If you’re just starting a business, it’s very easy to feel overwhelmed at the beginning. You have to think about, not only what your business is.
Maybe there’s a service that you provide, or maybe you have a product that you’re bringing to market, but then you have to think about all the backend.
What happens behind the scenes, in your business, and how your business operates. Are you incorporated? Are you an LLC? Are you hiring employees?
Or, my favorite, How do you pay yourself – the business owner? Let’s not forget that you need to get paid as well. So sometimes this can be really overwhelming.
In order to avoid that overwhelm, I created an acronym SOFT, and we’re going to break down each category and really focus on the essential questions you need to ask yourself.
So by the end of this post, you’re going to have the clarity you need and the confidence to move forward with your business.
How to Determine Business Structure
So let’s start with structure. Now, when I talk about structure, I mean legal structure, and I’ve spoken about this in this post all about choosing your business structure.
Are you incorporated? Do you want to be an LLC? Maybe you want to operate just as a sole proprietor and keep it simple.
There are pros and cons to each structure. And, basically, the structure determines how you act and how your business operates. It also determines the level of liability coverage that you get from the structure itself and also how you’re going to be taxed and at what tax rate.
How to Determine Business Operations
Let’s move on to the next one – operations. Now we could go down a rabbit hole and really dig in deep into all the details of how your business operates. But I want to keep this as kind of a high level and really the big picture operational items.
So what I mean by that is, are you flying solo? Is it just you and your business? Do you have a partner? Or maybe you have outside shareholders that are investing in your company.
These are the questions I want you to ask yourself.
How to Determine Business Finances
Next is finances – what finances does your business need? Do you need some preliminary funding? And if so, are you putting that funding in yourself? Are you personally investing? Are outside investors giving you money? Or maybe you’re just going and getting a bank loan.
How to Determine Business Tax
And then the last category – Tax. Who pays the business tax? Now, this may seem like a very simple question and it’s like, “Well, my business pays the business tax.” But here’s the thing, unless you’re incorporated as a C corporation, you, the business owner, are actually paying the tax on your individual tax return.
This is what we call a pass-through taxation. You can take cash from your business and cover that tax liability, and there are certain rules to follow, and you’ve got to do it correctly so you don’t end up paying additional tax if you take too much money out of your business.
Basically, it’s called a pass-through entity because whatever income your business generates, tax has to be paid on that. That income actually flows through and gets taxed on your individual tax return, which means it is subject to your individual tax rate. This also means that the tax rate is determined by all of your other sources of income. So it’s not just your business alone.
How Much Should You Set Aside for Taxes?
So I get this question a lot from small business owners, “How much should I set aside for my business to pay tax?” And I say, well, it really depends on what bracket you’re in. And it depends on all of your other sources of income.
It’s not that simple. And again, C corporations. It is that simple. They are a completely separate entity, but anything else, sole proprietor, LLC, partnership, S-corporation, all of those are actually subject to being taxed on the individual level.
So it’s funny cause we hear about this low corporate tax rate and it’s actually somewhat misleading. You know, over 95% of the businesses in the United States are actually pass-through entities, which means they’re actually being taxed at whatever their individual rate is. Not this low corporate tax rate that we keep hearing about.
This is not meant to deter you at all from starting a business. There are so many perks to being self-employed. So please don’t misunderstand what I’m saying here. There are a lot of ways you can reduce your taxable income when you’re self-employed.
This is meant to educate you though. So you actually make the right decision going forward and you have the knowledge about how all of this works.
So now let’s sum it all up. Let’s go back to this acronym, SOFT, that I’m talking about and break it down.
So for structure, number one, do you need the liability protection that a business structure provides?
Number two – operations. Are you flying solo? Do you have a partner? Are you hiring employees? And importantly, how do you want to pay yourself?
Number three, finance. How are you funding your business? Are you funding it yourself or do you have outside investors?
And number four, tax. How do you want your business income taxed purely on its own? Or are you okay with it passing through and being taxed on your individual tax return?
So once you address these questions in these categories, you are well on your way to having a solid understanding of how your business works.
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