process you will need to decide which business structure your new company will take on; will it be a sole proprietorship, a partnership, an Limited Liability Company (LLC), or a corporation. One thing that many aspiring entrepreneurs may not realize that it is relatively simple to switch from one business structure to another, and in fact it is likely that a business will change its organizational set up as it grows and develops. Nevertheless, you do want to try to get the best fit for your new business at the beginning or you could end up loosing a lot of time and money later on.

That said, when it comes time to decide on the legal structure of your business, it is recommended that you sit down with either a qualified accountant, attorney, or business consultant like Trevor McClintock and consider the following points:

  • What is the size  and scope of your business?  How many owners will there be? Will the business have employees? Are these numbers expected to grow in the future? A business with several full-time employees, may be better off as a corporation since several employee benefits are directly tax deductible.
  • What is the nature of your business? Is this business in an industry that is prone to lawsuits? Will you be handling a lot of equipment or inventory? How important is the level of employee talent, skill, or experience to the success of the venture? Each structure has different tax and liability implications. A corporation and an LLC, for example, offer limited liability protection to its owners, while a sole proprietorship and a partnership do not.
  • How much financing will your business need for start-up, operations, or growth? If there is access to financing or if the amount of financing that is required is relatively small, then the simple structures, the sole proprietorship, the partnership, and the LLC, may be more appropriate.
  • What are the needs of the owners? Will the owners of the business need access to profits? How much structure and control do you want?
  • What will be the tax implications of each structure on the business and on the owners? Different structures affect personal taxes and business taxes significantly. A corporation, for example, may be able to save on taxes by reinvesting funds back into the business.

For more information on the various business structures see the following:

The Quick MBA’s Guide to Business Legal Structures

Register the Legal Name of Your Business

The legal name of your business is that name that will appear on any legal or tax documentation related to your business. Depending on the structure you choose for your business as well as the state that you will be operating in, there are different requirements for registering the name. You will also need to decide if you will be using your personal name, or operating under either a fictitious name or a trade name (known as “Doing Business As” or DBA).

For more information on registering the name of your company as well as a listing of websites for state DBA requirements, see the SBA’s page on registering a business name.

Applying for an Employer Identification Number (EIN)

All business entities are legally required to pay federal, state, and any applicable local taxes. Most businesses will need to register with the U.S. Internal Revenue Service (IRS) as well as the state and local revenue departments in order to receive an EIN, also known as a federal tax identification number.

The best place to get information on an EIN is the IRS website. You can even apply for a tax ID number online for free.

Register Your Business for State and Local Taxation

Aside from your federal tax obligations, your business will also be subject to state and local taxation as well as other state-specific tax requirements. This includes state income tax, state workers’ compensation insurance and unemployment insurance taxes. You should be aware that each state and local community has its own set of tax rates and regulations, and thus it is vital that you become familiar with your specific state and local tax requirements to avoid costly problems down the road.

Note: that you may have to fulfill different sets of tax requirements if your business operates in or is located in more than one state.

The SBA has a list of state resources that will tell you what you need to know about doing business and paying taxes within a particular state.

Apply for Licenses and Permits and Abide by Local Zoning Laws

To run your business legally, you must also make sure that you receive any applicable licenses and operating permits. Depending on your business’ industry and physical presence, you may be required to get licenses and permits at federal, state, and/or local levels. Like the taxation registration mentioned above, it is extremely important to understand the licensing regulations where your business is located since failure to comply can lead to a host of legal and financial problems.

To find out what specific licenses and permits you will need to operate your business, see the SBA’s Business Licenses and Permits Search Tool.

Finally, you should also be aware of the local zoning laws, especially if you plan on running your business from a home office and/or you will be receiving customers on your property. Some residential neighborhoods make it explicitly illegal to operate businesses within their boundaries; others may allow commercial activity but with some restrictions. If you are caught violating the local zoning laws, you risk heavy fines and your business can be shut down.

For a comprehensive list of articles and other resources on zoning laws see this field guide to zoning laws and ordinances.

See the SBA for information on zoning laws for home-based businesses.

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