Am I a small business owner?

Do you have something you do on the side for a little extra cash? Do you enjoy it enough that you sometimes think, “Hey, maybe I could expand on this and become a business owner”? Well, guess what? You already are!

Sole Proprietorships

“Hey, wait a minute!” you say, “I never registered or signed any paperwork or anything!” It doesn’t matter. You’ve already formed the simplest type of business, the sole proprietorship. And that makes you a business owner.

First, the good news: You can score points at parties by telling everyone you’re a business owner (or maybe try a slightly more sophisticated term like “entrepreneur”). Go nuts, because it’s the truth.

The bad news: Because you haven’t realized you’re running a business, you could be at greater risk of lawsuits and tax penalties. For example, did you know that you’re likely supposed to be paying estimated taxes to the IRS four times a year? You’ll pay a penalty if you don’t.

Being a business owner has other consequences, too, if you don’t take the right measures and precautions. On the flip side, you could miss out on the perks of being a business owner if you’re unaware. 

We’ll walk you through ways to protect yourself, take advantage of your entrepreneur status, and stay in the government’s good graces.

What makes you a business owner?

The definition of “business owner” varies a bit across agencies, but the Internal Revenue Service does give a pretty clear definition of being self-employed. The IRS says that, generally, you’re considered self-employed if any of the following apply to you:

• You carry on a trade or business as a sole proprietor or an independent contractor.
• You’re a member of a partnership that carries on a trade or business.
• You’re otherwise in business for yourself (including a part-time business)

Being self-employed is not always synonymous with being a business owner, though. Shareholders in a corporation are business owners but aren’t considered self-employed, and thus don’t have to pay self-employment taxes. (More on those later.)

Liability

Maybe the biggest danger of being an unknowing business owner is personal liability. Now, sure, you don’t have to be a business owner to be sued, but owning a company does tend to expose you to more litigation than the average person.

If you’re selling things or services to people, there’s definitely a chance of someone getting injured or otherwise feeling wronged. When they do, they may want to sue the business. And, if you’re an unincorporated business like a sole proprietor or a general partnership, you are the business. The law sees you as the same legal entity.

That means that, if someone successfully sues you over something you did in the course of running your business, they can go after your personal assets. Your personal bank account, your house, your car, your kid’s college, etc. are all up for grabs. The same applies if the business goes into debt. Your debt and the business’s debt are the same.

One way to safeguard against this is by making your business a separate legal entity, such as a limited liability company (LLC) or a corporation. In most cases, the personal assets of the owners of these types of business entities are safeguarded from the business’s liabilities and debts.

Self-Employment Taxes

As you probably know, when you work for someone else, they pay for half of your Federal Insurance Contributions Act (FICA), a.k.a. Social Security and Medicare, while you pay the other half. So, you each pay 7.65%.

But when you’re your own employer, you have to pay both halves of FICA. Now you’re paying 15.3% of your earnings for Social Security and Medicare. Of course, that’s in addition to your other taxes.

However, if you made less than $400 in net earnings from self-employment, you can avoid paying self-employment tax. There’s an exception for church employee income; the self-employment tax requirement kicks in at $108.28 or more for them.

The IRS website has more specifics on how to estimate and pay self-employment taxes, but sole proprietors usually calculate them with Schedule SE with Form 1040 or 1040-SR.

Deductions

The IRS does allow a couple of deductions here. First, when figuring your adjusted gross income, you can deduct the employer-equivalent portion of your self-employment tax. Second, you can deduct the cost of your health insurance. Forms 1040 and 1040-SR have instructions for this.

S Corporations

As you might imagine, the higher taxes you pay for self-employment taxes can add up. Some business owners lessen the burden by applying to be taxed as an S corporation.

A limited liability company (LLC) or a C corporation (the default form of corporation) can apply for S corporation status. LLCs owners (called “members”) are, by default, taxed like a sole proprietorship or partnership, meaning that the members pay self-employment taxes on their portion of the company’s profits.

But S corporation status allows the LLC members to be paid in two ways, as employees and as owners receiving their share of the profits. When that happens, the members are only required to pay self-employment taxes on their salary, not the rest of their earnings from the LLC. This can add up to thousands of dollars in tax savings.

This isn’t without its drawbacks, though. If you’re a sole proprietorship or partnership and want to file for S corporation status, you’ll first have to form an LLC. From there, you need to file  Form 8832 to be taxed as a C corporation and then complete Form 2553 with the IRS to apply for S corporation status.

The IRS has restrictions on the number and type of owners for an S corporation. They also scrutinize S corporations more closely; for example, they check to make sure owners are paying themselves a “reasonable” salary so as not to dodge contributing to Social Security/Medicare entirely. That added scrutiny could mean a greater chance of audits.

Estimated Taxes

Yes, it’s true that the IRS expects most business owners to pay taxes four times a year as opposed to one, but it’s not as scary as it may sound. First, figure out if you’re one of the business owners who have to pay these estimated quarterly taxes.

Who pays estimated taxes?

If you’re an owner of a sole proprietorship, general partnership, or S corporation and you expect to owe $1000 or more in taxes when you file your return, you’ll need to make estimated tax payments. For corporations, they usually have to make estimated payments if they expect to owe $500 or more. 

For either category, if your tax was more than $0 the prior year, you’ll likely have to pay estimated taxes, unless perhaps your company hasn’t been in business for a full year or suffered a net loss of income the previous year.

How to Pay Estimated Taxes

First, figure out what you owe. Sole proprietorships, partnerships, and S corporation shareholders usually use the worksheet found in Form 1040-ES and the previous year’s tax return to figure estimated tax. Corporations generally use Form 1120-W to figure estimated tax.

Once you’ve estimated the amount you expect to owe at the end of the year, pay ¼ of that amount at the end of each quarter. If you think you’ve estimated too high or too low, you can recalculate on the form when the next quarter comes.

Of course, overpaying will result in a refund in April, and underpaying will mean paying the difference. Also, remember to pay each quarterly tax on time to avoid penalties.

Keeping a careful watch on both your business income and expenses will make this process considerably easier. An app like ZenBusiness Money can help you easily stay organized and get the deductions you’re entitled to.

Partnerships

We’ve mostly been talking about solo ventures, but you could also be business partners with someone and not fully realize it. A general partnership is basically two or more people in an unincorporated (not registered with the state, as an LLC or corporation would be) business together, sharing all the profits, losses, and financial and legal liabilities of the business.

Informational Returns for Taxes

What we’ve covered about sole proprietorships also applies to general partnerships, but there’s an important extra step for taxes. Like sole proprietors, partners report their income from the business on their Form 1040. Unlike sole proprietors, the partnership itself must file an informational return, Form 1065, with the IRS. In addition, each partner completes a Schedule K-1 listing their share of the business income, losses, credits, and deductions. They attach the K-1 to their Form 1040. 

These forms are for informational purposes, not additional taxes. An LLC with multiple members is, by default, taxed as a partnership, so in that case the LLC and each member would follow the same procedure for their taxes. 

Liability for Partner

As we mentioned earlier, a drawback of having an unincorporated business like a sole proprietorship is that you’re personally liable for the business’s debts. In a general partnership, the same is true, but you’re also liable for the actions of your partner.

So, even if you’re very careful in your business dealings, you could still pay the price if your business partner isn’t. The personal assets of all the partners could be at risk because of the actions of a single partner.

On that subject, sole proprietorships and partnerships are both able to hire employees. If they do, they’ll be liable for the actions of the employees, as well.

Naming Obligations

Being unaware of your legal obligations as a business owner could also land you in trouble if you misrepresent yourself. If you’re an unregistered business like a sole proprietor or general partnership, you’re legally obligated to do business under your own personal legal name.

Say your name is John Smith. (Apologies to all the actual John Smiths in the world who are forever serving as examples like this.) You make some money on the weekends by mowing lawns, word gets around, and soon you have so many potential customers that you have business cards printed that say “Smith’s Lawnscaping” or “Evergreen Lawn Mowing.”

In all but a couple of states, that’s a no-no that can result in fines and other penalties. To protect the public, the government needs business owners to truthfully represent themselves. They need to know who the business owner is so they can be accountable.

Doing Business As Names

If you want to represent your business as something other than your own personal name, you do have a legal alternative. You can apply for a “doing business as” (DBA) name. This acts as an alias for your business. DBA names are also called trade names, fictitious names, or assumed names in some states.

A DBA not only gives you a more professional-sounding name on your signs and business cards — it can also be used to open a business bank account under the DBA name. That means your clients can make their checks out to, say, “Austin Catering” as opposed to “Jill Smith.”

DBAs can also be used for incorporated businesses like LLCs and corporations. This can be useful if, say, Smith Apparel, LLC wants to open a line of kids’ clothing stores called “Smith Children’s Clothing.”

Licenses and Permits

Whether you’re just one person making some money on the side or a multi-national corporation, some things require business licenses or permits from the government. It doesn’t matter whether you consider yourself a business owner or not.

The government regulates certain professions, such as the medical field, law, engineering, food service, construction, and many others. A state board often has to approve a license for practicing these skills. The federal government regulates certain industries, as well.

Business Location

Where you plan to do business also matters. Don’t take it for granted that you can operate a business out of your home without investigating the local zoning ordinances. Some states and local governments require a general business license for doing any kind of business, regardless of what business entity type you are.

Because licensing and permitting can happen at the federal, state, and local levels, there’s no one place to check to see if you have all the licensing you’re required to have. You’ll have to do some research or use a service like our business license report.

Conclusion

As they say, ignorance of the law is not an excuse. Whether you fully realize that you’re a business owner or not, you still have the same obligations to Uncle Sam. But knowing you’re a business owner and arming yourself with the knowledge an entrepreneur needs can definitely help protect and benefit you.