Legal Structure, Licenses and Taxes

Creating an ecommerce website is the main part of the business. However, there are other components to consider such as the business structure, licensing and the tax implications.

My initial thought was to create a Sole Proprietorship for a number of reasons including;

  • Ease of formation – just register with the local county office (in California)
  • Tax benefits – taxes are paid in the individual’s personal tax forms, 1040. Losses from my business can be used to offset my personal income and can reduce my personal tax liabilities.
  • Employment – I can hire people which can lead to other benefits associated with job creation, such as tax breaks.

The downside, however, is that I will have to pay self-employment tax (Social Security and Medicare taxes) on my business income. Self-employment taxes consist of a 12.4% Social Security tax on income up to an annual income ceiling, and a 2.9% Medicare tax which is not subject to any ceiling.

A second concern is that I will be personally responsible for any liabilities incurred by my business.

As my business grows I will have to consider incorporating the business. An S Corporation looks very attractive because it will provide me (its owner and shareholder) with limited liability. As a shareholder, I am not personally liable for any of the corporation’s debts, although I will have to personally guarantee my business debts.

The main reason, however, why S corporations are attractive are the tax benefits.

Although an S corporation is a pass-through entity (income and losses pass through the corporation to my personal tax return) the same as a Sole Proprietorship, the main benefit concerns Social Security and Medicare taxes (self-employment tax).

As a sole proprietor, all the profit I earn from my business is subject to self-employment tax. However, this is not necessarily the case if my business is organized as an S corporation.

As the only employee of my online business structured as an S Corp, I can take a reasonably small salary and the rest of my income as profit distribution or investment income. Because the profit distribution is a corporate expense, the profit on which Social Security and Medicare is calculated is reduced and this tax is reduced.

Additionally, any investment income received by me taxed at a lower rate than earned income (salary). The bottom line for having an S Corp is that my self-employment tax is reduced and my personal income tax is reduced.

(Please see IRS Publication 17, chapter 7 for more information on Investment Income; https://www.irs.gov/pub/irs-pdf/p17.pdf)

 Licenses, Permits and Special Regulations

A sole proprietorship can be established in California without filing any legal documents with the California Secretary of State.  There are four steps to do this:

1  Choose a business name.

A company may use any name that is not the same as, or similar to, another registered business. The name may also not be misleading to the public.

Confirm that your business name is available by performing a search in the following government databases:

 

2  File a Fictitious Business Name Statement with the county recorder.

  • When a business name is used which is different from your legal name (such as John Brown doing business as Palm Springs Bug Busters), California requires you to file a Fictitious Business Name Statement in the county recorder’s office where the business is located.  This hyperlinkCalifornia State Association of Counties provides a list of county websites.
  • Business owners have a 40-day grace period from the business start date to file this statement.  The filing fee is $26.
  • The business owner must publish the statement in a well-known newspaper within the county for four consecutive weeks to complete the application process for registering a fictitious business name.

 

3  Obtain licenses, permits, and zoning clearance.

Your business may need to obtain a variety of licenses and permits depending on its business activities.  California provides a comprehensive database of every license and permit that may be required by any sole proprietorship.

Using the California Governor’s Office of Business and Economic Development CalGold website, it appears that I need to obtain the following permits and licenses for my online business:

  1. Business License – Business Tax Certificate
  2. Fictitious Business Name – Doing Business As Statement
  3. Registration Form for Employers
  4. State Income Tax Information
  5. Employer Identification Number (EIN or SSN)

 

Income Tax

1  Federal Income Taxes (www.irs.gov)

  • Obtain an Employer Identification Number EIN).
  • A Sole Proprietor needs to obtain an Employer Identification Number, or EIN if they intend to have employees. All businesses with employees will report wages to the IRS using their EIN. Registering for an EIN can be done online at irs.gov
  • Sole proprietors without employees can use their Social Security number to report taxes and are not required to have an EIN. Despite this, some banks require an EIN to open a bank account because it can reduce the risk of fraud and identity theft.

http://www.nolo.com/legal-encyclopedia/how-establish-sole-proprietorship-california.html

 

2  State Income Taxes (California)

  • Businesses that pay $100 or more to employees in a given quarter are also required to register for a California employer account number. This can be done online at the California Employment Development Department (EDD) website.
  • You must report and pay employment taxes quarterly if you have employees, and self-employment tax for yourself (the sole proprietor).

http://www.edd.ca.gov/pdf_pub_ctr/de44.pdf

http://www.nolo.com/legal-encyclopedia/how-establish-sole-proprietorship-california.html

 

Sales Tax

1  State Sales Taxes (state or province level sales taxes)

  • Online sales made by out-of-state retailers to California customers are treated the same as other remote sales made to California customers. Generally, remote sales by out-of-state retailers to California customers, whether made over the Internet, by telephone, or mail order, take place outside of California because the property is delivered to a common carrier outside the state for shipment into California, and are, therefore, not subject to sales tax. Please see https://www.boe.ca.gov/formspubs/pub109/
  • However, under a law that went into effect in 2012 called the Amazon Tax Law, larger Internet retailers with no physical presence in California are required to collect and pay California’s sales tax if certain conditions apply. An out-of-state retailer must collect sales tax from California customers if that retailer:
  • Has an affiliate agreement with a person(s) located in California to pay for customer referrals obtained via a link on the California seller’s website
  • The out-of-state retailer’s total cumulative sales to purchasers in California exceeds $10,000 during the preceding twelve months, and
  • The out-of-state retailer also has total cumulative sales to purchasers in California exceeding $1,000,000.

https://www.nolo.com/legal-encyclopedia/california-internet-sales-tax.html

The current sales tax in my area is 7.75% and is made up as follows:

  • California: 6%
  • Riverside County: 0.25%
  • Banning: 0%
  • Special: 1.5%

 

Employee Requirements

 1  Worker’s Compensation

All California employers must provide workers’ compensation benefits to their employees under California Labor Code Section 3700. If a business employs one or more employees, then it must satisfy the requirement of the law.

Sometimes a business owner (sole proprietor) may desire to purchase workers’ compensation insurance to cover himself/herself only. The inclusion of a sole proprietor must be clearly stated in the workers’ compensation policy or must be added as a coverage endorsement to the policy. Since workers’ compensation insurance is a type of liability insurance where the employer assumes complete liability for all worker injuries, a workers’ compensation policy for a sole proprietor may not be the best choice.

Purchasing health, life, and/or disability income insurance can be a viable option to workers’ compensation for a sole proprietor. Contact a licensed commercial broker-agent or a casualty broker-agent for further information and consultation.

Reference: https://www.dir.ca.gov/dwc/faqs.html

2  Property taxes

In the United States, property tax on real estate is usually levied by local government, at the municipal or county level (in my case, Riverside County, CA). Rates vary across the states, between about 0% and 4% of the home value.

3  Labor laws

The list below are some of the laws governing the employment and treatment of employees. Additional laws, policies and procedures are used within each industry to provide working agreements between employers and employees. This list below is taken from Wikipedia with the hyperlink displayed below.

  • The Fair Labor Standards Act of 1938 set the maximum standard work week to 44 hours. In 1950 this was reduced to 40 hours. There are exceptions such as farm workers may work over 72 hours a week, followed by at least 24 hours off.
  • Agreen card entitles immigrants to work, without requirement a separate work permit.
  • Professionals, clerical (administrative assistants), technical, and mechanical employees cannot be terminated for refusing to work more than 72 hours in a work week.
  • The Fifth and Fourteenth Amendments of theUnited States Constitution limit the power of the federal and state governments to  The private sector is not directly constrained by the Constitution, but several laws, particularly the Civil Rights Act of 1964, limit the private sector discrimination against certain groups.
  • TheFifth Amendment has an explicit requirement that the Federal Government not deprive individuals of “life, liberty, or property”, without due process of law and an implicit guarantee that each person receive equal protection of the law.
  • TheFourteenth Amendment explicitly prohibits states from violating an individual’s rights of due process and equal protection. Equal protection limits the State and Federal governments’ power to discriminate in their employment practices by treating employees, former employees, or job applicants unequally because of membership in a group, like a race, religion or sex. Due process protection requires that employees have a fair procedural process before they are terminated if the termination is related to a “liberty”, like the right to free speech, or a property interest.
  • TheNational Labor Relations Act, enacted in 1935 as part of the New Deal legislation, guarantees workers the right to form unions and engage in collective bargaining.
  • TheAge Discrimination in Employment Act of 1967 prohibits employment discrimination based on age with respect to employees 40 years of age or older.
  • Title VII of the Civil Rights Act is the principal federal statute with regard toemployment discrimination, prohibiting unlawful employment discrimination by public and private employers, labor organizations, training programs and employment agencies based on race or color, religion, sex and national origin. Retaliation is also prohibited by Title VII against any person for opposing any practice forbidden by statute, or for making a charge, testifying, assisting, or participating in a proceeding under the statute. The Civil Rights Act of 1991 expanded the damages available to Title VII cases and granted Title VII plaintiffs the right to jury trial.

Reference: https://en.wikipedia.org/wiki/Labour_law#United_States

 

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