Monday, April 18, 2011

Lesson #7: Establishing the Legal Entity; Part 1: Intro and Sole Proprietorship

In the Urban FIRE concept of entrepreneurship, we practice it as a realization that who we are and what we do in our lives is ultimately the most important destiny of our humanity. It is not just about starting our own business but it is a higher ideology of self-determination and freedom to achieve our purpose on this earth. It is the practical application of the belief that we are to seek and become the brilliant contributor to our world as we were meant to be.
Maybe that’s why there are so few entrepreneurs amongst us because such ideas are thought of as those of dreamers, desperados and misfits. From our youth, we are lead into the stables of group thinking, group fear and group conformity. We are lead to believe that our leaders will guide us and tell us what is true, and what is acceptable. If we are fortunate, a twist, a chance meeting or an impactful moment sparks an underlying interest. These are the times that entrepreneurs become self-actualized. If nurtured with the right experience and knowledge, they continue onward to their rightful destiny.    
While the concepts and visualizations are critical in forming a successful company, we are also bound by the legalities of what we do. In a society that provides the privilege of our own creative expression and financial rewards, we are also woven into a system of checks and balances that protects us and keeps us aware of our responsibilities. In their socially acceptable form, our entrepreneurial endeavors are created into “businesses” which must then be classified as a specific type of legal formation.  In California, you will need to select one of four types of legal entities. These include:
·       Sole Proprietorship
·       Partnerships
·       Limited Liability Companies
·       Corporations (including Non-Profit Corporations)
There are two main considerations for selecting your legal entity:
·       The simplicity or sophistication of the startup
·       The protection from risks and liabilities for both you and your business
Of course, both considerations require a financial commitment; one a lot more than the other. Two other necessities for any legal entity are:
  • Set up a website for your business along with an email address with the business name such as These days, not having a business website is suicide!
  • Purchase liability insurance either a Business Owners Policy (BOP) or a personal umbrella insurance policy which will cover you for personal liability. Depending on the risk factors of your business, it is essential that you have insurance coverage in case of a lawsuit against you.
It’s important to understand the differences in each of these entities but getting bogged down and stymied by the legalese of legal entities is bureaucratic. Instead, check out or get down to their outlet store at 950 Parker Street in West Berkeley. Nolo books are the best investment you’ll make in formalizing your business foundation. Believe me, they’re worth every penny. They will cut down hours of research and save you tons of money. The store has many products at a nice discount (25% to 35%) while the website is filled with books you can order and legal forms that can be filled out and sent directly to the proper government agencies. But whatever you do, make sure you’re writing your company guidelines (such as your bylaws) specific to your needs and that of our business. Don’t rubber stamp the generic language because it may not address your particular future issues. If you still feel unsure about the legalities of forming your new company, then seek legal assistance.
Finally, for space conservation, you’ll note that the Formation section under Sole Proprietorship will also apply to the other legal entities. The others, however, contain additional requirements.

Sole Proprietorship
This is the recommended legal entity to start with because it is simplest and cheapest to start. A sole proprietorship consists of only "one" individual; ownership by more than one person creates a partnership. (Note: A husband and wife can be classified as a sole proprietorship. A business conducted by registered domestic partners must be classified as a partnership.)
  • File for a fictitious business name with the county clerk’s office. You first go online at and do a search for a name to see if it’s available. Or if feel the need to do it in person, the address for the Alameda County clerk’s office is at 1106 Madison Street, Oakland, CA 94607. (If you use only your name as the business name, you do not need to file for a fictitious business name since it is a real name.) Cost is about $35.
  • Once you’ve claimed a fictitious name, several newspapers will be contacting you because by law, you are required to publicly announce the formation of your company which includes the business name, your name and your address. This is published one day per week for four weeks in the section of the paper listing all Fictitious Business Names. Cost is about $35
  • You must now register your business for a business license at your local city government - about $60. If your business is going to work out of Oakland, you can go online:
  • You’ll also find out the zoning requirements for your particular type of business via the website.
  • Depending on your type of business, you may be required to obtain a California business permit. You can find out if this is essential by going to: 
  • If you are going to be selling products, you’ll need to apply for a California Reseller’s Permit. This allows you to purchase inventory for sale without paying taxes. Instead, when you sell your finished goods, you will be collecting taxes from your customer and sending the payments to the state. In order to apply for a seller’s permit, go to:
·       If you are considering hiring employees, you will need to register with the California Employment Development Department at: The state defines your need to register when you pay someone $100 or more per quarter in salary. Under California's new hire program you are required to complete Form DE-1 for every new hire and Form DE-542 for every independent contractor you hire. Next, you will also need to inform the IRS: The IRS website details all of the necessary steps, including verifying work eligibility and withholding allowances certificates.
·       At the point you hire an employee, you are also required to carry workers' compensation insurance.
  • It’s not a not bad idea to check out all the tax information on the website for the Franchise Tax Board:
  • You are now ready to open for business! However, at this point (if you haven’t done so), you need to get business cards and letterheads ordered. There are a number of easy website (Google it) where you can design your own logos or if you have some funds available, have a local or online designer create something for you.

Operation of a Sole Proprietorship
  • As the owner, you call all the shots. You do not have other owners, shareholders or directors. As the name of this entity states, you are the sole owner of your business.
  • With your new business name registered, you can now open a business checking account. Most banks will want a minimum of $100 to start one and nowadays, it seems like more banks are charging a monthly fee for any sort of banking relationship unless you have a minimum amount. So be prepared to pay something for your business bank account. As a sole proprietor, it is not necessary for you to separate your business banking from your personal banking. However, it is highly recommended that you keep your finances separate. Otherwise, it can get messy as to what belongs to your business and what belongs to you personally.

  • Reporting of your business income goes directly through your normal personal tax filing to the IRS. A separate form called Federal Form Schedule C: Profit or Loss from Business is used to report the income and expenses of the business. The form is attached to the owner’s Form 1040. Any profit is taxed to the owner and any losses are deductible by the owner and may offset any other income the owner or his or her spouse may have.
  • Your Schedule C is included with your California personal income tax return (CA Form 540) with a return due date,  normally April 15 for calendar year taxpayers.
  • Your tax rate depends on the proprietor’s total taxable income.
  • Estimated tax payments are required of sole proprietors including all sources of income (e.g., wage income, investment income) when you expect to owe at least $500 ($250 if married/registered domestic partner filing separately) in taxes for the current year (after subtracting withholding and credits) and you expect your withholding and credits to be less than the smaller of:
Ø  90 percent of the tax on your current tax return, or
Ø  The tax listed on your prior year tax return including Alternative Minimum Tax. Prior year exception is eliminated if your adjusted gross income (AGI) is greater than $1 million ($500,000 if married/registered domestic partner filing separately.)
  • Estimated tax nstallments are due and payable on April 15, June 15, September 15 of the taxable year and January 15 of the following taxable year.
  • Individuals complete Form 540-ES, Estimated Tax for Individuals, to report their estimated taxes.

Liability Potential
  • A major drawback of operating as a sole proprietor is that you are personally liable for all of the business debts and taxes. In addition, if someone sues your business, all of your personal assets are at risk because there exists no separation between the owner’s and the business assets.
  • If you are operating in a high-risk industry where there is an increased potential for lawsuits (such as the restaurant or construction industries), you may want to consider forming a corporation or an LLC where the liability ends with the assets of your company and not you
  • Regardless of what form of business you operate, you should obtain BOP liability insurance to protect your business assets. In a sole proprietorship, minimally purchase “umbrella coverage” that serves as an attachment to your renter’s, homeowners or auto insurance. Umbrella coverage is inexpensive such as $2 million insurance for $400 annually. An umbrella policy protects your personal assets regardless of legal action brought against you in your business or any personal incidents such as someone falling down your stairs at home.
Withholding Requirements
  • Withholding is a prepayment of California state income or franchise tax. A sole proprietor is considered a withholding agent if they control, receive, have custody of, dispose of, or pay  with.
  • A withholding agent is required to withhold from all payments or distributions of California source income made to a nonresident payee unless the withholding agent receives authorization from us for a waiver or a reduced withholding amount. Withholding is optional, at the discretion of the withholding agent, on the first $1,500 in payments made during the calendar year.
  • If a sole proprietor is required to withhold and remit backup withholding to the Internal Revenue Service (IRS), the sole proprietor is also required to withhold and remit to the Franchise Tax Board (FTB), except for instances that are specifically excluded for California purposes.

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