If you’re thinking of starting a home-based business, you’re probably wondering, “Where do I begin?” It’s a question many entrepreneurs who plan on having an office outside of the home ask, too.
When you launch a business from home, you don’t have to worry about things like looking for affordable office space, finding a place to park, etc., but you do have to pay attention to many of the other startup tasks that all businesses do. An at-home company still needs to follow certain steps and rules to operate legally and successfully.
Let’s explore the following steps:
- Set Up a Dedicated Work Space
- Pick a Business Name
- Decide on a Business Entity Type for Your Home-Based Business
- Register Your Home-Based Business
- Obtain a Federal Tax ID Number
- Designate a Registered Agent
- Get Any Required Business Licenses and Permits
- Open a Business Bank Account
- Keep Accurate Financial Records Throughout the Year
- Keep Up With Ongoing Compliance Requirements
Steps for Starting a Home-Based Business
1. Set Up a Dedicated Work Space
Running a business from home provides some significant lifestyle perks:
- No commute
- Flexibility to work when it suits you best
- No need for childcare arrangements when school lets out for summer
- No need to to take time off when you the HVAC service tech, plumber, or other home repair provider is scheduled to visit
- Lower overhead costs
The key to taking advantage of them and having a sustainable business is to make sure you have an in-home workspace that allows you to focus on your business without constant interruption. Whether in the form of an addition to the house (one of my friends recently enclosed her front porch and converted it into an office space), a spare bedroom, or a secluded section of the basement, find a place that can be all yours.
Outfit your home office with all the essentials so that you have what you need at your fingertips:
- Shelves and file storage
Also, set some ground rules for other household members, relatives, and friends so that they know it’s not acceptable to disturb you during designated work hours (unless in the case of a real emergency, of course).
2. Pick a Business Name
No matter how small a business is, its brand’s name is critical for identifying it from its competition. When owners decide to use something other than their first and last name, they must check to make sure the desired business name hasn’t been taken by another company.
Checking a business name’s availability can be done by taking the following steps:
- Verify your desired business name doesn’t conflict with any state restrictions.
- Check the Secretary of State’s database to see whether the name is already registered within the state.
- Conduct a trademark search to determine whether someone has filed a trademark for the name.
- Run a comprehensive national name search that checks all state and local databases.
By doing all of the above, business owners can help ensure they’re not infringing on someone else’s name. It is far better to find out in advance that a name is spoken for than to spend money on business cards and marketing materials only to find you need to change your name to avoid legal issues.
3. Decide on a Business Entity Type for Your Home-Based Business
I recommend putting a great deal of thought and research into this step! It will have legal, financial, and administrative impacts on your company.
Common business entity types for home-based businesses include:
- Sole Proprietor
- General Partnership
- LLC (Limited Liability Company)
- C Corporation
- S Corporation
A Quick Overview of Each Business Structure
Each business structure has its own advantages and disadvantages, depending on the circumstances. Your choice in business structure will affect the taxes you pay and the personal liability protection you have, so it’s wise to consult an attorney and a tax advisor or accountant for guidance.
The most simplistic form of business, a sole proprietorship doesn’t have to file formation paperwork with the state, and it has the least amount of ongoing compliance requirements. That said, as with all types of business structures, certain licenses and permits may be needed at the federal, state, and local jurisdictions to operate lawfully. The nature of the business (types of goods and services it provides) affect the types of licenses and permits it will need.
One potential downside of starting a sole proprietorship is that there is no legal separation between a business and its owner. All business assets and liabilities (legal and financial) pass through to the owner. So if the business is sued or can’t pay its debts, the owner’s personal assets could be at risk.
A sole proprietor’s business tax obligations flow through to its owner’s and are reported on the owner’s personal income tax returns.
In a general partnership, there are multiple owners. As with a sole proprietorship, a general partnership doesn’t have to file formation documents with the state, and it has relatively minimal compliance requirements. General partnerships’ tax obligations pass through to their owners. Licenses and permits might be required. And, same as a sole proprietor, there is no personal liability shield for a general partnership’s owners.
The Limited Liability Company structure is one that many home-based business owners choose. An LLC can have just one owner or be a multi-member LLC.
The business entity type is simple to form, has minimal ongoing compliance obligations, and gives the personal liability protection of a corporation. By default, most LLCs are taxed as a sole proprietor or general partnership, with all tax obligation flowing through to the owners. However, LLC owners may instead opt to receive tax treatment as a Corporation or S Corporation.
A C Corporation is a legal entity separate from its owners (shareholders), and it offers the highest degree of personal liability protection. Incorporating involves more documentation to form the company, and there are more ongoing compliance formalities (such as creating bylaws, appointing a board of directors, etc.). The IRS considers a corporation to be a separate tax entity from its owners (shareholders), so it must report income and expenses—and pay taxes on its profits at the corporate rate. (Unless it has elected to be treated as an S Corporation, which I’ll explain next.)
Because corporations may sell stock to an unlimited number of shareholders to raise capital, they typically have more growth potential than other business structures.
An S Corporation is a special election (rather than a business structure on its own) made with the IRS to give a corporation pass-through tax treatment. With S Corp election, a business does not pay federal taxes at the corporate level. Profits or losses flow through to the owners (shareholders).
Corporations that choose S Corp election may only have up to 100 shareholders.
LLCs can request S Corp election, too. The difference it makes for them is that owners only pay self-employment taxes on their salaries rather than all business income.
Other aspects of operating a corporation or LLC remain the same as they would if they were not receiving S Corp tax treatment.
4. Register Your Home-Based Business
Business owners who want to form an LLC must submit Articles of Organization to the state in which they want to register the business. To incorporate, a business must submit Articles of Incorporation. LLCs and corporations that want S Corporation election must complete and file IRS Form 2553.
By forming an LLC or incorporating your business, your business name automatically becomes registered to you. If you opt to operate as a sole proprietor or general partnership, you will not have formation paperwork to complete, but you will need to file a DBA (Doing Business As) if you want to use a business name that does not include your first and last name.
5. Obtain a Federal Tax ID Number
Also known as an Employee Identification Number (EIN), a Federal Tax ID Number is free from the IRS. It is a nine-digit number used for tax filing and reporting purposes and for taking care of other business documentation (for example, opening a bank account, obtaining business licenses, etc.)
6. Designate a Registered Agent
If a business is an LLC or corporation, it must have a registered agent with a physical location within the state that the business is registered. A registered agent is a company or person given authority to accept service of process on behalf of a business. “Service of process” refers to government notices and legal documents—such as state correspondence, tax documents, notices of lawsuits, and other critical paperwork.
7. Get Any Required Business Licenses and Permits
Home-based businesses may need to obtain local business licenses or permits from your state or county.
Some examples of common licenses and permits that apply to in-home businesses include:
- General business licenses
- Professional and trade licenses
- Home occupation permit
- Health and safety permits
- Sign permits
- Construction permits
- Sale tax permit
Business owners can start their research using the SBA website, where they can see which licenses and permits might apply to their business type and state. Also, many state and local websites publish license and permit information on their websites. It’s also helpful to contact the state, county, and municipal offices directly to ensure nothing slips through the cracks.
8. Open a Business Bank Account
Business owners should never blend their personal and business finances. Not only is it confusing, but it can also “pierce the corporate veil” and destroy any personal legal and financial liability protections that owners have through forming an LLC or incorporating. To prevent blurring the line between personal and business funds, companies should have bank accounts used solely for the business purposes.
9. Keep Accurate Financial Records Throughout the Year
In addition to maintaining a business bank account, home-based business owners should keep track of costs in the home that are directly related to conducting business (such as a new desk or office chair) and also indirect expenses. Sole proprietors and general partnerships that operate from a home office can deduct certain home expenses based on the percentage of the home used for business purposes.
For example, if a sole proprietor uses a spare bedroom of 200 square feet as an office within a home that is 2.000 square feet, that business owner may deduct 10 percent (200 ÷ 2,000) of expenses such as mortgage payments, homeowners insurance, and utilities on each year’s tax return. There’s also a standard deduction option of $5 per square foot of home used for business (maximum of 300 square feet) that home-based business owners can use instead.
If a company is structured as an LLC, S Corp or C Corp, the corporation can reimburse its owners for home office costs on a monthly basis under an accountable expense reimbursement plan. Those reimbursements might qualify as deductible business expenses for the company.
A tax advisor’s or accountant’s guidance can help home-based business owners weigh their options and decide which will benefit them the most.
10. Keep Up With Ongoing Compliance Requirements
Besides the documentation and requirements related to starting a home-based business, there are various filings and renewals that must be completed to stay compliant every year. These will vary according to business entity type and location. It’s helpful to talk with an attorney and account to make sure you’re aware of your obligations (federal, state, and local) and their deadlines. Businesses that don’t abide by the rules could face fines, lawsuits, or even a suspension of business operations.
Where to Turn For Help When Starting Your Home-Based Business
You’ll discover you’ll have much to consider as you’re launching your home-based business. You can find some helpful information and resources through organizations like SCORE and the SBA. And, as I mentioned several times earlier, it’s essential to get all your legal and financial ducks in a row by talking with a lawyer and accounting professional.