Your New Business:



Your New Business:

Getting Started

Introduction

The following information has been compiled to provide some direction to those individuals starting a new business. We have included a brief analysis of the most typical issues confronted by today’s entrepreneurs in the early stages of their business ventures. These materials are far from comprehensive, but should serve as a useful resource in getting a new business off the ground.

Topics discussed

• The Selection of Legal Entity;

• Registering a New Business;

• Bookkeeping & Accounting Issues;

• Income, Franchise & Sales Taxes;

• Payroll Taxes;

• Payroll & Compensation Issues;

• Forecasts and Projections;

• Obtaining Credit & Financing;

• Setting Goals

Kenefick & Co. is experienced in assisting clients with new business endeavors. While the following is an objective and independent analysis of various business start-up issues, Kenefick & Co. offers a wide variety of value-added services to assist you in every stage of the process. These services include:

• Guiding clients through the choice of the appropriate legal entity;

• Walking clients through start-up government applications and other initial procedures;

• Aiding clients in compiling prospective financial statements;

• Assisting clients in compiling professional loan proposals;

• Helping clients set business non-financial and financial goals;

• Handling routine payroll reporting;

• Helping with routine bookkeeping and accounting issues, including accounting software implementation, training, and continual consultation;

• Compiling financial statements;

• Developing cost control systems;

• Preparing annual tax returns;

• Assisting in year-round income tax planning;

• Consulting on any additional client financial and business concerns.

If we can be of any assistance in answering any questions that the following materials do not, we welcome you to call us.

The Choice of Legal Entity

The form of legal entity that is most appropriate for your business is one of the first decisions you will have to make. Should you incorporate the business? Should you operate it as a sole proprietorship? Unfortunately, the answer is often unclear. The right answer for each company depends upon the individual characteristics of the owner(s) and the nature of the business. Some business owners may be interested in choosing the legal entity that will most simplify financial and income tax reporting; others may be most interested in limiting their personal liability for business debts.

Sole Proprietorship and Partnership

The sole proprietorship is a very popular form of legal entity for a new business because it is the easiest to set up, maintain and operate. One person runs the operation and reports all profits and losses personally (on Schedule C - Profit or Loss from a Business) on his or her individual income tax return.

A partnership is often chosen for the same reasons an individual chooses to be a sole proprietor. Both forms allow for flexibility in the distribution of assets while avoiding double taxation. In addition, partners can benefit by sharing the liability and capital responsibilities with one another; however, partnerships must file separate returns from the owners. Like the sole proprietor, the partners are personally liable for the debts of the business, a risk that often rules out the selection of these entities.

C-Corporation

A new business that is expected to experience tremendous short-term growth may benefit by electing the status of a C-corporation (The C). The C provides limited liability to its investors and places few restraints on the number of owners allowed. The C is classified as a going concern, meaning that The C is expected to carry on business for an indefinite period of time. However, owners are subject to taxation both at the corporate level (when profits are made) and at the individual level (when profits are distributed).

S-Corporation

The S-corporation (The S) is a separate entity from the entrepreneur that combines the benefits of limited liability for shareholders of the C-corporation with the avoidance of double taxation of the partnership/sole proprietor. Like the partnership, the S must file a separate tax return, but does not pay tax on its profits. The shareholders of the S report the income on their individual income tax returns. The shareholder’s liability is typically limited to his or her investment in the corporation. As such, the S-corporation has been a favorite choice of many small businesses since its inception in 1987.

Limited Liability Company

The limited liability company (or LLC) is a relatively new form of entity that is gaining in popularity for many small businesses. The LLC is in many ways similar to the S-corporation. A properly organized LLC is taxed as a partnership and members are afforded limited liability from company debts. In addition, an LLC is afforded more flexibility than a C or S corporation in terms of raising capital, managing the business and distributing profits.

Registering a New Business

Choosing a Name

One of the first and most important decisions your company will make is the choice of a name. Here are some basic guidelines to consider in making this decision:

1 Choose a name that is easy to remember.

2 Choose a name that is easy to pronounce.

3 Choose a name that clearly communicates what the business does.

It is also a good idea to choose a name that reflects the legal status of the business. (Ex. Bob’s Company, LLC or Bob’s Company, Inc.)

Reserving the Company Name

If you are incorporating or registering with your state, the next step is to check on the availability of the name for your business and reserve it. In North Carolina, this is easily accomplished by first calling the Secretary of State (1-800-228-8443) and asking if your name is available. If so, request that they send you a form for reserving the name. The cost is $10 and the Secretary of State will respond in writing that the name has (or has not) been reserved upon receiving the written application.

Registering with the Internal Revenue Service

Almost all new businesses are required to obtain a Federal identification number (in some cases, a social security number is sufficient for the sole proprietor). A Federal ID number is obtained by completing Federal Form SS-4 and mailing or faxing it to the IRS. Your CPA can assist you in preparing and filing the SS-4.

Registering with the State

In addition, the new business must register with the state. In North Carolina two separate state identification numbers may be required - an employer income tax withholding number (required if salaries are to paid to employees in NC) and a sales and use tax number (required if the business sells tangible personal property at retail). An application for these numbers can be obtained by calling the NC Department of Revenue at (919) 733-3661 or (919) 342-6121.

Registering with the City

In addition to registering with the State, new businesses are required to obtain a business license from the city in which they operate. An application can be acquired by calling your local business license office and requesting one. In Charlotte, the number is (704) 336-6315.

Bookkeeping and Accounting Issues

Expenses Incurred Before the Start of Business

All expenses related to the conduct of your business may be deductible. Consider opening your company checking account before you incur any business expenses, so your bank statements will serve as a backup for your business expenditures from day one. Keep a journal or ledger of all expenses incurred before business actually begins (examples: legal and accounting fees, fees paid to the Secretary of State, inspection fees for property, etc.).

Bank Accounts

A separate business checking account is essential for accurate record keeping in a new business. The account will facilitate consistent record keeping and enhance management=s ability to track the cash flow of the business by consolidating all deposits and disbursements into one place. All of the operating expenses of the company should be paid out of this account to keep business and personal funds clearly separated. Keep clear and detailed records of the nature of each cash receipt and disbursement.

Bank Reconciliations

A minimum bookkeeping requirement is to reconcile bank statements on a monthly basis. The time needed to accomplish this task is insignificant for most small businesses, and the process insures that management is well aware of the cash flow situation of the business.

Deposits

Deposits should be made on the day cash is received, and records should be kept which identify the character of all sales and cash receipts. The IRS will leave it up to the taxpayer to prove deposits are anything other than taxable revenues. Your CPA can help you format a bookkeeping ledger for your company so that in your first year of business you will know what items you need to track separately.

Expense Reports

Expense reports are required by the IRS for all payments reimbursing employees for business expenses. An expense report is a simple form that need only list the date an expense was incurred, what the expense was for (business purpose) and the amount. Employees should be required to turn in receipts with their expense reports and the employer should keep the receipts and reports on file. It is also recommended that the employer=s procedure for reimbursing employees be formally documented in a written plan. We can assist you in formulating and establishing such a plan.

Mileage Logs

Current tax law provides for the personal deduction of unreimbursed business miles incurred by an employee. In general, this means that any miles traveled from your place of business to a job site or business meeting can be deducted. The IRS requires that in order to take this deduction, a taxpayer must keep a log of the business miles traveled. Without such substantiation, the IRS will disallow the deduction. We can assist you in formatting an IRS acceptable mileage log.

Software Packages

Another consideration is accounting software packages. Many of these are simple to use, provide pertinent financial information and can be obtained at a low cost. Software packages such as QuickBooks can simplify your bookkeeping process and can be installed by your CPA. Your CPA can also assist you with making routine and non-recurring bookkeeping entries in your computer system.

Income, Franchise, and Sales Taxes

Income Taxes

The individual taxpayer pays tax on income and distributions from a business in a number of ways. The most common way is to have taxes withheld from wages and reported on a Form W-2. Another common form for reporting small business income is the Schedule C. This form is used by sole proprietors to summarize the revenues and expenses of a business before determining the amount taxable based on the owner=s individual tax rate. Individuals who own interests in partnerships and S-corporations are taxed at their individual tax rate based on income reported to them on a Schedule K-1.

Partnerships and S-corporations are required to file information returns with the IRS each year. A partnership files Form 1065 and an S-corporation files Form 1120S. No tax is paid with the filing of these forms.

A C-corporation pays tax on the net income it has earned at the end of a year. In addition, the shareholder in a C-corporation will pay tax personally on any distributions of profits, such as dividends, that are made to the shareholder. C-corporations file Form 1120 with the IRS.

Franchise Taxes

A franchise tax is a corporate tax on the right to do business in a particular state or locality. Thus, partnerships, sole proprietors, LLC=s and individuals are not subject to franchise tax. Generally, only S- and C-corporations are subject to this tax. In most cases, the amount of tax is based on the capitalization of the corporation, i.e., the greater the amount of capital in the company, the greater the franchise tax. In North Carolina, the franchise tax rate is $1.50 per one thousand dollars of capital (minimum $35 per year).

Sales and Use Tax

Sales taxes are imposed on the retail sale of tangible personal property in a state. The tax rate varies depending on the business.

Use taxes are similar to sales taxes. The tax applies to the purchase of property for use in the state. For example, if a manufacturer buys a machine in Tennessee to be used in a plant in North Carolina, a NC use tax is applied to the purchase. Use taxes are applied at rates similar to sales taxes.

Vendors often require a certificate of resale from a customer who plans to use their product and sell it to a third party. For example, if Buyer A purchases t-shirts from Hanes, Buyer A can avoid paying sales tax on the purchase with a certificate of resale. The certificate states that Buyer A is purchasing the shirts to be resold to the end consumer (at which point sales tax will be collected). Certificates of resale can be obtained directly from the Secretary of State. In North Carolina, call (1-800-228-8443).

Annual Report Fees

In North Carolina, C-corporations, S-corporations and LLCs are all required to file Annual Reports with the Secretary of State. General and limited partnerships are not required to file. The annual fee for the report is $20 for C- and S-corporations and $200 for LLCs. Your CPA can prepare the annual report for you along with your business income tax returns.

Payroll Taxes

Overview

Most new business owners will either take money out of their company in the form of profit distributions and/or personal salaries or wages. In any case, the government wants to collect its taxes on these amounts. These taxes include federal and state income taxes as well as FICA taxes (Social Security and Medicare).

Payroll Tax Reporting by Sole-Proprietors

Sole proprietors are considered self-employed individuals, as opposed to employees, for income tax purposes. As a result, a sole proprietor will simply extract money from his business when needed and is not required withhold income, Social Security or Medicare taxes on these payments. Instead, the individual will personally pay income taxes and self-employment taxes on the profits earned by the business. The government expects to receive these taxes ratably over the course of the year. Therefore, the sole-proprietor must consider making estimated tax payments each quarter of the year to the Federal government (and State) in order to avoid penalties assessed for underpayment of taxes. The same holds true for partners of a partnership or members of an LLC. All of these individuals are considered self-employed for income tax purposes and are not required to have taxes withheld from their pay.

Payroll Tax Reporting for Independent Contractors

Most businesses employ individuals who are paid on a regular basis. For tax purposes, these individuals are classified as either independent contractors or employees. The classification is an important one and is based on all relevant facts and circumstances. If the individual worker is deemed to be an independent contractor, then the payer must furnish him or her with a Form 1099 after the year ends indicating the amount of compensation paid to the contractor. The contractor is responsible for payment of all taxes related to such compensation (see sole-proprietor above). In order to properly complete the Form 1099, the payer must know certain things about the contractor, such as his social security number, name and address. This information can be obtained by having the contractor fill our Form W-9 before he begins his work. In addition to Form 1099, the principal must also file Form 1096 with the IRS. This form is simply a summary of all Form 1099 information and includes a single total for all compensation paid to all independent contractors throughout the year.

Payroll Tax Reporting for Employees

If a worker is considered an employee rather than an independent contractor for tax purposes, then the related payroll reporting becomes much more complex. To begin with, employees must fill out Federal Form W-4 forms (and in North Carolina Form NC-4) to indicate the number of allowances claimed. These forms are kept on file with the company. Based on the number of allowances reflected on these forms, the employer then goes to various tables to determine how much tax to withhold from the employee’s pay.

Federal income taxes, Social Security taxes and Medicare taxes are all withheld from employee checks and deposited on a monthly or more frequent basis (depending on the amounts being withheld) using a Federal Deposit Tax Deposit Coupon (Form 8109 or 8109-B). Alternatively, the deposits can be made over the telephone via EFTPS (Electronic Funds Transfer Payment System) with the IRS. At the end of the quarter, Federal Form 941 must be filed to report the federal income, Social Security and Medicare taxes withheld and paid. The Social Security tax is 12.4% of gross wages (6.2% withheld from the employee’s pay; 6.2% paid by the employer) and the Medicare tax is 2.9% of gross wages (1.45% withheld from the employee’s pay; 1.45% paid by the employer). The amount of the federal income tax withheld is dependent on the number of allowances claimed on an employee’s Form W-4. It should also be noted that with respect to Social Security tax, the tax only applies up to a certain amount of each employee’s wages. This threshold amount is known as the wage base and typically changes annually.

North Carolina income tax is required to be withheld from employee paychecks and remitted to the state on a quarterly or more frequent basis. Quarterly depositors use Form NC-5. Those who are required to deposit more frequently use either Form NC-5M or NC-5P. A North Carolina Withholding ID number can be obtained by calling (704) 342-6121.

In addition to FICA and income taxes, the employer is also responsible for payment of federal and state unemployment taxes (FUTA and SUTA). The Federal liability is reported on Form 940 at the end of the year. However, every quarter the FUTA tax must be computed. If it exceeds $100 for the quarter (including undeposited amounts from prior quarters), it must be remitted at that time (i.e. at the end of the quarter). In North Carolina, SUTA is reported to the Employment Security Commission on a Quarterly Tax and Wage Report. A North Carolina unemployment tax reporting number can be obtained by filing Form NCUI-604 - Employer Status Report.

Aside from payroll tax reporting to the IRS and the state, North Carolina employers are also required to submit a report to the North Carolina New Hire Reporting Program shortly after a new employee is hired. These forms can be downloaded from the Internet at .

The following is a comprehensive list of payroll reporting forms and due dates as they relate to employees.

PAYROLL DATES TO REMEMBER

REPORT NAME FORM DUE DATE SEND TO

Federal Reports

Annual Wage & Tax Statement W-2 1/31 Employee & SSA

Transmittal of Wage & Tax W-3 2/28 SSA

Statements

Withholding Allowance Certificate W-4 When hired Kept on file unless 10 or more allowances claimed.

Coupon for Federal 8109 or Quarterly Deposit at Bank or

Tax Deposit 8109-B or more over the telephone via EFTPS

frequently

Employer’s Quarterly Federal 941 Quarterly IRS

Tax Return

Employer’s Annual Federal 940 1/31 IRS

Unemployment Tax Return (FUTA)

North Carolina Reports

NC New Hire Reporting N/A Within 20 NC New Hire Reporting

days of Program

hire

Employer’s Annual Reconciliation NC-3, 2/28 NC Dept. of Revenue

of Income Tax Withheld NC-3A or

NC 3M

Employer’s Report of NC Income NC-5, Quarterly NC Dept. Of Revenue

Tax Withheld NC-5Q or or

NC-5M Monthly

Quarterly Tax and Wage Report NCUI-101 Quarterly Employment Security

(SUTA) Commission of NC

Payroll Services

As a company grows and adds employees, payroll reporting becomes a more involved task. Hiring a payroll service can be an easy and affordable way to ensure that all returns and tax deposits are timely handled and all employee checks are properly drafted. For further information, consult your CPA for recommendations or phone one of the many payroll services available.

Additional Payroll/Compensation Issues

Decisions on issues such as health care, pension plans and employee benefits can be very difficult for the new business owner. The laws on these issues, especially those concerning pension plans, change constantly. There is a growing number of companies providing these services for your business. The majority of these decisions depend upon the size of your company and its financial constraints. All employers will find, however, that attracting and retaining the best employees in today’s job market will be difficult without offering solid benefits. Some questions you should raise before starting your business follow:

Regarding health care:

Will you offer a health care plan and, if so, will you deduct health insurance payments from employee checks or pay it yourself?

Which health care insurance provider best meets your company’s needs?

Who will be covered under your plan (employees only, dependents also, etc.)?

Will you offer additional insurance for vision care, dental care, orthodontics, etc.?

Regarding pension plans:

Will you offer a pension plan/401(k) plan?

Will you match employee contributions?

Will you hire an outside service/broker to handle the plan? If so, who should be

your service provider?

What type of plan best suits your needs?

(Many different types of plans are available. The most popular - in order of increasing complexity - are a simple IRA, a basic 401(k) plan, a SEP, and a complex pension and profit-sharing plan. Your CPA or financial planner can further explain the differences between these plans and help you determine which one best suits your needs).

How will you handle the administration of the plan? For example:

How often will you and/or your employees contribute?

Who will handle the transfer of funds?

How will employees borrow money from their plan funds?

What percentage of their income will employees be allowed to contribute?

Regarding additional benefit issues:

Will you offer noncash compensation such as stock options? If so, how often and for what reasons will these be awarded?

Will you offer benefits to your employees relating to your line of business?

(Employee discounts for retail businesses, free dental work at dentist=s

office, etc.)

Will you choose to offer any of the additional benefits that are increasingly growing in popularity, such as employer reimbursements for child care expenses, moving expenses, education expenses or adoption agency fees?

Most owners of small businesses choose to offer cash compensation only, a simple pension plan (to which the employer may or may not match contributions) and a basic health care coverage plan. The above issues are very complex and you will need the assistance of a CPA, a financial planner/consultant and an attorney to help you determine which plans to offer and how to go about implementing them.

Forecasts and Projections

Forecasting will play a very important role in any new business. From the time the idea is born, forecasts are being made: will the new business be profitable? When? How much cash will it take to get the concept off the ground? These are typical questions that require some degree of financial forecasting. An astute, thorough projection of the company’s near future is vital to arriving at the correct answers.

Identifying Start-up Costs

The following is a short, non-exhaustive list of expenses typical to new entities:

Furniture and equipment Desk, chair, fax, computer hardware, filing cabinets

Other equipment Shelving, tools, cash register, signs, fixtures

Deposits Leases on equipment, last month=s rent, phone and

utility deposits

Professional fees Legal and accounting fees, design fees, other consulting fees

Advertising Business cards, grand opening, initial advertising

campaign

Office supplies Invoices, letterhead, pens

Leasehold improvements Any additional improvements necessary, not already in the lease

Inventory Amount of inventory needed to open business

Petty Cash For cash register and small cash transactions

Licenses Various licenses required to do business

Creating Projected Financial Statements

The following statements should be created and included in the company business plan:

Projected balance sheets

Projected income statements

Projected statement of cash flows

Statement of start-up costs

Notes to financial projections detailing assumptions made

It is easier to start by making projections for a short period of time (two years at the most). Using a shorter time period typically results in a greater degree of accuracy.

Obtaining Credit and Financing

Where is the money for the new business going to come from? Raising funds requires preparation, without which, finding sources of capital can often be rather difficult.

Sources of Capital

A variety of sources of capital are available to persons looking to start their own business, although some options will be more attractive than others. The following is a list of some of the more common sources of initial capital. Your CPA can help you to determine which funding sources will be best for your business.

Personal savings The most common form of capital used to start small

businesses

Family and friends Represent a second source of potentially no- or low-

interest loans

Banks and credit unions Offer loans at fair rates, but only if they feel the loan

will be repaid

Small Business Assoc. Requirements are similar to a bank loan

Leasing companies Good resource, particularly where fixed assets will be needed

Venture capital firms Viable source of initial capital, but at a steep price

Private offering Viable source of initial capital, but difficult for a small

business to obtain

Obtaining a Bank Loan

A bank will only lend money to a business expected to succeed and repay the loan. This means two things to the business seeking a bank loan. First, the business must be well prepared with a professional loan proposal to show the bank. Second, the owners of the start-up business should be ready to personally guarantee the loan. The following is a summary of information essential to a loan proposal:

General statements

1 The purpose for and specific ways in which the funds will be used;

2 The amount of money to be borrowed;

3 How and when the money will be repaid;

4 What will happen if something goes wrong (personal guarantee of the loan);

5 Business name, address and names and social security numbers of owners.

Management

A profile of the principal officers/owners of the company outlining their experience, education and other pertinent background information.

Market

Include information that, at a minimum, defines the company’s product and target market, existing competition, and customer base.

Financial Data

1 Detailed projected balance sheet and income statement for the coming years

2 Personal financial statements of the owners prepared by a CPA

3 A list of items that could be pledged as collateral against the loan

Setting Goals

The success of a new business depends upon many factors; however, no business will flourish unless the owners have a clear vision of what they want and reasonably expect the business to achieve. Establishing a system for setting goals and periodically evaluating the company’s progress is essential to the success of your business.

Mission Statement

A mission statement is a concise, one to two paragraph statement which encompasses the vision of the company. Having all employees know and understand the mission statement helps everyone keep in touch with “Why does this business exist and what are we as employees and owners trying to achieve?” Management should draft a mission statement appropriate to their goals and purpose at the beginning of their business venture.

The mission statement should state business goals and usually includes the following:

1. What the company is selling/producing;

2. Who are the target customers;

3. What niche in the market does the company intend to occupy (low costs and high volume production, high costs and low volume/specialty product production, other variations of niches);

4. What the company wants to accomplish;

5. Any other aspects of the business’s vision important to the owners.

Financial Goals

While a mission statement is important, it tends to be very broad and general. In planning your new business, you need to set extremely detailed long-term and short-term goals. Many people starting a new business decide that they want to make a profit, but fail to develop and implement a very specific, step-by-step plan of how they are going to do so. Periodically, business owners should review their goals and determine if they are still appropriate under current circumstances.

The most popular and effective method of goal setting is budgeting. When starting a business, it is imperative that you develop a budget that encompasses all revenues and expenses for each month or week. Goals should be set for sales revenues while constraints should be set for expenditures such as product costs and general and administrative expenses. Periodically, each aspect of the budget should be reviewed and appropriate changes should be made. Your CPA can help you develop a budget for your business.

Non-financial Goals

Non-financial goals are every bit as important as financial goals and can be applied to every level of the company. Management should use the same system for non-financial goals as financial goals. That is, they should be set at the inception of the business and reviewed periodically. Examples of non-financial goals include:

6. Achieving a certain number of customers by a certain date;

7. Hiring the best-quality personnel available;

8. Participating in a certain number of community service events;

9. Providing a service or product that meets your pre-defined quality standards;

10. Numerous other nonfinancial goals specific to your business.

!

Many business owners have found that tying financial rewards to non-financial performance measures motivates employees. For example, an accounts payable clerk could receive a bonus if he or she correctly processes a certain number of invoices during a certain pay period.

Timeliness

It is essential that business owners realize that goals (both financial and non-financial) and budgets become quickly outdated as the company evolves and grows. Company and employee needs must be continuously assessed and company goals and budgets need to be updated accordingly. Daily involvement in goal setting and achieving will keep business owners abreast of potential risks and rewards.

Let’s Get Started

The preceding pages should give you a basic idea of some of the issues you will be facing when you start your own business. When combined, these issues can initially be overwhelming. However, you can make your company a rewarding success with a clear business vision and hard work. We at Kenefick & Co. are ready to help in getting your business started. We urge you contact us if we can be of assistance with your new venture.

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