Starting a small business involves several legal steps. Following legal requirements is important to ensure your business remains compliant and profitable. As a small business owner, it’s up to you to research applicable laws and follow them. This process can be daunting at first, so we’ve put together a checklist of basic legal requirements you’ll want to review before starting your small business.
10 Legal Requirements for Starting a Small Business
1. Choose a Business Structure
A business structure is a legal structure that determines important components of your business such as how you pay taxes, if and how you are allowed to raise capital, who owns the company, and how profits are distributed. When considering which business structure to choose, start by asking yourself a few questions:
- What are my short- and long-term business goals?
- What type of services am I providing?
- Do I plan to hire employees in the future, or will this be a solo business venture?
- What capital do I have available and what future financial requirements do I have?
Gathering this information will help inform your choice. Every individual has different needs for their business, and legal entities are not a one-size-fits-all solution. While some individuals may feel their work carries little risk of legal action, others may choose to position their company for bigger growth that could carry more risk.
Four business structure options to consider when starting a small business:
Many independents begin their journey as sole proprietors. For tax purposes, sole proprietors generally operate under their personal Social Security number, but you can apply for a Taxpayer Identification Number (TIN) for your business instead. This business structure requires minimal paperwork and offers flexibility if you decide to freelance part-time.
A LLC (Limited Liability Company) is a business structure that provides a middle ground between operating a corporation and a sole proprietorship: it allows for the pass-through taxation of a sole proprietorship while also providing the limited liability of a corporation. LLCs are popular due to their simplicity, while providing strong legal protections of a corporation that shield personal assets. Think of it as the next step above a sole proprietorship.
With an S Corporation, or S-Corp, profits and losses pass through to the shareholder’s personal tax return, so the business itself is not taxed. The shareholder must be paid a fair market value, but any additional profit is not subject to self-employment tax.
With a C Corporation, or C-Corp, you are the majority shareholder of your company. This business structure provides limited liability, separating your personal and professional assets. While this structure is one of the most complex business arrangements available, it is also the most sophisticated, making it an attractive option for independents.
2. Register Your Business Name
If you choose to run your business as a Sole Proprietor, the name of the business will default to the name of the owner’s legal name. For example, if your name is Rachel Smith and you form a consulting company, the legal name of the business will be “Rachel Smith.” However, if you decide to name your company “Rachel Smith Consulting,” you’ll need to register this as a DBA name.
This process lets your state or local government know the name you are operating your business under. This allows you to create and use the name you want for branding purposes without having to incorporate. Specific DBA registration rules vary from state to state.
For those who are filing a legal entity, an application must be filed with your state for either Articles of Incorporation or Articles of Organization. Whether you choose an LLC, S Corp, or C-Corp in step one above, you will need to file a name for the company with your state.
3. Trademark Names, Logos, or Slogans
If you are planning on operating nationally or providing online services, you may want to consider getting your business name trademarked. A DBA name or incorporated business name will not offer brand protection in the 49 states where your business is not registered. While trademarking is not a requirement, it will provide stronger protection for your brand. This process involves applying for a trademark with the U.S. Patent and Trademark Office. If you do want to pursue a trademark, start by conducting a comprehensive search to make sure the name you want to use is available.
Check out: 9 Ways to Build a Personal Brand for Small Business
4. Get an Employer Identification Number (EIN) from the IRS
Any business that operates as a corporation or partnership or has employees will be required to have an Employer Identification Number (EIN) from the IRS. An EIN identifies your business for tax purposes—think of it as a Social Security number for your business—and you can use to open a business bank account, file tax returns, and apply for business licenses.
The easiest way to apply for an EIN is online via the IRS EIN Assistant. If you operate as a sole proprietorship or single member LLC, you are not required to obtain an EIN, although obtaining one is a way to create additional separation between business and personal liability and it will shield your social security number on business documents and help protect against identity theft.
5. Learn About State and Local Taxes
Income tax is likely not the only tax you are responsible for paying into, so it’s important to understand other tax requirements you may have. The majority of independent contractors are considered to be self-employed and are therefore subject to paying Self-Employment (SE) Tax in addition to income tax. SE Tax is both the employer and employee halves of Social Security and Medicare (FICA).
However, there are circumstances in which your tax situation may differ. For example, how your business is structured may affect which taxes you are required to pay into. In addition, whether or not your business made a significant profit during the past year could also be a factor. More information about tax requirements can be found on the IRS website.
Learn more: Filing Independent Contractor Taxes: 4 Best Practices
6. Obtain Required Business Permits and Licenses
Just like any other business, independent contractors must obtain proper permits and licenses. Depending on your industry and where your business is located, you may need to be licensed on the federal level as well as on the state or local level. Federal licenses are required for businesses involved in any sort of activity that is supervised and regulated by a federal agency. State licensing and permits will vary depending on location.
7. Create a Compliance Plan
Even as a small business owner, you’re subject to some of the laws and regulations that apply to large corporations. These include advertising, marketing, finance, intellectual property, and privacy laws. For companies that have employees, there are additional state and federal regulations that may need to be followed situationally. The SBA has helpful advice for keeping your small business compliant.
Additionally, small businesses must ensure that they are free and clear of contractor misclassification concerns. Not only is this a threat to your business itself, but also your future clients.
Don’t miss: 5 Tips for Staying Legally Compliant as a Small Business
8. Open a Business Bank Account
Legally, having a separate bank account for business transactions will enable you to better track and report on your income and expenses. It is advisable to set up a business bank account before you start receiving payments from clients but it’s even better if you do so once you start setting up your business. Do your research and find a bank that best fits your needs. You will often need several pieces of information when opening a business bank account, such as:
- Your EIN (Employer Identification Number) or your social security number if your business is a sole proprietorship
- Formation documents for your business
- Your ownership agreement documents
- Your Business License
9. Obtain Business Insurance
The decision to start a small business means that you are responsible for ensuring the legal and financial well-being of your company. Remember that you are your business—if any legal or financial problems arise that affect your company, they will also affect you directly. It’s important to protect your business against the risk of liability losses not just because many clients will require you to have these insurances, but it also to protect yourself and your future security.
Of course, the types of insurance that are right for your business will vary greatly and depend on your industry, the size of your business, and the type of clients you work with, among other factors. Here are a few common types of business insurance that many independent contractors carry:
1. General Liability Insurance
General liability insurance is often necessary for independents. This insurance covers a wide range of incidents, including accidental damage to a client’s property, claims of libel or slander, and the cost of defending lawsuits.
2. Errors and Omissions Insurance
Errors and omissions insurance, also known as professional liability insurance, provides protection in the instance that a client incurs financial harm due to an error or omission—that is, a failure on your behalf to perform an integral part of your responsibility on a project.
3. Home-based Business Insurance
While an insurance policy for a home-based business doesn’t apply to everyone, it’s relevant for independents who choose to work out of a home office. Most homeowners’ insurance policies do not cover losses sustained out of a home office, but an insurance policy for a home-based business can provide the protection you and your clients need.
Check out: Business Insurance Requirements for Independent Consultants
10. Consider How You Will Handle Your Back Office
Back-office management consists of all of the administrative and support tasks that need to be done to run your business. This includes filing paperwork, tracking expenses, filing taxes, and billing clients. While managing your back office is not technically a legal requirement, how you choose to manage these tasks can have legal implications down the road.
Some independents choose to hire administrative support help while others go the do-it-yourself route using online tools and tech to generate invoices, track expenses, and bill clients. Others will use a professional service like MBO Advantage for support. Planning for how you will manage these responsibilities is a smart move as a new small business owner and will allow you to focus your time and attention on clients rather than routine business maintenance.
The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.