When you are starting your new part-time business, take a few minutes to think about what legal category your business will be. This is important for both legal and tax reasons. Don’t get scared, though! Many part-time businesses, especially those run from home, won’t have to do much extra legal work.
Define Your Business
Most businesses fall into one of three business categories; those categories also break down into different sub-categories. Your business’s legal status defines your personal liability (how much you are legally responsible for and who or what gets sued in the case of a serious problem), and what taxes you will have to pay.
This is the easiest business category to get started. You’ll “declare” that you are a sole proprietor on your annual tax returns, and itemize both your sales income and your business expenses. To do this, use tax form 1040 Schedule C. No formal documentation is necessary.
You are a sole proprietor if you:
- Have not incorporated your business
- Have no employees
- Are 100 percent responsible for your business
- Do freelance or contract work
- Are personally responsible for any business debt you take on
- Use your Social Security number for your federal Tax ID number
Most side-hustle businesses fall into this category.
Fairly obvious from its name, a partnership is when two or more people start a business. This may be a little complicated for a side-hustle business, but something to think about if you decide to bring in another person to help run your business. You will need legal assistance to set up a partnership, to protect both yourself and your partner(s) and to protect the business.
You are a partnership if:
- You operate the business with another equal partner, or group of people
- All partners are legally responsible for the business
- Assets, income, and expenses are divided between the partners
- Each partner has specific business responsibilities
- The federal government assigns your business its own separate Tax ID number
Limited Liability Company (LLC):
An LLC can be owned by either just one person or by a group of people. The percentage of each partner’s ownership can be tailored to suit your needs and preferences. This is popular with many small business owners because it separates the owner personally from the business. If something bad were to happen, the owner could not be sued personally–your assets (your home, your personal money, your car, etc.) would not be put at risk. Only the business itself could be sued. Like a partnership, an LLC needs to be set up with legal assistance, with both federal and state paperwork.
You are in a Limited Liability Company if:
- You are officially incorporated
- Your personal assets are protected
- The net income from your business is divided between your shareholders or members
- You pay an annual federal tax on your LLC
For more details on each, and for other kinds of corporations, check at Nolo for information on all.
Which to Choose?
Consider the nature of your business, and what category it should fall into. If you are making crafts, art, or other products at home, a sole proprietorship should be fine for you. If you are planning to start a guided tour business, you might want to think about an LLC to protect yourself against lawsuits resulting from accidents, just as one example.
If you need help either in figuring out which business category to choose, or in making sure you are filing all the appropriate paperwork, seek assistance. Of course, you can consult an attorney, but that can be pricy! For advice, try consulting with your local Small Business Association, or SCORE. There, you can talk to volunteers who are frequently retired business people and who are experts in their fields. Both agencies have many other resources to offer as well.
Each state has different regulations that govern owning and operating a business. And remember that sometimes cities and/or counties have their own business regulations. Check on the websites for your state/county/city for information specific to your area.
In Hawaii, PayDayHawaii can help you apply for your GET (General Excise Tax) license.
Consider all the options for your business category. Talk to other business people, reach out to the agencies mentioned above, and search out appropriate online forums. Need more legal information? Reach out to the Legal Aid Society of Hawaii, and ask. Think about which structure you would find most effective and useable. Look at your new business and consider which category would best suit it.
Although this sounds complicated, it’s not! Just work your way through the points above. It’s an important step, and you want to make the best decision you can.