Legal and Tax Implications When Setting Up a Business in Florida

Neil I. RumbakRumbak Law, [email protected]

Jake AdamsSouth Florida Remote [email protected]

September 22, 2011

Legal and Tax Implications When Setting Up a Business in Florida

You Are Not an Island.◦Refrain from doing things alone◦Delegate and focus on what you’re good at◦Seek advice from attorneys, accountants,

insurance agents, business and marketing consultants, bankers, insurance brokers, etc.

A Couple of Tips Regarding Starting Your Business…

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Attend Seminars, Training Workshops, Read

◦Small Business Administration

◦Florida Small Business Development Center Network

◦Internal Revenue Service

◦Florida Department of Revenue

◦Rumbak Law, P.A.’s Website(www.rumbaklaw.com)

A Couple of Tips Regarding Starting Your Business…

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sunbiz.org

◦Lots of information about business formalities◦Can extensively research other businesses◦File necessary documents to form business

entities◦File annual reports (information including

entity name, principal place of business, mailing address, name and address of registered agent, names and titles of officers, directors, managers)

◦Pay fees

Starting Point: Florida Department of State Division of Corporations

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Joe Smith is a web designer who is employed full time but is thinking about starting his own business

Joe knows nothing about business but is determined to be successful

Let’s help Joe decide his path to setting up his first business

Why are you forming a business?

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The first thing Joe wants to do is look professional and have a good image

Joe’s first client asks to write Joe a check, but Joe is embarrassed to ask for the check written out to him individually

Joe decides he wantshis clients to be able to write checks toWeb Design Services

Joe Smith, Web Designer

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Joe knows about corporations, but is unfamiliar with the other options

Web Design Services, Inc?Pros Cons

Fictitious Name: D/B/A as a Sole Proprietor

Inexpensive and easy to start

Can’t grow past Joe as owner/manager, very little legal protection

LLC Can grow as large as possible, can add members at any time, no changes in tax forms (if one member), flexibility,more legal protection

State filing fees, annual reports, and other paperwork,may require complex tax forms and planning

Corporation Can grow as large as possible with no changes, add shareholders at any time, more legal protection

State filing fees, annual reports, and other paperwork, could be double taxed, requires complex tax forms and planning

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Joe decides he wants to start easy and inexpensively

Joe advertises the name in the newspaper and registers the name with State of Florida for $90.00, valid for 5 years

Joe opens a bank account as Joe Smith, DBA Web Design Services

Joe can now accept checks and payment as Web Design Services

Joe Smith, DBA Web Design Services

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Search Sunbiz and the US Patent and Trademark Office (tess2.uspto.gov) to see if the name you want/similar names are taken

Consider a Fictitious Name◦Name under which a person/entity transacts

business in Florida other than the person or entity’s legal name

Why a Fictitious Name?◦Perhaps the official name of your business is

not as attractive as a fictitious name◦Required in most cases when you/your entity

transact business in Florida under than your legal name/your entity’s legal name

◦May have a few different businesses under one entity and want a distinct name for each

Picking a Name for Your Business

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Two years into his business, Joe is starting to get some big contracts and he is concerned about his legal protection from his business

Joe decides to form Web Design Services, LLC to provide himself with legal protection

Web Design Services, LLC

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After Joe forms his LLC, he starts to get more work than he can handle on his own and begins to hire employees

As Joe is starting payroll, we advise Joe to Incorporate under the Small Business Election (S-Corp) to pay less Social Security and Medicare taxes (as we will discuss later)

Changing from LLC to Inc requires changing EIN numbers and bank accounts

Web Design Services, Inc.

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Joe wants to know…when should he drop the S election?

You automatically lose your S election if the IRS disqualifies you under their rules

When corporate officers can benefit more from company provided fringe benefits than the tax benefits of the S-Corp election

When he wants to take his company “public” or when large amounts of capital are needed to grow the business

Web Design Services, Inc.

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Florida business structures include:◦Sole Proprietorship◦Corporation◦General Partnership◦Limited Partnership◦Limited Liability Partnership ◦Limited Liability Limited Partnership ◦Limited Liability Company◦Professional Corporation◦Professional Limited Liability Company◦Not for Profit Corporation

Business Structures

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We will focus on these:

Sole Proprietorship

Limited Liability Company (LLC)

Corporation S Corporation C Corporation

Which Business Structure Makes Sense for You?

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Registering your Business Entity With help from a lawyer or accountant

◦Recommend getting assistance from a trusted source before and during registration

Do it yourself◦The Company Corporation @

incorporate.com (includes startup papers)◦File directly at Sunbiz.org

Afterwards, register for your employer Identification number (EIN) through IRS.gov at no cost to you

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Which Business Structure?Federal and State Tax Overview

•LLCs can choose their tax structure

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Sole Prop S Corp C Corp

Federal Income Tax

Only personal

Only personal

•Corporateincome•Dividends

SS&Medicare All earnings

Wages only

Wages only

Ownership 1 person 1-100 1 or many

Fl State Income Tax

No No 5.5%

Which Business Structure?

Florida Legal IssuesSole Prop

LLC Corporation

How to Form Informal File Articles of Organization

File Articlesof Incorporation

Filing Fee $0 $125 $70

Annual Report None $138.75 $150

Internal Governing Document

None Operating Agreement

Bylaws

Management of Business

You choose

Depends Board of Directors

Limited Personal Liability

No Yes Yes

Protection of Business Interest

No OneMember:Maybe

Multi-Member:Yes

No

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Main issues to focus on:

1. Management of business by owners or a board?

2. Federal tax consequences1. Income Tax2. Social Security/Medicare taxes

3. Personal protection from/Exposure to Liability from the business

4. Can business interest be taken from you to satisfy your personal liabilities?

Which Business Structure Makes Sense for You?

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In determining which business structure is right for you, keep these issues in mind:

Social Security/Medicare Taxes Social Security Taxes: 10.4% (as opposed to 12.4% previously

and in 2012) on earnings up to $106,800 Medicare Taxes: 2.9% on all earnings (for all years)

Thus, in 2011, 13.3% (as opposed to 15.3% previously and in 2012) combined Social Security and Medicare taxes are paid on the first $106,800 of earnings

Which Business Structure?

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Main issues to focus on:

1. Management:However you want2. Federal Tax Consequences

1. Income Tax: Flows to personal2. Social Security/Medicare Taxes:

On all earnings, but adjusted before income taxes

3. You are exposed to liability from the business

4. Sole proprietorship assets can be taken to satisfy your personal liabilities

Sole Proprietorship

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Sole Proprietorship

Payment into Social Security & Medicare 15.3% (13.3% in 2011) tax on 92.35%

of business income Deduct ½ of SE Tax as an adjustment Let’s see how this would work:

Business Income $40,000 Adjustment for 1/2 of SE Tax $2,826

Adjusted Gross Income $37,174

Regular Federal Income Taxes $3,675

Self employment tax (15.3%) $5,652

Tax expense for the year $9,327

That’s $.2449 in tax on every dollar at $40,000 that you earn J

3. LLC Federal Tax Consequences

LLC

By default, single members are taxed as sole proprietors

By default, multiple member LLCs are taxed as partnerships

But can elect to be taxed as an S or C Corporation no matter how many members

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Main issues to focus on:

1. Management: You manage the business how you want to manage it

2. Default Federal Tax Consequences:1. Income Tax: Flows to member2. Social Security/Medicare Taxes: On all

earnings, but adjusted before income taxes

3. Personal protection from business liability4. Membership interest can be taken from you

to satisfy your personal liabilities only if if the creditor proves that distributions will not satisfy the liabilities within a reasonable time

Single Member LLC

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Main issues to focus on:

1. Management: You and the other owners (members) manage the business how you want to manage it

2. Default Federal Tax Consequences1. Income Tax: Flows to members2. Social Security/Medicare Taxes: On all

earnings, but adjusted before income taxes

3. Personal protection from business liabilities

4. Membership interest cannot be taken from you to satisfy your personal liabilities

Multi-Member LLC

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A Florida corporation is an incorporated entity in Florida. Its default tax treatment is as a C Corporation. A small business may elect S Corporation status, which generally is a preferred tax structure for small businesses.

To be an S Corporation, must elect on a Form 2553 (Election by a Small Business Corporation) and file it with the IRS within 2 months and 15 days

Corporation

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Can only be an S corporation if (among other things):

No more than 100 shareholdersNo shareholder can be a nonresident alien

Usually, all shareholders must be individuals

No more than one class of stock

S Corporation

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Main issues to focus on:

1. Management generally controlled by a board of directors, but you can be the board

2. Federal Tax Consequences1. Income Tax: Flows to shareholder2. Social Security/Medicare Taxes: On

wages, but not dividends3. Personal protection from business

liabilities4. Membership interest can be taken

from you to satisfy your personal liabilities

S Corporation

◦You may be able to pay less Social Security/Medicare taxes by declaring onlyreasonable compensation as wages, and any dividends would not be subject to Social Security/Medicare taxes

• Reasonable compensation is determined on a case-by-case basis, but factors include:

• Training and experience• Duties and responsibilities• Time and effort devoted to the business• What comparable businesses pay for similar

services

S Corporation

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S Corporation  S Corp  Sole Proprietor Revenues less Expenses $40,000 $40,000 Payroll Expenses ($25,000 gross pay)

$21,174

Business deductable portion of payroll taxes (7.65%)

$1,913

BusinessNet Profit $16,913 $40,000

Personal Income Taxes: S Corp  Sole Proprietor Business Income / Wages $21,174 as an employee $40,000 as self-employedS Corp earnings (from Sch. E) $16,914 as an owner Adjustment for 1/2 of S.E. Tax $2,826 Adjusted Gross Income $38,088 $37,174 Federal Income Taxes $3,847 $3,675

Self employment tax (15.3%) $5,652 paid on $40,000Personal payroll taxes(7.65%) $1,913 paid on $25,000 Total contributed to Social Security & Medicare

$3,826 $5,652

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Tax Consequences:

1. Income to corporation subject to federal and Florida income tax

2. Dividends to shareholders subject to federal income tax

3. Social Security/Medicare taxes: Shareholder pays on wages, but not dividends

If the vast majority of the activities of a C Corporation involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, it may be taxed at a flat 35% corporate income tax

C Corporation

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Benefits of a C Corporation

Retained Earnings: Money held in the corporation instead of being distributed◦Owners can save on taxes by keeping

profits in the company and deciding on distribution dates

Fringe Benefits: The corporation can expense some or all costs of fringe benefits provided to employees, the board of directors, and owners. This can save thousands on corporate taxes.

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Enter into agreements that will govern the internal workings (ex., management, voting rights, meetings, record keeping, tax issues) of the entity◦No specific document for a sole proprietorship◦Bylaws and Shareholder Agreements for

Corporations◦Operating Agreements for LLCs

◦Why Necessary? Required for corporations To avoid disputes among owners Efficient management of business

Agreements Governing Internal Workings of Entity

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Professional Licenses: List of professions is more extensive than you may think. Go to the Florida Department of Business & Professional Regulation website (www.myfloridalicense.com/dbpr/) for more information…

Realtors, CPAs, doctors, and lawyers need licenses, but so do, among many other professionals, agents for athletes, boxers, boxing promoters, and talent agencies

Alcoholic Beverage and Tobacco Licenses Hotels and Restaurants

Keep an Eye Out for Necessary Licenses

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The sale of tangible personal property sold at retail, stored for use or consumption, or leased or rented in Florida is subject to a 6% tax by the state (dor.myflorida.com/dor/taxes/sales_tax.html)◦Rental of certain real estate◦Admissions to events◦Note that a discretionary sales surtax may

also be required in certain counties Broward and Palm Beach do not have a

discretionary sales surtax

Sales Tax

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Cities and Counties may require business to pay fee and acquire a business tax receipt to engage in business within that area◦Requirements and fees for each city◦Broward County

If you do business in Broward County, you need a Broward County Business Tax Receipt For each location where you’re operating For each category of business

Includes home-based companies and one-person businesses

Business Tax Receipts

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The Heart of the Sole Prop. Tax All income and expenses listed on Sch. C

The truth is: if you already do your own taxes now, you can do your own taxes!

•Name•Social Security #•What do you do?•Does your business have a name?•Where is it located?•Do you offer credit terms?•It’s your business, yes?•Is it new?

•How much did you make?•Did anyone return anything ?•Cost of goods sold…tricky…

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Cost of goods sold (COGS) Use if you made (manufactured)

or purchased goods to sell

•Cost: The amount it cost you to acquire your goods to sell

•You started the year with all your goods you ended the year with, yes?

•How much in goods did you have on January 1st?

•How much of goods did you buy to resell?

•Did you pay anyone to handle your products?

•What did you spend making goods yourself?

•How much worth of goods did you have on December 31st?

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Sole Proprietor Expenses You can expense anything ordinary and

necessary in your course of business

Most expenses are listed in other

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Taxing a Sole Proprietorship or LLC

Now we have income and expenses… As a “pass through entity” the business

is not taxed on profits, the owner is Sch. C line 31 net profit and loss, is

carried to your 1040 line 12, business income or loss

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Reporting income from a S-Corp or LLC

Part II of your 1040 schedule EJ

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