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Why should I register a separate business entity for my home business?

Most people with side hustles or home businesses start and operate as a sole proprietorship, also known as an unincorporated business. As your home business grows, however, there are benefits to setting up a separate business entity and formalizing your business structure.

As a sole proprietor, if something goes wrong or there is a debt the business cannot cover, the business owner is personally liable. This means that the business owner may have to pay out debts from personal assets and bank accounts. Businesses that register as a corporation or a limited liability company (LLC) don't have to worry about this. Generally, creating an LLC or corporation provides personal asset protection for the business owner, allowing the business to bear the risk.

Additionally, both corporations and LLCs provide tax flexibility for their owners. With a corporation, you can avoid double taxation of business profits and dividends by electing S-corp tax status. An LLC can elect to be taxed as a corporation or have the business profits and losses "passed through" to the owner's personal taxes. In addition, both corporations and LLCs allow you to deduct ordinary business expenses, such as salaries, office supplies, and computer equipment, reducing the overall tax burden.

Finally, a formal structure enhances a business's credibility with customers, potential employees, vendors, banks, and the Internal Revenue Service (IRS). When a business has an "LLC" or "Inc." in its name, there is a positive effect on that business's reputation as people will see it as a professional operation. Before deciding on which structure is right for your business, you may want to talk to a Legal Pro.

When should I register a separate business entity for my home business?

There's no set timeline for setting up a business entity your home business. It may depend on your growth, your customers, and your plans. Choosing the right time is important, as registering an LLC or corporation after an incident, or after a contract was signed, may not protect owners from personal liability.

Businesses may want to establish a separate entity before entering into any contracts, such as Employment Contracts, loans or vendor contracts. Businesses can sign contracts, borrow money, and own property as separate legal entities. This allows a lender to use the business's assets, not the owner's personal assets, to secure a loan. It also limits the owner's personal liability if something goes wrong with a vendor or employee.

If a business has more than one founder or outside investment, establishing a separate entity early on can clearly establish ownership interests, financial interests, and managerial responsibilities. Investors often require a separate business entity before putting their money into a business. The business formation documents, such as the Articles of Incorporation and Corporate Bylaws or Operating Agreement, describe the interests and responsibilities of the owners and managers, helping to avoid misunderstandings.

Finally, it is a good idea to set up a separate business entity for your home business before hiring employees. As numerous issues can arise in the employer-employee relationship, you can protect your personal assets from an employee's actions or mistakes, or from your mistakes managing employees, limiting the liability only to the corporation or LLC's assets.

Can I start a business if I have a regular day job?

Generally, it is legal to start a business even if you are a full-time employee for another company. Your Employment Contract, or employer's policies, however, may prohibit starting a business or taking on other employment. So while it may be legal, if you're not careful, there could be consequences for your day job.

Additionally, your Employment Contract, or an Invention Agreement, may impact the ownership of inventions or innovations you create. So, for example, if you invent a new computer program as part of your side business, your full-time employer may claim they own that invention even though you created it for your side business away from your full-time work for your employer.

Further, your employment may have a Noncompete Agreement, preventing you from working in a similar field as your full-time employment while employed, and sometimes for a period of time after you leave. Understanding what you can and cannot do is critical, as the last thing you want to do is to invite a lawsuit, or lose your steady job, just as you're getting started.

When should I get a location for my business outside my home?

A home business, with all the flexibility of working from home, may seem ideal, but sometimes it just won't work. As your business develops, you may find that a home office is too small or a distraction, it may also be off-putting to prospective employees, partners, customers, or clients.

Further, zoning regulations and neighborhood bylaws may prohibit you from growing, or offering certain services, or operating certain types of businesses out of your home. If the business has the capital or is generating enough revenue to support a brick and mortar location, or even just a shared office space, the investment can often reap big rewards.

When a business decides to move locations, the following should be considered:

  • Location, location, location—This old adage is true. A business's location is essential.
  • Space—How much space do you need now? How much space will you need in six months? Can your location grow with the business?
  • Rent or buy—When just starting out, a business may only have a budget suitable for renting space. As you grow, however, or if you're flush with capital, you may consider purchasing a space or building. If you are looking at buying, don't forget to assess property taxes to understand the true cost. You may also want to talk to a Legal Pro about whether it's best for you, or the business, to make the purchase.

If you run your business from home, then employees may need to work in your home. This is legal, though you may need to comply with federal and state employment laws, such as the Fair Labor Standards Act (FLSA). The FLSA and state laws, for example, will cover overtime, minimum wage, and recordkeeping, and set forth many more requirements for qualified employers.

State law may also impose requirements when hiring employees or independent contractors who will work in your home, like they would for any other worksite. You may need to provide a restroom, safety equipment, specific signs or postings about the law, and meet other requirements to have employees present. Before hiring employees to work out of your home, it is best to review your state and local labor laws with a Legal Pro, and consider registering your business to protect yourself from liability.

Understanding when to register your home business is essential to understanding your responsibilities as a business owner. With a Rocket Legal+ membership, your first business registration filing is FREE (excluding state fees). Using the Rocket Lawyer Mobile App can save you time and get your business the legal help you need anywhere and on any device.

This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.

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