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LEGAL ENCYCLOPEDIA

Business & Human Resources


Do I Need a Business Lawyer?
Consulting & Contracting

Pros and Cons of Freelancing, Contracting, and Consulting


Legal and Tax Rules for Independent Contractors

Minimal Requirements for Working as an Independent Contractor


Top Ten Tax Deductions for Professionals
Hobby Business Tax Rules
Paying Estimated Taxes
Preserving Your Status as an Independent Contractor
Billing and Contracting as an Independent Contractor

Use Written Service Contracts for Your Clients


Getting Clients to Pay Up
How Much Should You Charge for Your Service?
Home Business Issues

Insuring Your Home Business


Hobby Business Tax Rules
Zoning Rules for Home Businesses
Home & Hobby Businesses: Overview
The Home Office Tax Deduction
Starting a Business

Raising Money From Family and Friends


Starting a Business: 50 Things You'll Need to Do
Evaluating Your Business Idea

Starting and Researching the Right Business


Will My Business Make Money?
Financing Your Business

Raising Money From Family and Friends


The Lowdown on Business Loans
Understanding Promissory Notes
Getting a Business Loan: Getting the Lender to Say "Yes"
Raising Money for Your Small Business: Loans vs. Equity Investments
Raising Money Through Equity Investments
Loans and Equity Investments Compared
Writing a Business Plan

Why You Need to Write a Business Plan


The Essentials of a Business Plan
Naming Your Business
Cybersquatting: What It Is and What Can Be Done About It
Pick a Winning Name for Your Business
What to Do If the Domain Name You Want Is Taken
Choosing and Registering a Domain Name
Avoid Trademark Infringement When You Choose a Domain Name
Make Sure Your Proposed Business Name Is Available
Registering Your Business Name
Obtaining Licenses & Permits

State Start-Up Requirements


Local Start-Up Requirements for Small Businesses
Federal Start-Up Requirements for Small Businesses
Finding and Renting Space for Your Business

Pick a Legal Location and Avoid Zoning Trouble


Dealing With Zoning Problems
Tips for Assessing the Cost of the Rental
How Commercial Leases Are Made
Choosing a Successful Location for Your Business
Understanding Common Commercial Lease Terms
Negotiating the Best Commercial Lease Terms
Finding the Right Commercial Space
Understanding Commercial Leases
Renting Real Estate for Your Business: Overview
Ten Steps to Determining the Space You Need for Your Business
Ownership Structures

Choosing the Best Ownership Structure for Your Business


Types of Ownership Structures
Risky Businesses
Corporations vs. LLCs
Chart: Ways to Organize Your Business
Small Business Insurance
Sole Proprietor

Sole Proprietorship Basics


Running a Business With Your Spouse
How Sole Proprietors Are Taxed
Partnership

How Partnerships Are Taxed


Creating a Partnership Agreement
Making Special Allocations
Partnership Basics
Owner Buyout Agreements: Plan Ahead for Changes in Partnership
Ownership
Corporation
Running a Corporation: Keeping the Minutes
Shareholder Buyout Agreements: Plan Ahead for Changes in Corporate
Ownership
Corporation Basics
Professional Corporations
S Corporation Facts
How to Form a Corporation
Cut Taxes With Corporate Income Splitting
How Corporations Are Taxed
Limited Liability Company (LLC)

When Your Spouse Helps Out With Your LLC


Owner Buyout Agreements: Plan Ahead for Changes in LLC Ownership
How LLCs Are Taxed
Cut Taxes With Corporate Income Splitting
LLC Basics
Creating an LLC Operating Agreement
How to Form an LLC
Making a Profit
Saving Business Taxes

Top Ten Tax Deductions for Landlords


Why the Self-Employed Are Audit Targets
Business Income Defined
Top Ten Tax Deductions for Professionals
What Auditors Look for When Examining a Business
Understanding Small Business Tax Deductions
Preparing for a Business Audit
Deductions Your Small Business Shouldn't Miss
Current vs. Capital Expenses
Bookkeeping and Accounting

Cash vs. Accrual Accounting


When Your Business Ships Goods
Invoicing Customers and Extending Credit
Bookkeeping and Accounting Basics
Accounting Terms Every Businessperson Should Know
Contracts & Transactions

When Your Business Ships Goods


Mediation for Small Businesses
Selling: Wholesale, Retail, and Consignments
Invoicing Customers and Extending Credit
Consumer Protection Laws
Buying vs. Leasing Business Equipment
Consumer Credit Laws
Keeping Your Contracts Simple -- and Enforceable
Debt Collections

Taking a Business Customer to Small Claims Court


Deciding Whether to Pursue Payment by a Bankrupt Customer
Ten Tips for Minimizing Losses Due to Customers' Bankruptcies
Collecting Business Debts
Marketing

Listings: Advertising That Works


Marketing Without Spam
Ten Ways to Help Your Customers Find You
Ten Ways to Build and Market Your Business Image
Seven Rules for Legal Advertising
e-Commerce

Making Contracts Online: Electronic Signatures


Terms and Conditions for Your Website
Sales Tax on the Internet: Who Pays It, Who Doesn't
Obtaining a Business Method Patent
Challenging or Infringing Another's Business Method Patent
Getting Your Business Online
Buying or Selling a Business

Ten Good Reasons Not to Buy a Franchise


When You Can't Pay Your Business Debts: Personal Liability and
Bankruptcy Options
Ten Tips for Financially Troubled Businesses
Buying a Business: What You Need to Know
Buying or Selling a Business: an Overview
Figuring Out What Your Business is Worth
Deciding When and Whether to Sell Your Business
What to Investigate Before You Buy a Business
Checklist for Closing Your Business: 20 Things You Need to Do
Eight Key Steps to Selling Your Business
Closing Your Business: What You Need to Do
Nonprofit Organizations

Create a Strategic Plan for Your Nonprofit


Protecting Your Nonprofit Corporation's Tax-Exempt Status
Nonprofit Basics
Using Your Nonprofit’s Website to Help Fundraise
How to Form a 501(c)(3) Nonprofit Corporation
Five Reasons to Incorporate Your Nonprofit Association
Tax Concerns When Your Nonprofit Corporation Earns Money
Human Resources

When Do I Need an Employment Lawyer?


Employers' Rights and Responsibilities
Hiring Employees

Hiring Young Workers


Running Background Checks
Conducting Job Interviews
Avoid Disability Discrimination When Hiring New Employees
Writing and Using Job Descriptions
Testing Job Applicants
What Are Agricultural and Hazardous Agricultural Jobs?
Written Employment Contracts: Pros and Cons
Hiring Independent Contractors

Independent Contractor or Employee: How Government Agencies Make


the Call
Put Your Independent Contractor Agreements in Writing
How to Protect Your Intellectual Property Rights in Works Created By
Contractors
Pros and Cons of Hiring Independent Contractors
Require Documentation When You Hire Independent Contractors
Abiding by Wage and Hour Laws

When Do I Have to Pay the Minimum Wage?


When Do I Have to Pay Overtime?
Compensatory Time Might Not Be Legal
Legal Limits on Pay Docking and Unpaid Suspensions
Paying Employees Who Are On Call or Traveling for Business
Personnel Policies & Practices

How to Conduct Employee Evaluations


Why You Need an Email Policy
Who Has a Right to View Personnel Files?
Developing a Disciplinary Policy
Why You Should Create an Employee Handbook
Creating and Maintaining Personnel Files
Providing Family, Medical, and Other Types of Leave

Providing Pregnancy and Parental Leave


Giving Employees Time Off for Voting and Jury Duty
Providing Vacation and Sick Leave
Providing Military Leave
Providing Family and Medical Leave
Preventing Discrimination

Guidelines for Handling Discrimination and Harassment Complaints


Reasonable Accommodations for People With Disabilities: The ADA
Preventing Retaliation Claims by Employees
Preventing Sexual Harassment in the Workplace
Avoiding Discrimination Based on Race and National Origin
Religious Discrimination in the Workplace
Sexual Orientation Discrimination in the Workplace
Avoiding Age Discrimination
Ensuring Privacy in the Workplace

Workplace Searches: Dos and Don'ts


Monitoring Employee Communications
Testing Employees
Monitoring Employees' Off-Duty Conduct
When Workers Leave

Should You Offer Severance Pay?


Chart: Final Paychecks for Departing Employees
Giving References for Former Employees
Using Severance Agreements to Avoid Lawsuits
Firing Employees

Employer Liability for an Employee's Bad Acts


Punishing Whistleblowers Can Lead to Trouble
Illegal Reasons for Firing Employees
Firing Employees With Employment Contracts
Legal FAQ
Business & Human Resources
Consulting & Contracting

Working as an Independent Contractor FAQ


Starting a Business
Evaluating Your Business Idea

Evaluating Your Business Idea FAQ


Financing Your Business

Business Financing FAQ


Writing a Business Plan

Writing a Business Plan FAQ


Naming Your Business

Domain Names and Trademarks FAQ


Choosing a Business Name FAQ
Finding and Renting Space for Your Business

Finding and Renting Space for Your Business FAQ


Ownership Structures
Sole Proprietor

Sole Proprietorships FAQ


Partnership

Partnerships FAQ
Corporation
Corporations FAQ
Limited Liability Company (LLC)

Limited Liability Company FAQ


Making a Profit
Saving Business Taxes

Small Business Taxes FAQ


Buying or Selling a Business

Buy-Sell Agreement FAQ


Nonprofit Organizations

Nonprofits FAQ
Human Resources
Hiring Employees

Hiring Employees FAQ


Hiring Independent Contractors

Hiring Independent Contractors FAQ


Abiding by Wage and Hour Laws

Wage and Hour Laws FAQ


Personnel Policies & Practices

Personnel Policies and Practices FAQ


Providing Family, Medical, and Other Types of Leave

Leave Policies in the Workplace FAQ


Preventing Discrimination

Preventing Employment Discrimination FAQ


Ensuring Privacy in the Workplace

Privacy in the Workplace FAQ


When Workers Leave

When Workers Leave FAQ


Firing Employees

Firing Employees FAQ

Do I Need a Business Lawyer?


From the Nolo Business & Human Resources Center
Find out when you can do it yourself -- and when you should call in an expert.
For most businesspeople, deciding whether to call a lawyer should be like deciding whether to go to the doctor. If you have
severe chest pain, odds are you’re not going to hesitate to call your physician or hightail it to the emergency room. But if
you just have a bad cold, you might wait a few days to see if it turns into pneumonia before you drag yourself to the
dreaded doctor’s office.
Likewise, you should call a lawyer when you have a serious legal problem -- for instance, you’re being investigated for
securities fraud by the SEC or a customer is severely injured by one of your products.
But in other instances it might not be so clear. For instance, do you need a lawyer when you’re starting a business?
Dissolving one? Buying or selling a business? Hiring high-level employees? Since legalities seem to pervade even the most
basic business decisions -- and lawyers have helped this perception along -- you might be afraid to tackle a “legal” issue
without a lawyer. Or, on the flip side, you might have had a bad experience with a lawyer that was enough to put you off
them forever, no matter what the cost.
If you’re the “always need a lawyer” type, there is actually a lot you can start to do for yourself. But if you’re the “no
lawyers for me, thanks” type, it’s important to recognize when you’re in over your head and need the help of a competent
lawyer.
When You Probably Need an Attorney
There are a few situations when you’ll want or need the advice of a good small-business attorney. Here are just a few
examples of serious legal issues that require the help of an experienced lawyer:
1. You and your business partners want to make so-called “special allocations” of profits and losses in your
partnership agreement or LLC operating agreement (this is a tricky area that needs the help of an experienced tax
attorney).
2. You and/or your business partners want to contribute appreciated property to a partnership or LLC (this also
requires the assistance of an experienced tax attorney).
3. You’re buying a business and a major environmental issue comes up (environmental protection laws carry heavy
penalties for landowners, even for those who didn’t cause the contamination).
4. An employee or former employee threatens to sue your business for discrimination or one of your managers for
sexual harassment.
A mistake in any of these areas can cost you -- and your business partners -- serious money. In any of these situations,
paying for the help of an experienced lawyer will more than offset the potential harm you might cause your business if you
don’t deal with these issues properly. The tricky part is finding a lawyer who is experienced in these specialty areas, as
well as being someone you can work with.
When You Probably Don’t Need a Business Lawyer
If you’re just starting out in business, you can take care of most tasks yourself. The following is just a small sample of
tasks lawyers charge lots of money for, but which you can easily accomplish yourself with a good self-help resource:
1. research and reserve a trademark or trade name for your business
2. file a fictitious business name statement if you will do business under a different name
3. research and reserve a name for your corporation or LLC
4. apply for and reserve a domain name, if you will do business on the Web
5. create your own partnership agreement, LLC operating agreement or shareholder’s agreement
6. form your own partnership, LLC or corporation
7. apply for your business employer identification number (EIN)
8. apply for the required business licenses and permits
9. lease commercial space, and

10. interview and hire employees, and complete the necessary IRS paperwork.

There are some great self-help resources that can get you started on all of these tasks that can save save you hundreds, if
not thousands, of dollars in legal fees. You can find a book or software product that will walk you through each of these
transactions on the Nolo website at www.nolo.com.
Once your business is up and running, there are even more legal tasks you can take care of yourself. For instance, you
can:
1. hire independent contractors and consultants, and prepare written agreements for them
2. create written contracts with customers and clients for the sale or rental of goods
3. document LLC meetings and actions
4. call and hold corporate meetings and prepare corporate minutes
5. create a buy-sell agreement with your business partners
6. update your partnership agreement, operating agreement or shareholder’s agreement as your business
circumstances change, and

7. handle an IRS audit.

With the right self-help resource, you can accomplish all kinds of legal tasks at a fraction of the cost of hiring a lawyer.
When You and Your Lawyer Can Work as a Team
One of the nice things about taking care of your own legal tasks is that if you educate yourself about basic legal issues,
you can take care of a lot of the legal legwork yourself and just involve your attorney when you have a specific question.
Lots of businesspeople like to create their own business contracts and then ask their lawyer to look them over to make
sure there aren’t any gaping holes or major legal issues. This “legal coach” arrangement can be one of the most cost-
effective ways to use legal services.
No matter how you decide to approach business legal issues, make sure you find an attorney with whom you have a good
rapport, who is responsive and willing to let you handle some of your own legal issues.
Click here for related information and products from Nolo
Copyright 2006 Nolo

Pros and Cons of Freelancing, Contracting, and Consulting


by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
The benefits -- and drawbacks -- of working as an independent contractor rather than as an employee.
An independent contractor (IC) is a person who contracts to perform services for others without having the legal status of
an employee. Most people who qualify as independent contractors follow their own trade, business, or profession -- that is,
they are in business for themselves. This is why they are called "independent" contractors: They earn their livelihoods from
their own businesses instead of depending upon an employer for a paycheck.
Good examples of ICs are professionals or tradespeople with their own practices such as doctors, graphic artists,
accountants, plumbers, and carpenters. Independent contracting is also common in highly specialized or technical fields
such as computer programming, engineering, and accounting. You can find ICs in almost every field, from construction to
marketing to nursing. Any person who is in business for himself or herself qualifies as an IC.
Some people seek to become ICs, while others have the status thrust upon them. Whichever group you fall into, working
as an IC has benefits and drawbacks.
Advantages of Working as an Independent Contractor
Independent contractors reap many rewards that regular wage earners may never experience.

You are your own boss.


When you're an IC, you're your own boss, with all of the risks and rewards that entails. Most ICs bask in the freedom that
comes from being in business for themselves. They would doubtless agree with the following sentiment expressed by one
IC: "I can choose how, when, and where to work, for as much or little time as I want. In short, I enjoy working for
myself."
ICs are masters of their economic fate. The amount of money you make is directly related to the quantity and quality of
your work. This is not necessarily the case for employees. ICs don't have to ask their bosses for a raise -- if they want to
earn more, they just have to go out and find more work. And, because most ICs are not dependent upon a single company
for their livelihood, the hiring or firing decisions of any one company don't impact ICs as they do employees.

You may earn more than employees.


You can often earn more as an IC than as an employee in someone else's business. For example, an employee in a public
relations firm decided to become an IC when she learned that the firm billed her time out to clients at $125 per hour while
only paying her $17 per hour. She charges $75 per hour as an IC and makes a far better living than she ever did as an
employee.
According to The Wall Street Journal, ICs are usually paid at least 20% to 40% more per hour than employees performing
the same work. Hiring firms can afford to pay ICs more because they don't have to pay Social Security taxes
or unemployment compensation taxes, provide workers' compensation coverage, or provide employee benefits like health
insurance and sick leave. Of course, how much you're paid is a matter for negotiation between you and your clients. ICs
whose skills are in great demand may receive far more than employees doing similar work.

You'll probably pay lower income taxes.


Being an IC also provides you with many tax benefits that are not available to employees. For example, no federal or state
taxes are withheld from your paychecks, as they must be for employees. Instead, ICs have to pay estimated taxes directly
to the IRS four times a year. This means you can hold on to your hard-earned money longer before you have to turn it
over to the IRS. Moreover, it's up to you to decide how much estimated tax to pay (but there are penalties if you
underpay). This flexibility gives ICs more control over the money they earn. For more information on estimated taxes,
see Paying Estimated Taxes.
You can also take advantage of many business-related tax deductions that are not available to employees. When you're an
IC, you can deduct from your taxable income any necessary expenses related to your business, as long as they are
reasonable in amount and ordinarily incurred by businesses of your type. This may include, for example, office expenses
(including costs associated with a home office), travel expenses, entertainment and meal expenses, cable TV and
magazine expenses, equipment and insurance costs, and much more.
ICs can also establish tax-advantaged retirement plans such as SEP-IRAs and Keogh Plans. This enables them to shelter a
substantial amount of their income until they retire.
Because of these tax benefits, ICs often pay less tax than employees who earn similar incomes.
Disadvantages of Working as an Independent Contractor
Despite the advantages, being an IC is no bed of roses. Here are some of the major drawbacks.

No job security.
Although it can be great to work for yourself, it can also be a burden.
When you're an employee, you must be paid as long as you have your job, even if your employer's business is slow. This is
not the case when you're an IC. If you don't have business, you don't make any money. As one IC says, "If I fail, I don't
eat. I don't have the comfort of punching a time clock and knowing the check will be there on payday."

No employer-provided benefits.
Many employers provide their employees with health insurance, paid vacations, and paid sick leave. More generous
employers may also provide retirement benefits, bonuses, and even employee profit sharing.
When you're an IC, you get no such benefits. You must pay for your own health insurance, often at higher rates than
employers have to pay. Time lost due to vacations and illness comes directly out of your bottom line. And you must fund
your own retirement. If you don't earn enough money as an IC to purchase these items yourself, you will have to do
without.

No unemployment insurance benefits.


ICs also don't have the safety net provided by unemployment insurance. Hiring firms do not pay unemployment
compensation taxes for ICs, and ICs can't collect unemployment when their work for a client ends.

No employer-provided workers' compensation.


Hiring firms do not provide workers' compensation coverage for ICs. If a work-related injury is an IC's fault, he or she has
no recourse against the hiring firm.

Few or no labor law protections.


A wide array of federal and state laws protects employees from unfair exploitation and discrimination by employers. Very
few of these laws apply to ICs.

Risk of not being paid.


Some ICs have great difficulty getting their clients to pay on time or at all. When you're an IC, you bear the risk of loss
from deadbeat clients. For information that will help you collect what you're owed, see Getting Clients to Pay Up.

Liability for business debts.


Finally, most ICs are personally liable for the debts of their businesses. An IC whose business fails could lose most of what
he or she owns.
Click here for related information and products from Nolo
Copyright 2006 Nolo

Minimal Requirements for Working as an Independent Contractor


From the Nolo Business & Human Resources Center
When you do freelance or consulting work, there are a few things you must do to stay out of trouble with the
law.
Many independent contractors and service providers start earning money without really planning on it. Before they know it,
their sideline projects have become legitimate businesses -- which means that they have to fulfill some basic business
start-up requirements. Whenever you provide services and get paid, you must comply with a few governmental rules, even
if you work only a few hours per week for one or two clients.
At a minimum, do these three things when you're first starting out as an independent contractor:
1. Choose a business name (and register it, if necessary).
2. Get a business license (and any vocational license required for your profession).
3. Pay estimated taxes (advance payments of your income and self-employment taxes).
Choose a Business Name
It's a good idea to choose a business name that you can use on your invoices and business cards; to many potential
clients, using a business name rather than your own appears more professional.
Depending on the name you choose, you may or may not have to register it with the government. Any business that
doesn't use the legal name of its owner as part of its business name must register the name as a fictitious business name
(called an assumed name or a DBA -- "doing business as" -- in some states). This allows customers to easily contact the
business owner with a complaint or to take legal action against the business. For example, Madeline Quinn names her
consulting business "Madeline Consulting." Because the business name doesn't include her full name, Madeline must
register it as a fictitious business name.

Skipping This Requirement


If you use your full name in your business name, you don't have to register it. For instance, many contractors who run
small service businesses simply add a word or two after their full name to come up with a business name, such as Aidan
Ray Editorial or Mike Russell Architectural Services. You can start using a name like this without filing any paperwork.
If you don't use your full name, however, you should register it, for a couple of reasons. First, you won't be able to enforce
any contract that you sign under an unregistered name. Second, many banks won't open an account under your business
name unless you provide proof that you have properly registered the name.

How to Register Your Fictitious Business Name


In most states, including California, you'll register your fictitious business name at the county level, with your county clerk.
As a result, each county in your state may have different forms and fees for registering a name. (In a few states, such as
Florida, you register a fictitious name with a state office, such as the Department of State.)
The best thing to do is call your county clerk's office to find out its procedures, requirements, and fees.
Get a Business License
Many cities and counties require every business -- even single-owner, home-based operations -- to get a general license.
This license is sometimes called a business license, sometimes called a tax registration certificate. A business license is
essentially a receipt for the tax you must pay to the city for the privilege of doing business in the city, and nothing more.
If you operate your business out of your home, you usually need to get a business license in the city where you live, even
if none of your clients are in that city. Contact your city clerk for a business license application.

Skipping This Requirement


Some independent contractors skip the business license, figuring they can stay under the local government's radar. But
consider this: Business licenses are inexpensive -- usually only $30-$50 -- but the penalties for operating without a license
can be in the hundreds of dollars. In addition, in some locales it is a misdemeanor to violate the city ordinances by
operating without a business license.

Getting a Vocational License


Depending on your trade, you may also have to get a professional or vocational license. For instance, some states license
auto mechanics, barbers, massage therapists, and real estate agents. Ask your trade association or go to your state
government's website to see if you need a particular license. .
Pay Estimated Income and Self-Employment Taxes
Unlike employees, who have income taxes and self-employment taxes (Social Security and Medicare taxes) withheld from
their paychecks, independent contractors have to handle all of their own taxes. This means you have to set aside enough
money to pay your tax bill each year. All independent contractors who make over $400 per year on business activities
must report their business income to the IRS.
In addition, if your business is at all profitable, the IRS requires you to pay your taxes in four installments during the year,
called paying "estimated taxes." (If you will bring in more than $3,000 or $4,000 in adjusted gross income from business
activities in any year, plan on paying estimated taxes.) .

Skipping This Requirement


If you have a dayjob, you can avoid making estimated tax payments by asking your employer to increase the income
withheld from your paycheck, to offset the taxes that will be due on your business income.
Some small-time independent contractors skip paying taxes on their freelancing or consulting income altogether. But
before you consider hiding income from the IRS, know that penalties and interest on back taxes, especially self-
employment taxes, can be quite high. Also, any client who pays you more than $600 in any calendar year must report the
income paid to you to the IRS, and the IRS will check your tax returns to see if you are reporting this income.
It's better to bite the bullet and just pay taxes on your business income. By being clever about deducting your expenses,
you may not end up paying taxes on much income at all -- independent contractors can deduct many more expenses than
employees, often lowering their income by as much as 50% for tax purposes. In addition, sometimes your business
activities can produce a tax loss that can lower your income from other work.

How to Register With the IRS as an Independent Contractor


To set yourself up as a self-employed taxpayer with the IRS, you simply start paying estimated taxes (on Form 1040-ES,
Estimated Tax for Individuals) and file Schedule C, Profit or Loss From Business, and Schedule SE, Self-Employment Tax, with your
Form 1040 tax return each April. You can get these forms from the IRS website at www.irs.gov.
As Your Business Grows
Above are the three basic steps you need to take before you start providing services as an independent contractor. Once
you get started, you will be running a legitimate business (a sole proprietorship, if don't have a business partner and don't
form a corporation or a limited liability company).
As a small business owner, you should learn the basics of bookkeeping and record keeping, and you may also want to take
small marketing steps such as listing your business in the Yellow Pages.
Click here for related information and products from Nolo
Copyright 2006 Nolo

Top Ten Tax Deductions for Professionals


by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
Don’t pay more in taxes than you need to.
If you’re a professional, no one needs to tell you that taxes are one of your largest expenses. The IRS doesn’t make a
point of advertising ways to lower your taxes and it certainly won’t complain if you don’t take all the deductions you’re
entitled to. In fact, many professionals miss out on all kinds of deductions every year simply because they aren’t aware of
them -- or because they neglect to keep the records necessary to back them up.
Here are the top ten tax deductions that every professional business owner should know about.
1. Business operating expenses. This includes all your ordinary and necessary business expenses -- the bread-and-
butter costs virtually every professional incurs for things like rent, supplies, and salaries. If you don’t maintain an
inventory or buy expensive equipment, these day-to-day costs will probably be your largest category of business expenses
-- and your largest source of deductions.
2. Business entertainment. Oftentimes important business meetings, client contacts, and marketing efforts take place at
restaurants, golf courses, or sporting events. The tax law recognizes this and allows professionals to deduct half of the cost
of their business-related entertainment. However, taxpayers have abused this deduction in the past, so the IRS imposes
strict rules limiting the types and amount of entertainment costs you can deduct.
3. Local travel. Professionals can deduct the costs of their local transportation expenses if they are ordinary and
necessary for their business. It makes no difference how you travel -- by car, van, SUV, limousine, motorcycle, taxi, bus,
or train -- or whether the vehicle you use is owned or leased. But, beware: transportation expenses are a red flag for the
IRS. They are the number one item that IRS auditors look at when they examine small businesses.
4. Long distance travel. Professionals who travel overnight for business can deduct their airfare, hotel bills, and other
expenses. And, if you plan your trip right, you can even mix business with pleasure and still get a deduction. However, IRS
auditors closely scrutinize this deduction. To avoid unwanted attention, you need to keep proper records and understand
the limitations on this deduction.
5. Long-term assets. A long-term asset is business property that you reasonably expect to last for more than one year.
For professionals, this typically includes items such as office furniture, computer equipment, medical, dental, or other
specialized equipment, buildings, automobiles, and books. There are two basic ways you can deduct long-term assets: by
depreciating them (deducting some of the cost each year over the asset’s useful life) or by using Section 179 of the
Internal Revenue Code to deduct all of the cost in one year.
6. Home office deduction. If, like many professionals, you regularly work at home, you may able to claim the home
office deduction. (Sometimes you can use this deduction even if you have an outside office where you do the bulk of your
work.) However, if you want to use this deduction, you must learn to do it properly. There are strict requirements you
must follow. How you claim the deduction will depend in part on what type of business entity you have.
7. Outside office. The great majority of professionals have outside offices where they do their work. An outside office --
that you rent or own -- presents many opportunities for tax deductions. Virtually all your outside office expenses are
deductible, including rent, utilities, insurance, repairs, improvements, and maintenance.
8. Health insurance. As business owners, professionals have an advantage that most others don’t have with regard to
health care costs -- they can deduct many of their health insurance costs from their taxes. In addition, professionals can
deduct a wide variety of uninsured medical expenses, including nonprescription medications, acupuncture, and eyeglasses.
9. Retirement plans. When it comes to saving for retirement, professional small business owners are better off than
employees of most companies. This is because the federal government allows small businesses to set up retirement
accounts specifically designed for small business owners. These accounts provide enormous tax benefits that are intended
to maximize the amount of money you can put away in tax-deferred accounts during your working years.
10. Hiring workers. You may deduct most or all of what you pay someone you hire as a business expense. Thus, for
example, if you pay an employee $50,000 per year in salary and benefits, you’ll ordinarily get a $50,000 tax deduction. If
you hire an independent contractor to perform services for your practice, you can deduct the amount you pay as a
business operating expense.

Want to Learn More?

For more information on deducting health insurance, vehicles, travel, and home office expenses, see
Tax Deductions for Professionals, by attorney Stephen Fishman (Nolo). This book can also help you:
1. choose the best legal structure for your practice
2. decide whether to buy or lease the building you work in, and

3. maximize your retirement funding.

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Copyright 2006 Nolo

Hobby Business Tax Rules


From the Nolo Business & Human Resources Center
Be ready to prove that your hobby is a business if you want to write off your hobby losses.
Often a person's hobby or sideline business is a labor of love rather than a reliable source of income. This is most often the
case when the business owner or freelancer has other means of financial support -- such as a regular job or a working
spouse -- that effectively underwrites the microbusiness. These types of tiny businesses are usually run from home
(renting an office would be too expensive) and are often based on semi-recreational activities near and dear to the owner,
which has earned them the nickname "hobby businesses."
There are as many types of hobby businesses as there are hobbies. A basement jewelry studio, a jazz band for hire, or an
antique refinishing business might all qualify. The owners would probably continue to make jewelry, play jazz, or restore
antiques without making money, but they are trying to turn their hobbies into profitable businesses (or at least deduct
their hobby-related expenses or losses from their income to lower their tax bill!).
Deducting Hobby Losses From Your Income
For most business owners, losing money for more than a year or so is a cue to close up shop. But if you love what you're
doing, it might make sense for you to stick with your losing business even though it makes little or no money. That's
because an unprofitable business can be a tax shelter: If you have another source of income, you may be able to use the
losses from your hobby business -- including your expenses and depreciation on assets you purchase -- to offset your
other taxable income. Deducting these losses can not only lower the amount of income on which taxes are owed, but may
also drop you into a lower tax bracket.
The catch is that only bona fide businesses can deduct their losses from their other income -- you're not allowed to deduct
losses from your favorite activities, only from a legitimate, profit-motivated business. If the IRS decides that you are
indulging a hobby rather than trying to earn a profit, it won't allow you to deduct your business losses.

Example

Reza earns a salary as a chef in a local restaurant, and his wife Kay has no outside income. They file
a joint tax return. Kay has a passion for plants, and decides to try making a business of selling some
of the hundreds of plants she grows and propagates in her backyard greenhouse. After she spends
thousands of dollars on exotic plants, better lighting equipment, and permits, the greenhouse heater
goes on the fritz and many of her plants die. Her expenses for the year total $10,000, and she has
sold only $200 worth of plants.
The silver lining for Kay and Reza comes at tax time, when they deduct the $9,800 loss from their
joint taxable income of $65,000. By reducing their joint taxable income to $55,200, they not only are
taxed on less income, but their tax bracket is reduced from 25% to 15%.
Here's the catch: If Kay had not intended to make a profit -- that is, if she wasn't trying to run a
business -- the IRS would not have allowed Kay to use the loss to offset any income, except
against the $200 revenue she received from plant sales.

Of course, most entrepreneurs would much rather make money by earning a healthy profit rather than by taking tax
deductions because their business is losing money. And the savings made possible by a tax shelter do not always justify
continuing a marginal or losing business. But they definitely can make a difference when you're deciding whether or not it's
worth it to keep spending money on your hobby.
Proving That Your Hobby Is a Business
If you consistently use your business as a tax shelter, deducting your losses from your other income year after year,
you'll probably attract the attention of the IRS. Make sure that the IRS will consider you a real business in case you're ever
audited, before you start claiming deductions for the costs of your art projects or toy car collection.
The deciding factor in determining whether a business is legitimate is whether the activity is engaged in "for profit." In
other words, you must prove to the IRS that you're trying -- not necessarily succeeding -- to make a profit with your
venture. The IRS uses several different criteria for deciding whether or not your business truly has a profit motive.
One popular test for determining profit motive is called the "3-of-5" test. If your business makes a profit in any three out
of the past five consecutive years, it is presumed to have a profit motive. This means that if you claim a loss for the third
straight year after starting your business, you may be inviting an audit.
While the IRS gives a lot of weight to the 3-of-5 test, it is not conclusive. In other words, if you flunk the 3-of-5 test, you
still may be able to prove that your business is motivated by profit. You can use virtually any kind of evidence to show that
you're trying to make money.
Business cards, a well-maintained set of books, a separate business bank account, current business licenses and permits,
and advertising or other marketing efforts will all help to persuade an IRS auditor that your activity really is a business.
Complying With Local Business Rules
Many cities require every local business to obtain a business license, or tax registration certificate. Technically, this rule
applies to any money-making activity -- even if you don't intend to claim any federal or state tax deductions for your
hobby business. Also, if you sell goods (such as homemade jewelry), your sales will be subject to state sales taxes, which
means you'll have to apply for a "seller's permit."
In practice, many microbusinesses -- so tiny that the word "business" seems excessive -- might be able to fly under these
agencies' radar. But be aware that, depending on your local rules, you could be penalized if you're caught doing business
without the licenses or permits required by your state or local government. These penalties may include fines and any back
taxes that apply.
In addition, getting the necessary licenses and permits will help show the IRS that you really are running a business. For
more information, see Obtaining Licenses and Permits.
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Copyright 2006 Nolo
Paying Estimated Taxes
by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
Contractors and consultants don't have taxes withheld from their paychecks, but they have to pay estimated
taxes every quarter.
Now that you're an independent contractor, you won't have any taxes withheld from your pay -- and your take-home pay
will be substantially higher than that of an employee who earns a similar amount.
However, self-employed workers still have to pay taxes, just like everyone else. And they don't have the luxury of waiting
until April 15 to pay all of their taxes for the previous year -- the IRS wants its money faster than that. Independent
contractors have to pay tax on their estimated annual incomes in four payments, spread out over each year. These
payments are called estimated taxes and are used to pay income taxes and self-employment taxes (Social Security and
Medicare taxes).
Because of this estimated tax requirement, self-employed people need to budget their money carefully. If you don't set
aside enough of your earnings to pay your estimated taxes, you could face a huge tax bill on April 15 -- and possibly
penalties for not paying estimated taxes -- and have a tough time coming up with the money to cover it.
Who Must Pay Estimated Taxes?
If, like the vast majority of self-employed people, you are a sole proprietor (that is, you own your own business), you have
to pay estimated taxes if you expect to owe at least $1,000 in federal tax for the year.
However, if you didn't have to pay any taxes last year -- for example, because your business didn't make a profit or
because you weren't working -- you don't have to pay any estimated tax this year, no matter what you earn. This rule
applies only if you were a U.S. citizen or resident for the year and your tax return for the previous year covered the whole
12 months.
How Much Estimated Tax You Must Pay
You should figure out how much estimated tax to pay after completing your tax return for the previous year. Most people
want to pay as little estimated tax as possible, so they can earn interest on their money instead of handing it over to the
IRS. However, the IRS imposes penalties if you don't pay enough estimated tax. You can avoid these penalties by paying
the lesser of:
1. 90% of your total tax due for the current year, or
2. 100% of the tax you paid the previous year (or possibly more, if you're a high-income taxpayer).
When to Pay Estimated Tax
You usually have to pay estimated tax in four installments, starting on April 15. However, you don't have to start making
payments until you actually earn income. If you don't receive any income by March 31, you can skip the April 15 payment
and make only three payments for the year, starting on June 15. If you don't receive any income by May 31, you can skip
the June 15 payment as well, and so on.
Here are the due dates and periods covered for each installment payment:
Income Received for the Period Estimated Tax Due

January 1 through March 31 April 15

April 1 through May 31 June 15

June 1 through August 31 September 15

September 1 through December 31 January 15 of next year

How to Make Your Estimated Tax Payments


The IRS wants to make it easy for you to hand over your money, so the mechanics of paying estimated taxes are simple.
You file your federal estimated taxes by using IRS Form 1040-ES. This form contains instructions and four numbered
payment vouchers for you to send in with your payments.
If you did not pay estimated taxes last year, get a copy of Form 1040-ES from the IRS. You can get IRS forms by calling
800-TAX-FORM, visiting your local IRS office, or downloading them from the IRS website, at www.irs.gov. After you make
your first payment, the IRS should mail you a Form 1040-ES package with the preprinted vouchers.
Penalties for Underpaying Your Estimated Taxes
The IRS imposes a fine if you underpay your estimated taxes. You have to pay the taxes due plus a percentage penalty for
each day your estimated taxes went unpaid. This percentage is set by the IRS each year. In recent years, the penalty has
ranged from 6% to 8% annually.
This penalty is only a bit higher than the interest you'd have to pay on borrowed money. Many self-employed people
decide to pay the penalty at the end of the year rather than taking money out of their businesses during the year to pay
estimated taxes. If you decide to follow their lead, make sure you pay all of the taxes you owe for the year by April 15 of
the following year. If you don't, the IRS will tack on additional interest and penalties -- and quickly make it prohibitively
expensive to pay late.
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Copyright 2006 Nolo

Preserving Your Status as an Independent Contractor


by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
Follow these strategies to avoid being reclassified as an employee.
The IRS is always looking to reclassify independent contractors as employees of businesses they audit. (It gets more
money from employees than from contractors, who can deduct business expenses from their incomes. And it gets its
money faster from employees, who have to pay taxes every payday through payroll withholding.)
If you're reclassified as an employee, you'll suffer some consequences. For example, the hiring firm may decide not to use
you any more because it doesn't want to pay the additional expenses of treating you as an employee. And reclassification
as an employee could create additional tax burdens for you, if you have to forego some of the deductions to which you
were entitled as an contractor.
So how do you make sure that the IRS and other government agencies (such as a state taxing authority or unemployment
agency) classify you as an independent contractor? If you consistently follow the guidelines below, you'll have a good
chance of surviving an audit with your contractor status intact.
Retain Control of Your Work
The most fundamental difference between employees and independent contractors is that employers have the right to tell
their employees what to do and how to do it. Never permit a hiring firm to supervise or control you as if you were one of
its employees. It's perfectly okay for the hiring firm to give you detailed guidelines or specifications for the results it
expects from you. But how you go about achieving those results should be entirely up to you.
Following these guidelines will help you show that you are the one in charge:
1. Don't ask for or accept instructions or orders from the hiring firm about how to do your job.
2. Don't ask for or receive training from the hiring firm.
3. Don't let the hiring firm dictate your working hours, although the firm may give you a deadline for completing
your work.
4. Decide where you will do the work, unless the work has to be performed on the hiring firm's premises.
5. Decide whether to hire assistants to help you; if you hire workers, pay and supervise them yourself.
Show Opportunities for Profit and Loss
Because they run their own businesses, independent contractors have the opportunity to earn profits or suffer losses. If
you run absolutely no risk of loss, you're probably not really an independent contractor. The best way to meet this test is
to have recurring business expenses, such as office rent, equipment, and possibly even salaries for assistants. This
demonstrates that you could face a loss if you don't find enough work.
You can also show an opportunity for profit or loss by charging your clients a set price for a specific project, rather than
billing by the hour or day. If the project price exceeds your expenses, you'll make money; if you charge too little, you'll
come out in the red.
Look Like an Independent Business
Take steps to make yourself look like an independent businessperson. Here are a few things you can do to cultivate this
image:
1. Use a fictitious business name instead of your own name.
2. Maintain a separate bank account for your business.
3. Obtain all necessary licenses and permits for your profession.
4. Carry business insurance.
5. Don't accept employment benefits -- such as health insurance, paid vacations, or pension benefits -- from your
clients; instead, charge your clients enough to purchase these items yourself.
Make Your Services Widely Available
Independent contractors usually offer their services to the general public, not just to one person or company. Government
auditors will be impressed if you market your services to the public. Here are some ways to do this:
1. Obtain a business card and letterhead.
2. Hang out a sign advertising your services.
3. Maintain listings in business and telephone directories.
4. Attend trade shows and similar events.
5. Join professional organizations.
6. Advertise in newspapers, trade journals, and magazines.
7. Mail brochures or other promotional materials to prospective clients.
8. Phone potential clients to drum up business.
Have Multiple Clients
Government auditors will rarely question the status of an independent contractor who works for three or four clients at a
time. If the nature of your work requires you to work full time for one client for a while, try to work for other clients over
the course of a year. For example, you might work for one client for six months, then work for another client for the rest of
the year.
Use Written Agreements
Use written independent contractor agreements for all but the briefest, smallest projects. Among other things, the
agreement should make clear that you are providing a service as an independent contractor and that the hiring firm does
not have the right to control the way you do your work. A written service agreement alone won't definitively prove that
you are an independent contractor, but it will help convince government auditors of your intent. For tips on creating
service agreements, see Use Written Service Contracts for Your Clients.
Work Off Site
If your work can be done anywhere, don't do it anywhere at the client's premises. This shows that you are not subject to
the client's control.
Of course, there are some types of work that you will have to do at the hiring firm's premises. For example, if you are
hired to lay carpet or paint an office, you will have to work at the client's workplace.
Don't Accept Employee Status
Some clients will only hire you as an employee, not as an independent contractor. This is a particularly common problem
for those who work for high technology companies. Because the government closely scrutinizes these firms' hiring
practices, and because of special IRS rules pertaining to these workers, high tech companies are often wary of using
independent contractors.
You may be tempted to let one hiring firm classify you as an employee, particularly if other firms are willing to hire you as
an independent contractor. But this is a bad idea -- it will encourage the IRS to classify you as an employee for all of your
jobs.
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Copyright 2006 Nolo

Use Written Service Contracts for Your Clients


From the Nolo Business & Human Resources Center
Independent contractors: Avoid trouble by putting client agreements in writing.
When you agree to perform services for a client, you are entering into a legal contract -- you promise to do the work, and
the client promises to pay you for it. Many independent contractors rely on handshake agreements with their clients.
Instead of writing down the deal, the contractor and client discuss what the contractor will do and what the client will pay,
and that’s the end of the story.
Until the deal falls apart, that is. If the client refuses to pay, insists that you agreed to perform more or different work,
says that you agreed to charge less than your usual rate, or otherwise won’t live up to his or her end of the bargain as you
believed it to be, you’re in a bind. You could try to convince a court that your version of the contract is correct, but it will
be your word against the client’s, and there’s no telling whom a judge or jury will believe. Whether the client really does
remember the agreement differently than you or is intentionally trying to rip you off, you don’t want to end up in this
situation.
Fortunately, there’s an easy way to avoid these problems: Always get your agreements in writing. Using written contracts
will help you prevent misunderstandings, clearly define the expectations you and the client have about the job, and prove
your case in court, should it come to that.
What’s more, a written client agreement can help you establish that you are an independent contractor, not the client’s
employee -- which will be very useful if the IRS or another government agency questions your status.
What Service Contracts for Clients Should Include
A written client agreement should cover at least these topics:
1. the services you will perform
2. how much you will be paid
3. how and when you will be paid (for example, will you receive a set fee or an hourly rate, will you be paid up
front, at completion, or in installments, will the client have to pay a fee for late payments, and so on)
4. who will be responsible for paying expenses (most ICs pay their own)
5. who will provide materials, equipment, and office space (again, most ICs provide their own, but there are
exceptions)
6. how long the agreement will last
7. the circumstances in which you or the client have the right to terminate the agreement, and
8. information relating to your independent contractor status -- that is, that you are an independent contractor, that
you have all of the necessary permits and licenses to do the work, that you will pay your own state and federal taxes, and
that you have your own liability insurance.
There are also a few standard legal provisions you should include, such as a statement that you and the client are not
partners in business and that you and the client have no outside agreements about the deal except what’s been included in
the contract. You can find language for all of these provisions (and many more) in Consultant and Independent Contractor
Agreements and Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants, both written
by Stephen Fishman and published by Nolo.
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Copyright 2006 Nolo

Getting Clients to Pay Up


by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
Getting work is one thing, getting paid is another. Here's some advice about what to do if a client won't, or
can't, pay.
You completed your latest project on time, sent an invoice to your demanding client, and are eagerly awaiting
payment . . . and waiting . . . and waiting . . . and waiting. Does this scenario sound all too familiar?
The sad fact is that even the most seasoned independent contractors (ICs) often have difficulty getting paid. Some clients
feel free to pay late; others never pay at all.
Businesses usually pay their employees like clockwork. They know that if they don't, the employees can complain to their
state labor department, which can impose fines and otherwise make life miserable for the business. However, this is not
the case when you're self-employed. There is no government agency that will help you get your money. It's entirely up to
you to take whatever steps are appropriate and necessary to get your clients to pay up.
What's worse, many clients are aware of these hard facts of life and will purposely pay you late or not at all because they
know many self-employed people simply don't have the will or know-how to collect what they're owed. You don't have to
accept this type of unethical behavior. There are many legal methods available to get deadbeat clients to pay.
How to Demand Payment
Your first step in collecting an unpaid bill should be to send a statement or a collection letter requesting payment of the
invoice. (Quicken Legal Business Pro provides 30-day, 60-day, and 90-day collection letters for this purpose.) Some firms
routinely wait 60 or 90 days to pay bills because of cash flow problems of their own. If your clients follow this practice,
sending a routine collection letter might prompt them to put the check in the mail.

Get Personal
If letters don't work, it's time to get personal. It's a lot harder to withhold payment from someone you know than from a
stranger. For this reason, you shouldn't rely solely on successive collection letters. Instead, telephone the client. If you're
dealing with a large company, you may have to first contact someone in the accounts payable or purchasing department.
But if they don't prove helpful, don't hesitate to call higher-ups, including the president of the company.
Explain that cash flow is important to your business and that you can't afford to carry this unpaid receivable any longer. If
phone calls don't work, make an appointment to personally visit whoever is in charge of paying you.

Be Persistent
When it comes to collecting debts, the squeaky wheel usually gets paid first. A client who is struggling financially and has
only enough money to pay one creditor will likely pay the one who has made the most fuss. However, don't lose your
temper, make threats, or otherwise harass the client. This kind of behavior can get you into legal trouble.
If letters, phone calls, and personal meetings don't get you what you're owed, you have a few options.
Formal Methods of Getting Money From Your Client
If you know the client has the money to pay you, or you think that he or she will have the money some time in the future,
don't give up. There are a number of legal means available to collect debts.

Sue the Client in Small Claims Court


If the debt is not too large, the first option you should consider is suing the client in small claims court. All states have
courts called small claims courts that are set up to resolve disputes involving relatively modest amounts of money. The
limit is normally between $2,000 and $7,500, depending on your state. If you're owed more than the limit, you can still
sue in small claims court and waive (that is, give up your right to collect) the amount that exceeds the limit.
Small claims court is particularly well suited to collecting small debts because it's inexpensive and fairly quick. In fact, debt
collection cases are by far the most common type of cases heard in small claims court. And you don't need a lawyer to
bring your case. Indeed, a few states -- including California, New York, and Michigan -- don't allow anyone to be
represented by a lawyer in small claims court.
If you file a suit in small claims court and your client doesn't show up when he or she is supposed to, you'll win by default.
A substantial percentage of clients don't contest claims for unpaid fees in court because they know that they owe the
money and can't win.
.

Sue the Client in Superior Court


If the client owes you substantially more than the small claims court limit for your state, you may wish to sue in a formal
state trial court, usually called the municipal court or superior court. Debt collection cases are usually very simple, so you
can often handle them yourself or hire a lawyer for the limited purpose of giving you advice on legal points or helping with
strategy. In truth, few collection cases ever go to trial. Usually, the defendant either agrees to settle before trial or fails to
show up in court (which gives you a default judgment for the amount owed).

Take the Client to Arbitration


Before you sue the client in court, be sure to look at your client agreement to see whether it contains an arbitration clause.
This provision -- usually entitled "arbitration" -- requires you to submit any disputes with the client to arbitration, rather
than going to court.
If your contract has such a clause, you'll be barred from suing the client in small claims court or any other court. This is
not necessarily a bad thing. Arbitration is similar to small claims court in that it's intended to be speedy, inexpensive, and
informal. The main difference is that an arbitrator, not a judge, rules on the case. An arbitrator's judgment can be entered
with a court and enforced just like a regular court judgment.
When to Give Up
If the client has gone out of business or vanished from the face of the earth, or you know that he or she will likely never be
able to pay you anything (either now or in the future), your best option may be to write off the debt. As the old sayings
go, you can't get blood out of a turnip -- and you shouldn't throw good money after bad.
Unfortunately, if your business provides only services, you can't tax a tax write-off for the bad debt. The rationale behind
this rule is that it would be too easy for independent contractors to inflate bills and claim large deductions for bad debts
that were never really incurred. (If any part of the bad debt is for goods however, you can deduct the cost of goods that
the client received but never paid for.
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Copyright 2006 Nolo

How Much Should You Charge for Your Service?


by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
How to price your services to attract business and make a profit.
Independent contractors (ICs) can charge for their services in a variety of ways, such as a fixed amount for an entire
project, an hourly fee, or a sales commission.
No matter how you bill clients, however, you first need to figure out how much to charge per hour -- even if you charge a
fixed fee for the whole project. You can't determine how much your fixed fee should be unless you know roughly how
many hours the job will take and what you need to earn per hour to make it worth your while.
If you're experienced in your field, you probably already know what to charge because you are familiar with market
conditions. However, if you're just starting out, you may have no idea what you can or should charge. If you're in this
boat, try using a two-step approach to determine your hourly rate:
1. Calculate what your rate should be based on your expenses.
2. Investigate the marketplace to see if you should adjust your rate up or down.
Calculate Your Hourly Rate
Business schools teach a standard formula for determining an hourly rate: Add together your labor and overhead costs,
add the profit you want to earn, then divide the total by your hours worked. This is the minimum you must charge to pay
your expenses, pay yourself a salary, and earn a profit. Depending on market conditions, you may be able to charge more
for your services -- or you might have to get by on less.
To determine how much your labor is worth, pick a figure for your annual salary. This can be what you earned for doing
similar work when you were an employee, what other employees earn for similar work, or how much you'd like to earn (as
long as your goal is reasonable).
Next, compute you annual overhead. Overhead includes all of the costs you incur to do business -- for example:
1. telephone expenses
2. office equipment and furniture
3. rent and utilities
4. stationery and supplies
5. postage and delivery costs
6. clerical help
7. business insurance
8. business-related meals and entertainment
9. travel expenses
10. professional association memberships
11. legal and accounting fees, and

12. advertising and marketing costs -- for example, the cost of a yellow pages ad or brochure.

Overhead also includes the cost of your fringe benefits, such as medical insurance, disability insurance, and retirement
benefits, as well as your income taxes and self-employment taxes.
If you're just starting out, you'll have to estimate these expenses or ask other ICs in the same field what they pay in
overhead, then use that amount in your calculations.
You're also entitled to earn a profit over and above your salary and overhead expenses. Your salary does not count
as profit; it's one of the costs of doing business. Profit is the reward you get for taking the risks of being in business for
yourself. It also provides money to expand and develop your business. Profit is usually expressed as a percentage of total
costs. There is no standard profit percentage, but a 10% to 20% profit is common.
Finally, you need to determine how many hours you'll work and get paid for during the year. Assume you'll work a 40-hour
week for purposes of this calculation, although you may end up working more than this. If you want to take a two-week
vacation each year, you'll have a maximum of 2,000 billable hours per year (50 weeks x 40 hours). If you want to
take more vacation, you'll have fewer billable hours.
However, you'll probably spend at least 25% to 35% of your time on tasks that you can't bill to clients, such as
bookkeeping and billing, drumming up business, and upgrading your skills. This means you'll probably have only 1,300 to
1,500 hours for which you can get paid each year, if you still want that two-week vacation.

Example

Sam, a self-employed website designer, earned $50,000 per year as an employee and feels that he
should receive at least the same annual salary as an IC. He estimates that his annual overhead will
be about $20,000 per year. He wants to earn a 10% profit and estimates that he'll work about 1,500
billable hours each year. Sam determines his hourly rate as follows:
1. He adds his salary and overhead together: $50,000 + $20,000 = $70,000.
2. He then multiplies this total by his 10% profit margin and adds this amount to his salary
and overhead: 10% of $70,000 = $7,000; $70,000 + $7,000 = $77,000.
3. Finally, he divides the total by his annual billable hours to arrive at his hourly rate:
$77,000 ÷ 1,500 = $51.33.
Sam rounds his hourly rate off to $50. However, depending on market conditions, Sam might be able
to charge more -- or have to accept less.

Investigate the Marketplace


It's not enough to calculate how much you'd like to earn per hour: You also need to determine whether this figure is
realistic. This means that you'll have to go out into the world and find out what other ICs are charging for similar services
-- and what your potential clients are willing to pay. There are many ways to gather this information.
1. Contact a professional organization or trade association for your field. It may be able to give you good
information on what other ICs are charging in your area.
2. Ask other ICs what they charge. You can communicate pricing concerns with other ICs over the Internet.

3. Talk to potential clients and customers -- for example, attend trade shows and business conventions.

You may discover that your ideal hourly rate is higher than what other ICs are charging in your area. However, if you're
highly skilled and performing work of unusually high quality, don't be afraid to ask for more than other ICs with lesser
skills charge. Lowballing your fees won't necessarily get you business. Many potential clients believe that they get what
they pay for -- and are willing to pay more for quality.
One approach is to start out charging a fee that is at the lower end of the spectrum for ICs performing similar services,
then gradually increase it until you start meeting price resistance. Over time, you should be able to find a payment method
and fee structure that enable you to get enough work while adequately compensating you for your services.
Make a Written Fee Agreement
Once you decide what you will charge, make sure you enter into a written fee agreement with every client. (If you choose
to charge a fixed fee for a project, multiply your estimated hours for a job by your chosen hourly rate.)
.
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Copyright 2006 Nolo
Insuring Your Home Business
From the Nolo Business & Human Resources Center
If you use your home for business, you may need additional insurance coverage.
If you operate a business from your home, it's important that you obtain adequate insurance coverage for your business
equipment and transactions, just as if you had a separate office. Even a small home enterprise needs full protection
against the risks of doing business.
Homeowners' or Renters' Insurance Policies
Do not rely exclusively on your regular homeowners' or renters' policy to protect your home business, at least without
checking first with the insurance company. Many of these policies do not cover business use of a home, which means that
you probably won't be protected against losses relating to your business. For example:
1. After your computer is stolen, you may find out that it's not covered by your homeowner's policy because
business property is excluded.
2. After your house burns down, you may find that your fire coverage is void because you didn't tell the insurance
company that you were using your home for business.
3. After a delivery person slips on your front porch and breaks his back, you may find that you're not covered for
injuries associated with business deliveries.
It's easy to avoid these nasty surprises. Sit down with your insurance agent and fully disclose your planned business
operations. It's relatively inexpensive to add riders to your homeowner's policy to cover normal business risks.
Replacement Cost
When you talk to your insurance agent and/or review policy provisions, make sure that the policy will pay you the full
replacement cost for your business equipment and furnishings -- not the (much lower) value of your used office property.
Figure out how much it would cost to replace your business property after a fire, theft, or other disaster. Don't overlook
things such as the specialized business software you run on your computer. Depending on the nature of your home
business, replacing equipment and furniture could run into the many thousands of dollars.
Ask your insurance agent what it will cost to insure this valuable property, allowing for a good-sized deductible to keep
costs down.
Liability Insurance
Your homeowners' or renters' insurance may not adequately protect you from liability to business visitors. Accidents --
such as people getting hurt when they trip and fall -- are more likely to happen at home than in a well-planned office
building. Your homeowners' policy probably protects you if you're sued by a social guest or someone at your home for a
nonbusiness purpose -- a florist's truck driver delivering flowers or the meter reader who's checking on gas usage.
Most homeowners' policies, however, do not cover injuries to a business associate, employee, customer, or delivery person
who is hurt on your property. To cover these risks, you may need a rider to your homeowners' policy or a commercial
general liability policy.
Also, think about the extent of your general liability coverage, should you accidentally injure someone or damage their
property while away from home on business. You may need a rider or special policy to cover this risk.
Certain types of businesses, home-based or not, need special kinds of insurance. If you render professional services, look
into professional liability insurance. If you manufacture, distribute, or sell products that may hurt someone, you might
consider products liability insurance. And if you have employees, you'll need to provide workers' compensation coverage.
Automobile Insurance
Of course, you'll need automobile liability insurance for cars or trucks that you use only for business. But if you do business
in your personal vehicle, make sure that your car insurance covers injuries that occur while you're on business errands.
You may have to switch companies to find insurance that will cover business-related driving.
If you have employees who use their own cars for work errands or deliveries, you'll want to consider getting special
insurance (called employers' non-owned automobile liability insurance).
Policies for Both Home and Business
Several insurance companies have developed special policies that cover both your home and a business run from your
home. Typically, these policies cover your computer equipment and other business property -- whether used in your house
or elsewhere -- and protect you from business liability lawsuits and loss of income.
These home/business policies can be less expensive than either adding riders to your home insurance or buying separate
policies for home and business. But check the coverage carefully, as these policies tend to primarily address home offices
and may not adequately insure you if, for example, you're a small manufacturer or a wholesaler who stores inventory in
your home.
.
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Copyright 2006 Nolo

Hobby Business Tax Rules


From the Nolo Business & Human Resources Center
Be ready to prove that your hobby is a business if you want to write off your hobby losses.
Often a person's hobby or sideline business is a labor of love rather than a reliable source of income. This is most often the
case when the business owner or freelancer has other means of financial support -- such as a regular job or a working
spouse -- that effectively underwrites the microbusiness. These types of tiny businesses are usually run from home
(renting an office would be too expensive) and are often based on semi-recreational activities near and dear to the owner,
which has earned them the nickname "hobby businesses."
There are as many types of hobby businesses as there are hobbies. A basement jewelry studio, a jazz band for hire, or an
antique refinishing business might all qualify. The owners would probably continue to make jewelry, play jazz, or restore
antiques without making money, but they are trying to turn their hobbies into profitable businesses (or at least deduct
their hobby-related expenses or losses from their income to lower their tax bill!).
Deducting Hobby Losses From Your Income
For most business owners, losing money for more than a year or so is a cue to close up shop. But if you love what you're
doing, it might make sense for you to stick with your losing business even though it makes little or no money. That's
because an unprofitable business can be a tax shelter: If you have another source of income, you may be able to use the
losses from your hobby business -- including your expenses and depreciation on assets you purchase -- to offset your
other taxable income. Deducting these losses can not only lower the amount of income on which taxes are owed, but may
also drop you into a lower tax bracket.
The catch is that only bona fide businesses can deduct their losses from their other income -- you're not allowed to deduct
losses from your favorite activities, only from a legitimate, profit-motivated business. If the IRS decides that you are
indulging a hobby rather than trying to earn a profit, it won't allow you to deduct your business losses.

Example

Reza earns a salary as a chef in a local restaurant, and his wife Kay has no outside income. They file
a joint tax return. Kay has a passion for plants, and decides to try making a business of selling some
of the hundreds of plants she grows and propagates in her backyard greenhouse. After she spends
thousands of dollars on exotic plants, better lighting equipment, and permits, the greenhouse heater
goes on the fritz and many of her plants die. Her expenses for the year total $10,000, and she has
sold only $200 worth of plants.
The silver lining for Kay and Reza comes at tax time, when they deduct the $9,800 loss from their
joint taxable income of $65,000. By reducing their joint taxable income to $55,200, they not only are
taxed on less income, but their tax bracket is reduced from 25% to 15%.
Here's the catch: If Kay had not intended to make a profit -- that is, if she wasn't trying to run a
business -- the IRS would not have allowed Kay to use the loss to offset any income, except
against the $200 revenue she received from plant sales.

Of course, most entrepreneurs would much rather make money by earning a healthy profit rather than by taking tax
deductions because their business is losing money. And the savings made possible by a tax shelter do not always justify
continuing a marginal or losing business. But they definitely can make a difference when you're deciding whether or not it's
worth it to keep spending money on your hobby.
Proving That Your Hobby Is a Business
If you consistently use your business as a tax shelter, deducting your losses from your other income year after year,
you'll probably attract the attention of the IRS. Make sure that the IRS will consider you a real business in case you're ever
audited, before you start claiming deductions for the costs of your art projects or toy car collection.
The deciding factor in determining whether a business is legitimate is whether the activity is engaged in "for profit." In
other words, you must prove to the IRS that you're trying -- not necessarily succeeding -- to make a profit with your
venture. The IRS uses several different criteria for deciding whether or not your business truly has a profit motive.
One popular test for determining profit motive is called the "3-of-5" test. If your business makes a profit in any three out
of the past five consecutive years, it is presumed to have a profit motive. This means that if you claim a loss for the third
straight year after starting your business, you may be inviting an audit.
While the IRS gives a lot of weight to the 3-of-5 test, it is not conclusive. In other words, if you flunk the 3-of-5 test, you
still may be able to prove that your business is motivated by profit. You can use virtually any kind of evidence to show that
you're trying to make money.
Business cards, a well-maintained set of books, a separate business bank account, current business licenses and permits,
and advertising or other marketing efforts will all help to persuade an IRS auditor that your activity really is a business.
Complying With Local Business Rules
Many cities require every local business to obtain a business license, or tax registration certificate. Technically, this rule
applies to any money-making activity -- even if you don't intend to claim any federal or state tax deductions for your
hobby business. Also, if you sell goods (such as homemade jewelry), your sales will be subject to state sales taxes, which
means you'll have to apply for a "seller's permit."
In practice, many microbusinesses -- so tiny that the word "business" seems excessive -- might be able to fly under these
agencies' radar. But be aware that, depending on your local rules, you could be penalized if you're caught doing business
without the licenses or permits required by your state or local government. These penalties may include fines and any back
taxes that apply.
In addition, getting the necessary licenses and permits will help show the IRS that you really are running a business. For
more information, see Obtaining Licenses and Permits.
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Copyright 2006 Nolo

Zoning Rules for Home Businesses


From the Nolo Business & Human Resources Center
Municipalities govern whether you can run a business out of your home.
Your city or county planning or zoning department has probably established zones for stores and offices (commercial
zones), factories (industrial zones), and houses (residential zones). In some residential areas -- especially in affluent
communities -- local zoning ordinances absolutely prohibit all types of business. In the great majority of municipalities,
however, residential zoning rules allow small, non-polluting home businesses, as long as any home containing a business is
used primarily as a residence and the business activities don't negatively affect neighbors.
Read Your Local Ordinance
To find out whether residential zoning rules allow the home-based business you have in mind, get a copy of your local
ordinances from your city or county clerk's office, the city attorney's office, or your public library. (Many cities also make
their ordinances available online -- check your city's home page to find out whether it has joined the Internet revolution.)
As you read the ordinance, keep in mind that zoning ordinances are worded in many different ways to limit business
activities in residential areas. Some are vague, allowing "customary home-based occupations." Others allow homeowners
to use their houses for a broad list of business purposes (for example, "professions and domestic occupations, crafts, or
services"). Still others contain a detailed list of approved occupations, such as "law, dentistry, medicine, music lessons,
photography, or cabinetmaking."
Ask the Planning Department
If you read your ordinance and still aren't sure whether your business is okay, you may be tempted to ask for a meeting
with zoning or planning officials. But it can be a mistake to call attention to your home business plans until you are sure
that you'll meet the requirements. One way to cope with this problem is to have a friend who lives nearby, but who doesn't
plan to open a home-based business, make detailed inquiries.
Appeal If Necessary
In many cities and counties, if a planning or zoning board says that you can't run your business from your home, you can
appeal -- often to the city council or county board of supervisors. While this can sometimes be an uphill battle, it is likely to
be less so if you have the support of all affected neighbors.
You may also be able to get an overly restrictive zoning ordinance amended by your municipality's governing body. For
example, in some communities, people are working to amend ordinances that prohibit home-based businesses entirely or
only allow "traditional home-based businesses," to permit those that rely on the use of computers and other high tech
equipment.

Planned Development Rules (CC&Rs)

In an effort to protect residential property values, most subdivisions, condos, and planned unit
developments create special rules -- called Covenants, Conditions, and Restrictions (CC&Rs) -- that
govern many aspects of property use.
CC&Rs pertaining to home-based businesses are often significantly stricter than those found in city
ordinances. As long as the rules of your planned development are reasonably clear and consistently
enforced, you must follow them. Because many planned developments enforce their rules more
zealously than municipalities do, it's essential that you make sure your home-based business is in full
compliance.

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Copyright 2006 Nolo

Home & Hobby Businesses: Overview


From the Nolo Business & Human Resources Center
Improve your chances of success when your hobby starts becoming a business.
Home businesses are booming, and craft and hobby businesses are flourishing as well. For example, U.S. craftwork is a
$13 billion dollar industry and crafts artisans now average $76,000 in annual sales. That’s great news for artisans,
entrepreneurs, and even Uncle Sam, who also makes money when you do. And when it comes to taxes, the tax code is full
of deductions for businesses -- and you are entitled to take them whether you work from home or from a studio space.
Besides the financial opportunity, there are many reasons to pursue a home or hobby business. Perhaps you seek artistic
freedom or are driven by a desire to love what you do. Maybe your family requires schedule flexibility or for you to travel
less. Possibly there’s just no more shelf space for your ceramic creations and your spouse thinks it is time for you to start
sharing them with the world. Whatever your goals, there are some basic things you can do to improve your chances of
success, and make sure you’re running a safe and legal business.

1. Get up to speed on business basics. If you’re taking money for your art, you’re in business. Make the most of
what you earn by operating your business like... a business. Nolo's book, Whoops! I’m in Business, will get you going.

2. Write a business plan. It doesn’t have to be complex or formal, but putting your ideas on paper can help you
test their viability and improve your chances for success. It can also give you a clear idea of how you want to work with
sales channels and if you need professional advisors or potential helpers such as contractors or employees. Nolo’s How to
Write a Business Plan will give you coaching and templates. If you’re already in business, a plan can still help you fine tune
your business and improve your results.

1. Have a clear plan for funding. Whether you’re financing your efforts out of pocket or require investment to
expand, you need to know where your start-up capital will come from (if you need it), whether you will be servicing a debt,
and what resources you can call upon in the future. If you’re seeking funding, start with friends, family and the people in
your community. If you must tap into retirement accounts, read Nolo's IRAs, 401(k) & Other Retirement Plans: Taking
Your Money Out to find out how to minimize penalties.

2. Know how you’re going to bring in revenue. How will you sell your work? Will certain services (like credit
card processing) enhance your ability to sell? Is there a distribution network available to you? Will being online, attending
events like trade or craft shows, licensing your work, or other opportunities boost your revenue? Are their industry norms
for selling that affect your business (such as returns policies or payment schedules)? Nolo's Your Crafts Business will help
you plan and prepare and coaches you on distribution alternatives.

3. Keep your money. The fastest way to boost your profits is to keep what you earn. Deductions can help you
reduce your taxable income to a very low number, even to below zero in your first year or two of operation. Instant help is
available from Deduct It! and Tax Savvy for Small Businesses.
1. Get the right setup for your business. If you’re not sure what business structure will give you the most
advantages, check out LLC or Corporation? How to Choose the Right Form for Your Business. If you want to form a
partnership, you need The Partnership Book to make sure your business is protected in the future.

2. Make sure you have the right workspace. What are the space needs of your hobby/business? Do you require
storage space? Industrial strength refrigeration? Extra power? Two sewing machines? A quiet place to make uninterrupted
phone calls? Can you effectively work from your home or do you need to get studio or office space? If you’re renting space,
be sure to read Negotiate the Best Lease for Your Business. If you’re working from home, you can save a lot of money with
Home Business Tax Deductions: Keep What You Earn.

3. Get the proper licenses and permits. Depending on the type of business you start, you may need to get a
permits and occupational license from your city or state. Many cities and counties require every business -- even single-
owner, home-based operations -- to get a business license (a.k.a. tax registration). You may also have to get a sales tax
permit (often called a seller's permit) from your state.

1. Protect your intellectual property assets. When you name a product, or your business, you’re often taking
the first step to building a brand. Even though you may not care too much about the names you choose, protecting your
brand will be important later. Your brand can become one of your most important assets in building, and even selling, your
business. And if you’re a creative artist, your work product itself -- designs, writings, you name it -- need protection. Start
with Trademark: Legal Care for Your Product or Business Name and The Copyright Handbook.
While this list may seem intimidating, don’t let it scare you. These are common needs for any business and there’s plenty
of help to be found to deal with them.
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Copyright 2006 Nolo

The Home Office Tax Deduction


From the Nolo Business & Human Resources Center
Running a business from home can help you lower your tax bill.
When you use part of your home for business, you may be able to deduct expenses for what the IRS calls the "business
use of your home." If you meet the technical requirements of the tax law, you should be able to deduct a percentage of
many of the costs of running your home, such as utilities, rent, insurance, depreciation, mortgage interest, real estate
taxes, and some casualty losses, repairs, and improvements (if they relate to the part of the house you use for business).
The home office deduction is available to renters and homeowners alike. It is available for office space and other areas you
use for business in your home -- such as a studio, workshop, or garage. And according to the IRS, your "home" can be a
house, condo, or apartment unit -- or even a mobile home or boat, as long as you can cook and sleep there. However, you
must meet two tax law requirements to qualify for the home office deduction:
Requirement #1: You must regularly use part of your home exclusively for a trade or business.
Requirement #2: You must also be able to show at least one of the following:
1. You use your home as your principal place of business.
2. You meet patients, clients, or customers at home.
3. You use a separate structure on your property exclusively for business purposes.
We'll explain these requirements in turn below.

Ordinary business expenses are deductible even if you don't qualify for the home office deduction. If you
don't meet the rules above, you can still deduct ordinary and necessary business expenses that arise at your home --for
instance, long-distance phone calls, a separate business telephone line, and the cost of office supplies and equipment. The
above IRS rules apply only to home-connected expenses such as utilities, rent, depreciation, home insurance, mortgage
interest, real estate taxes, and repairs.
Regular and Exclusive Use
To take deductions for home-related expenses, you must regularly use part of your home exclusively for your trade or
business.
Regular use. The IRS doesn't offer a clear definition of regular use -- only that you must use a part of your home for
business on a continuing basis, not just for occasional or incidental business. You can probably meet this test by working a
couple of days a week from home, or a few hours each day.
Exclusive use. Exclusive use means that you use a portion of your home only for business. If you use a room of your
home for your business and also for personal purposes, you don't meet the exclusive use test. However, you can set aside
a portion of a larger room to be used only for business, as long as your personal activities don't stray into it.

Example

Brook, a lawyer, uses a den in his home to write legal briefs and prepare contracts. He also uses the
den for poker games and hosting a book club. Because he uses the den for both business and
pleasure, Brook can't claim business deductions for using the den.
Marvin has a den he uses only for business. He also puts a business calendar, desk, and computer in
his kitchen, but continues to cook and eat there as well. Marvin can claim business deductions for the
den, but not the kitchen.

There are two exceptions to the exclusive use rule: You don't have to meet the exclusive use test if you use part of your
home to store inventory or product samples, or if you run a qualified day care facility at your home. (The storage
exception is discussed just below. For the day care rules, check IRS Publication 587, Business Use of Your Home, at
www.irs.gov.)
Storing inventory or product samples at home. If you store inventory or samples at home, you can deduct expenses
for the business use of your home, whether or not you use the storage space exclusively for business.
There are two limitations, however: First, you won't qualify for the deduction if you have an office or other business
location outside of your home. Second, you have to store the products in a particular place -- your garage, for example, or
a closet or bedroom. It's okay to use the storage space for other purposes as well, as long as you regularly use it for
storing inventory or samples.

Example

Jim sells heating and air conditioning filters to small businesses. His home is the only fixed location of
his business. Jim regularly stores his inventory of filters in half of his basement. He sometimes uses
the same area for working on his racing bikes. Jim can deduct the expenses for the storage space,
even though he doesn't use that part of his basement exclusively for business.

Finally, the home office deduction is available only if you are running a bona fide business. If the IRS decides that you are
indulging a hobby rather than trying to earn a profit, it won't let you take the home office deduction.
Principal Place of Business
In addition to using part of your home regularly and exclusively for a business, your home must be your "principal place of
business." If you conduct your business only from home, then you meet this requirement. But if you have more than one
business location (including your home) for a single trade or business, you must determine whether your home is your
principal place of business for that enterprise.
Your home automatically qualifies as your principal place of business if both of the following are true:
1. You conduct the administrative or management activities of your business from home.
2. You have no other fixed location where you conduct those activities.

Example

Ellen, a wallpaper installer, performs services for clients in their homes and offices. She also has a
home office that she uses regularly and exclusively to keep her books, arrange appointments, and
order supplies. Ellen is entitled to deduct home office expenses for that part of her home (assuming
she also satisfies the "regular and exclusive use" rule, above).

In other words, your home doesn't have to be the place where you generate most of your business income. It's enough
that you regularly use it for tasks such as keeping your books, scheduling appointments, doing research, and ordering
supplies. As long as you have no other fixed location where you do these things -- for example, an outside office -- you
should be able to take the deduction.
Even if your home is not your principal place of business or you have another location, there are two other ways to fulfill
the principal place of business requirement:
You meet clients or customers at home. If you regularly use part of your home to meet with clients, customers, or
patients, you may qualify for the deduction. Doing so even one or two days a week is probably sufficient. You can use the
business space for other business purposes, too -- doing bookkeeping, for example, or other business paperwork -- but
you'll lose the deduction if you use the space for personal purposes, such as watching videos.
Maintain an appointment book in which you carefully note the name of the client or customer and the date and time of
each meeting at your home. Save these books for at least three years. These logs will document your business use of your
home if your tax return is audited by the IRS.
You use a separate building for your business. You can deduct expenses for a separate, freestanding structure that
you use regularly and exclusively for your business. This might be a studio or a converted garage or barn, for example.
The structure doesn't have to be your principal place of business or a place where you meet patients, clients or customers.
But be sure you use the structure only for your business: You can't store garden supplies there or use it for the monthly
meeting of a club.
How to Claim the Home Office Deduction
If you qualify for the home office deduction, you must figure the amount of your deduction on IRS Form 8829, Expenses
for Business Use of Your Home. (You can find this and other tax forms at the IRS website, www.irs.gov.) Then you enter
the total amount of the deduction on Schedule C, Profit or Loss from Business. Attach both Form 8829 and Schedule C to
your Form 1040 tax return.
Be ready to prove to the IRS that you are entitled to take the home office deduction. Here are some steps you can take to
help establish your legal right to deduct home office expenses:
1. Photograph your home office and draw a diagram showing the location of the office in your home. Keep this
information in your tax folder.
2. Have your business mail sent to your home.
3. Use your home address on your business cards and stationery and in all business ads.
4. Get a separate phone line for the business.
5. Have clients or customers visit your home office -- and keep a log of those visits.
6. Keep track of the time you spend working at home.
For more information on the home office deduction as well as many other deductions for small business owners should
take, see Home Business Tax Deductions: Keep What You Earn, by Stephen Fishman (Nolo).
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Copyright 2006 Nolo

Raising Money From Family and Friends


by Asheesh Advani
From the Nolo Business & Human Resources Center
Use the same type of financing that helped Wal-Mart, Subway, and millions of other U.S. businesses get their
start.
Money from relatives and friends can supplement the business financing you're receiving from other sources -- or even fill
a critical gap in starting up your business. And, the financing terms for loans or investments from your relatives and
friends are often more affordable and flexible than what you would get from a bank or professional investor.
Getting friends and family involved in business financing is not uncommon -- nearly one in ten Americans reports a loan
outstanding to a relative or friend. And, although lenders usually get involved to help you out, they can benefit from the
deal as well. For example, the interest you pay will probably be higher than what they would receive from other short-
term investments such as CDs or money market funds. And you'll still be paying less than you would on your credit card!
Protecting Everyone’s Interests
Of course, there are potential pitfalls and hassles that come with mixing money and relationships. Family members may
feel that you "owe them one." Or, you may not like having some lenders or investors watching your every move and
criticizing your new car or family vacation. And, not every lender will be sympathetic as you try to explain to your need to
reschedule or skip a payment.
For the most part, these are issues that can and should be dealt with in advance. Make the arrangement as professional as
possible. That way, your private lender or investor will treat this as a business, not a personal arrangement. You can, for
example, offer collateral to secure your friend or family member's loan. And, you should agree on clear and definite terms
for any loan, including payment dates, interest rate, and penalties, if any. If your friends or family make equity
investments, you might agree to give them a right to share the proceeds from the business’s assets if it’s sold.
Asking Friends and Family for Financial Support
The biggest hurdle stopping many entrepreneurs from getting private financing is simply the fear of asking. You can
overcome this fear with a combination of careful preparation and choosing a time and place that makes you and your
prospective lender or investor comfortable.
Try for a "kitchen table pitch," in which you get the other person excited about your business idea in person. Suggest a
loan or investment opportunity and promise to follow up with written materials. Then be ready with your business plan and
a detailed loan or investment proposal.
Documenting the Loan or Investment
Once someone has agreed to participate in financing your business, it's crucial to get the agreement in writing. In the case
of a loan, you and your lender would draw up a promissory note detailing the amount you'll owe, your repayment
schedule, and penalties if you fail to make a payment. In the case of an equity investment (which assumes that you’ve set
up a corporation or LLC), you would negotiate a stock purchase agreement that includes your disclosures about the
business and a description of the investor's ownership rights.
For more information on every aspect of private financing -- from making your pitch to preparing the appropriate
paperwork to maintaining good relations with your lender or investor over the life of your business -- see Investors in Your
Backyard: How to Raise Business Capital From the People You Know, by Asheesh Advani, President and CEO of
CircleLending.
Click here for related information and products from Nolo
Copyright 2006 Nolo

Starting a Business: 50 Things You'll Need to Do


From the Nolo Business & Human Resources Center
Here is what you need to do to start a business -- be sure to bring time, patience, and energy -- because it's a
long list.
Thinking about starting a business? You’re not alone. Every year, thousands of Americans catch the entrepreneurial spirit,
launching small businesses to sell their products or services. Some businesses thrive; many fail. The more you know about
starting a business, the more power you have to form an organization that develops into a lasting source of income and
satisfaction. For help with the beginning stages of operating a business, the following checklist is a great place to start.
Evaluate and Develop Your Business Idea
1. Determine if the type of business suits you.
2. Use a break-even analysis to determine if your idea can make money.
3. Write a business plan, including a profit/loss forecast and a cash flow analysis.
4. Find sources of start-up financing.
5. Set up a basic marketing plan.
Decide on a Legal Structure for Your Business
6. Research the various types of ownership structures:
1. Sole proprietorship
2. Partnership
3. LLC
4. C Corporation
5. S Corporation
7. Identify the number of owners of your business.
8. Decide how much protection from personal liability you'll need, which depends on your business's risks.
9. Decide how you'd like the business to be taxed.
10. Consider whether your business would benefit from being able to sell stock.
11. Get more in-depth information from a self-help resource or a lawyer, if necessary, before you settle on a structure.
Choose a Name for Your Business
12. Think of several business names that might suit your company and its products or services.
13. If you will do business online, check if your proposed business names are available as domain names.
14. Check with your county clerk's office to see whether your proposed names are on the list of fictitious or assumed
business names in your county.
15. For corporations and LLCs: check the availability of your proposed names with the Secretary of State or other
corporate filing office.
16. Do a federal or state trademark search of the proposed names still on your list. If a proposed name is being used as a
trademark, eliminate it if your use of the name would confuse customers or if the name is already famous.
17. Choose between the proposed names that are still on your list.
Register Your Business Name
18. Register your business name with your county clerk as a fictitious or assumed business name, if necessary.
19. Register your business name as a federal or state trademark if you'll do business regionally or nationally and will use
your business name to identify a product or service.
20. Register your business name as a domain name if you'll use the name as a Web address too.
Prepare Organizational Paperwork
21. Partnership:
1. Partnership agreement
2. Buyout agreement (also known as a buy-sell agreement)
22. LLC:
1. Articles of organization
2. Operating agreement
3. Buyout agreement (also known as a buy-sell agreement)
23. C Corporations:
1. Pre-incorporation agreement
2. Articles of incorporation
3. Corporate bylaws
4. Buyout agreement (also known as a buy-sell agreement or stock agreement)
24. S Corporations:
1. Articles of incorporation
2. Corporate bylaws
3. Buyout agreement (also known as a buy-sell agreement or stock agreement)
4. File IRS Form 2553, Election by a Small Business Corporation
Find a Business Location
25. Identify the features and fixtures your business will need.
26. Determine how much rent you can afford.
27. Decide what neighborhood would be best for your business and find out what the average rents are in those
neighborhoods.
28. Make sure any space you're considering is or can be properly zoned for your business. (If working from home, make
sure your business activities won't violate any zoning restrictions on home offices.)
29. Before signing a commercial lease, examine it carefully and negotiate the best deal.
File for Licenses and Permits
30. Obtain a federal employment identification number by filing IRS Form SS-4 (unless you are a sole proprietorship or
single-member limited liability company without employees).
31. Obtain a seller's permit from your state if you will sell retail goods.
32. Obtain state licenses, such as specialized vocation-related licenses or environmental permits, if necessary.
33. Obtain a local tax registration certificate, a.k.a. business license.
34. Obtain local permits, if required, such as a conditional use permit or zoning variance.
Obtain Insurance
35. Determine what business property requires coverage.
36. Contact an insurance agent or broker to answer questions and give you policy quotes.
37. Obtain liability insurance on vehicles used in your business, including personal cars of employees used for business.
38. Obtain liability insurance for your premises if customers or clients will be visiting.
39. Obtain product liability insurance if you will manufacture hazardous products.
40. If you will be working from your home, make sure your homeowner's insurance covers damage to or theft of your
business assets as well as liability for business-related injuries.
41. Consider health & disability insurance for yourself and your employees.
Set Up Your Books
42. Decide whether to use the cash or accrual system of accounting.
43. Choose a fiscal year if your natural business cycle does not follow the calendar year (if your business qualifies).
44. Set up a recordkeeping system for all payments to and from your business.
45. Consider hiring a bookkeeper or accountant to help you get set up.
46. Purchase Quicken Home and Business (Intuit), QuickBooks (Intuit) or similar small business accounting software.
Set Up Tax Reporting
47. Familiarize yourself with the general tax scheme for your business structure. (See Tax Savvy for Small Business, by
attorney Frederick Daily.)
48. Familiarize yourself with common business deductions and depreciation. (See Deduct It! Lower Your Small Business
Taxes, by attorney Stephen Fishman.)
49. Obtain IRS Publications 334, Tax Guide for Small Business, and 583, Taxpayers Starting a Business.
50. Obtain the IRS's Tax Calendar for Small Businesses.
As you can see, starting a business involves making quite a few initial decisions and getting policies and paperwork in
place. For more information about and help with starting a business, consult the following Nolo resources: Legal Guide for
Starting and Running a Small Business, by attorney Fred Steingold; Whoops! I’m in Business, by attorneys Richard Stim
and Lisa Guerin; or Quicken Legal Business Pro (software).
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Copyright 2006 Nolo

Starting and Researching the Right Business


From the Nolo Business & Human Resources Center
Your business should have a solid chance at profitability -- but it should also suit your particular skills and
strengths.
If you want to work for yourself, but don't have a particular business in mind, you're probably wondering what kind of
business you should start. Fortunately, the answer is always the same: Pick a venture you know intimately, and then
research it some more.
Know the Ins and Outs of the Business
Don't fall into the trap of starting a particular business just because someone tells you, "It's a sure thing." Potential
customers will part with their hard-earned money only if you convince them that they're getting their money's worth, so
you'll need to know what you're doing, no matter what the task.

Choosing a Business You Know


Starting a business in which you already have experience has many advantages: You can use your knowledge about the
industry, your training and skills, and your network of contacts who might help you find financing, suppliers, and
customers.
Example

For ten years Steve worked for several different construction companies -- first as a journeyman
carpenter and then as a project manager. When he got the itch to start his own business, it made
perfect sense for him to start a small contracting business specializing in home-improvement. He
knew the industry well, including the best places to buy supplies and what he could charge for
services, and he had the required skills, such as how to estimate and bid jobs -- and it didn't hurt
that he knew how to pound nails as well. The contacts he had developed over the years were glad to
talk to him about running a small contracting business, and many customers he had worked with in
the past told him they'd be willing to hire him if he were working on his own.

If you're interested in turning something you know and love into a business, talk to people you've worked with about what
it takes to run that kind of business. Learn all you can about start-up costs, overhead and expenses, and how much
revenue you can expect to make. If you have several interests, but aren't sure which would make the best business,
consider how you can translate your strengths, education, and skills into business opportunities, and research the
marketplace to see which types of business are presently needed in your area.

Starting a Business in an Unfamiliar Industry


Unfortunately, the lure of quick profits convinces many people to start businesses in areas they know little or nothing
about. This is a sure recipe for failure.

Example

Leo opened an upscale nursery and garden supply outfit at a time when, seemingly, such a business
"couldn't miss." Leo knew a good deal about running a small business, had a personality well suited
for it, and could borrow enough money to begin. However, the business never took off, and it cost
him two years and $30,000 to get rid of it.
Why? In his hurry to make a profit, Leo overlooked several crucial facts. The most important was
that Leo, a self-described "brown thumb," knew virtually nothing about plants and didn't really want
to learn. Not only was Leo unable to chat with customers about what types of flowers grow well in
partial shade or how to get rid of various garden pests, but he didn't even know enough about
nurseries to properly hire and supervise the right salespeople. In short, Leo made a classic mistake --
he started a business in a "hot" field because someone was foolish enough to lend him the money.

If you don't know much about the business you want to start, but are set on it, be prepared to spend enough time learning
it before you begin.
Research and Evaluate Your Business Idea
Here's a step-by-step guide to evaluating whether you and your chosen business are a good fit.

1. Try it out. Before you start a business of your own, get some experience in the industry or profession that
interests you -- even if you work for free. Learn everything you can about every aspect of the business. For
example, if you want to start a pasta shop, but don't know ravioli from cannelloni, go out and get a job with a
pasta maker.

Talk to Entrepreneurs in the Same Field

If you're not familiar with the business you want to start and you're unable to find work in the
field, talk with others who provide the product or service that interests you. To increase your chances
of getting interviews and reliable answers to your questions, it's best to do this in a different locale
from the one in which you plan to locate. Small business owners are often quite willing to share their
knowledge once they are sure you will not compete with them.

2.

3. Evaluate whether you enjoy the work and excel at it. If not, find a new venture. It's a lot harder to make a
success of a business you don't like, and it's unlikely you'll like something you're not good at. If you enjoyed the
work and determined you were skilled enough to base your own business on it, go on to the next step.
3. Judge your ability and desire to handle every aspect of the business. If you don't want to or can't pitch in
wherever and whenever something needs to be done -- whether it involves manufacturing a product, dealing with
customers, or keeping the books -- you should think twice about starting that kind of business.

4. Determine whether the business has a solid chance of turning a profit. After working in the field for a few
months, you should have a good idea of whether the business is a potential moneymaker. To be sure, you should
analyze your market and conduct a break-even analysis, a preliminary financial projection that shows you the
amount of revenue you'll need to bring in to cover your expenses (this amount is called your break-even point).
If you're able to bring in more revenues than your break-even point, you'll be in the black (that is, you'll make a
profit).

5. Evaluate the risk this particular business requires. Even the best-laid plans can sour if you pick a business
that is unusually risky, vulnerable to competition, or subject to financial failure. For instance, the following
businesses have higher than average failure rates:

○ trucking firms
○ computer stores
○ restaurants
○ laundries and dry
cleaners ○ infant clothing
stores
○ florists
○ bakeries, and
○ used car dealerships
○ gas stations
○ grocery and meat
stores.

If your business idea is on this list, don't despair -- it doesn't mean you should automatically abandon it. However, you'll
need to be more critical and careful with the numbers when preparing your business plan.
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Copyright 2006 Nolo

Will My Business Make Money?


by Attorney Bethany K. Laurence
From the Nolo Business & Human Resources Center
Prepare a break-even analysis before spending time on a complete business plan.
How can you tell if your business idea will be profitable? The honest answer is, you can't. But this uncertainty shouldn't
keep you from researching the financial soundness of your idea. Preparing what's known as a "break-even analysis," or
"break-even forecast," as well as several other financial projections, can help you determine whether or not your business
will succeed.
What a Break-Even Analysis Tells You
A break-even analysis shows you the amount of revenue you'll need to bring in to cover your expenses, before you make
even a dime of profit. If you can attain and surpass your break-even point -- that is, if you can easily bring in more than
the amount of sales revenue you'll need to meet your expenses -- then your business stands a good chance of making
money.
Many experienced entrepreneurs use a break-even analysis as a primary screening tool for new business ventures. They
won't write a complete business plan unless their break-even forecast shows that their projected sales revenue far exceeds
their costs of doing business. The good news is that a break-even analysis is part of every business plan, so if you start by
doing a break-even analysis now, you'll have already started work on your business plan.
How to Prepare a Break-Even Analysis
To perform a break-even analysis, you'll have to make educated guesses about your expenses and revenues. You should
do some serious research -- including an analysis of your market -- to determine your projected sales volume and your
anticipated expenses. Business plan books and software can teach you how to make reasonable revenue and cost
estimates.
You'll need to make the following estimates and calculations:
1. Fixed costs. Fixed costs (sometimes called "overhead") don't vary much from month to month. They include
rent, insurance, utilities, and other set expenses. It's also a good idea to throw a little extra, say 10%, into your break-
even analysis to cover miscellaneous expenses that you can't predict.

2. Sales revenue. This is the total dollars from sales activity that you bring into your business each month or year.
To perform a valid break-even analysis, you must base your forecast on the volume of business you really expect -- not on
how much you need to make a good profit.

3. Average gross profit for each sale. Average gross profit is the money left from each sales dollar after paying
the direct costs of a sale. (Direct costs are what you pay to provide your product or service.) For example, if Antoinette
pays an average of $100 for goods to make dresses that she sells for an average of $300, her average gross profit is $200.

4. Average gross profit percentage. This percentage tells you how much of each dollar of sales income is gross
profit. To calculate your average gross profit percentage, divide your average gross profit figure by the average selling
price. For example, if Antoinette makes an average gross profit of $200 on dresses that she sells for an average of $300,
her gross profit percentage is 66.7% ($200 divided by $300).

Calculating Your Break-Even Point


Once you've calculated the numbers above, it's easy to figure out your break-even point. Simply divide your estimated
annual fixed costs by your gross profit percentage to determine the amount of sales revenue you'll need to bring in just to
break even. For example, if Antoinette's fixed costs are $6,000 per month, and her expected profit margin is 66.7%, her
break-even point is $9,000 in sales revenue per month ($6,000 divided by .667). In other words, Antoinette must make
$9,000 each month just to pay her fixed costs and her direct (product) costs. (Note that this number does not include any
profit, or even a salary for Antoinette.)

If You Can't Break Even


If your break-even point is higher than your expected revenues, you'll need to decide whether certain aspects of your plan
can be changed to create an achievable break-even point. For instance, perhaps you can:
1. find a less expensive source of supplies
2. do without an employee
3. save rent by working out of your home, or

4. sell your product or service at a higher price.

If you tinker with the numbers and your break-even sales revenue still seems like an unattainable number, you may need
to scrap your business idea. If that's the case, take heart in the fact that you found out before you invested your (or
someone else's) money in the idea.
Further Financial Analysis
If your break-even forecast shows you'll make more revenue than you need to break even, you can consider yourself
fortunate. But you still need to figure out how much profit your business will generate, and whether you'll have enough
cash available to pay your bills when they are due. In short, a break-even forecast is a great screening tool, but you need
a more complete analysis before you start investing real money in your venture.
The following are additional financial projections that should also be part of your business plan, to round out your
business's financial picture.

1. A profit-and-loss forecast. This is a month-by-month projection of your business's net profit from operations.

2. A cash flow projection. This shows you how much actual cash you'll have, month by month, to meet your
expenses.

3. A start-up cost estimate. This is the total of all the expenses you'll incur before your business opens.

For instructions on how to create a profit-and-loss forecast and a cash flow projection, see How to Write a Business Plan,
by Mike McKeever (Nolo).

Don't Forego a Break-Even Analysis

Although creating a break-even forecast might sound complicated, you owe it to yourself to
prepare one as one of the first steps in your business planning process. Now is the time to get used
to using cost estimates and profit margins, if you're going to succeed in business. And as you can
see, a realistically prepared break-even forecast will tell you whether your idea is a sure winner, a
sure loser or, like most ideas, needs modifications to make it work. Plus, you'll have a big headstart
on your business plan!

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Copyright 2006 Nolo

Raising Money From Family and Friends


by Asheesh Advani
From the Nolo Business & Human Resources Center
Use the same type of financing that helped Wal-Mart, Subway, and millions of other U.S. businesses get their
start.
Money from relatives and friends can supplement the business financing you're receiving from other sources -- or even fill
a critical gap in starting up your business. And, the financing terms for loans or investments from your relatives and
friends are often more affordable and flexible than what you would get from a bank or professional investor.
Getting friends and family involved in business financing is not uncommon -- nearly one in ten Americans reports a loan
outstanding to a relative or friend. And, although lenders usually get involved to help you out, they can benefit from the
deal as well. For example, the interest you pay will probably be higher than what they would receive from other short-
term investments such as CDs or money market funds. And you'll still be paying less than you would on your credit card!
Protecting Everyone’s Interests
Of course, there are potential pitfalls and hassles that come with mixing money and relationships. Family members may
feel that you "owe them one." Or, you may not like having some lenders or investors watching your every move and
criticizing your new car or family vacation. And, not every lender will be sympathetic as you try to explain to your need to
reschedule or skip a payment.
For the most part, these are issues that can and should be dealt with in advance. Make the arrangement as professional as
possible. That way, your private lender or investor will treat this as a business, not a personal arrangement. You can, for
example, offer collateral to secure your friend or family member's loan. And, you should agree on clear and definite terms
for any loan, including payment dates, interest rate, and penalties, if any. If your friends or family make equity
investments, you might agree to give them a right to share the proceeds from the business’s assets if it’s sold.
Asking Friends and Family for Financial Support
The biggest hurdle stopping many entrepreneurs from getting private financing is simply the fear of asking. You can
overcome this fear with a combination of careful preparation and choosing a time and place that makes you and your
prospective lender or investor comfortable.
Try for a "kitchen table pitch," in which you get the other person excited about your business idea in person. Suggest a
loan or investment opportunity and promise to follow up with written materials. Then be ready with your business plan and
a detailed loan or investment proposal.
Documenting the Loan or Investment
Once someone has agreed to participate in financing your business, it's crucial to get the agreement in writing. In the case
of a loan, you and your lender would draw up a promissory note detailing the amount you'll owe, your repayment
schedule, and penalties if you fail to make a payment. In the case of an equity investment (which assumes that you’ve set
up a corporation or LLC), you would negotiate a stock purchase agreement that includes your disclosures about the
business and a description of the investor's ownership rights.
For more information on every aspect of private financing -- from making your pitch to preparing the appropriate
paperwork to maintaining good relations with your lender or investor over the life of your business -- see Investors in Your
Backyard: How to Raise Business Capital From the People You Know, by Asheesh Advani, President and CEO of
CircleLending.
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Copyright 2006 Nolo
The Lowdown on Business Loans
From the Nolo Business & Human Resources Center
If you're seeking a loan for your business, make sure you understand the basics.
As you know, a loan is based on a simple idea: someone gives you money and you promise to pay it back, usually with
interest. Loans are so common that you probably are familiar with the mechanics, but nevertheless it makes sense to
review the basics. The success or failure of your business can hinge on borrowing money sensibly: you want to borrow
enough that your company can reach its potential but not so much that you have severe difficulty paying it back.

Start on a shoestring. It can be a mistake to pour too much money into your business at the beginning. A fair
number of small businesses fail in the first year, so raising and spending a pile of money for an untested business idea can
lead to much grief -- especially if you’re personally on the hook for borrowed funds. Consider starting as small and cheaply
as possible.
Types of Lenders
You have many options when looking a loan for your business. For small ventures, friends and family members are
sometimes willing to help. For sophisticated or mid-sized businesses, banks, credit unions, and savings and loans may be
willing to lend you money. The U.S. Small Business Administration (SBA) and many state and local governments have loan
programs to encourage the growth of small businesses. For an excellent primer on loans and lenders, see
www.sba.gov/financing.
The Promissory Note
A lender will almost always want you to sign a written promissory note -- a paper that says, in effect, "I promise to pay
you $XXX plus interest of XX%."
While a friend or relative may be willing to lend you money on a handshake, this is a bad idea for both of you. It's always a
better business practice to put the loan in writing, and to state a specific interest rate and repayment plan. Otherwise, you
open the door to unfortunate misunderstandings that can chill your relationship. Also, you want to have documentation of
the loan's terms in case the IRS decides to audit your business.
Interest
State usury laws prevent lenders from charging illegally high interest on loans. As a general rule, a lender can safely
charge you interest of up to 10% per year and not have to worry about violating this usury law. However, there's a lot of
variation in usury laws from state to state, and different rules apply to commercial lenders and private lenders, so you
should check your state's law if you're concerned. Look under interest or usury in your state's statutes.
If your corporation is taking a loan from a shareholder (including yourself), make sure the interest rate is not too low --
the IRS likes to see loans that are commercially reasonable. Otherwise, the IRS might consider the loan as a capital
investment by the shareholder and treat the loan repayments as dividend payments to the shareholder.
Security Interests
Many lenders will require you to put up valuable property (called "security" or "collateral") that they can sell to collect their
money if you don't make your loan payments. For example, a lender may take a second mortgage or deed of trust on your
house, or ask for a security interest or lien on your business's equipment, inventory, or accounts receivable.
Personal Liability
Depending on how your business is organized, if you don't make good on your repayment commitment, a lender has the
right to sue you individually (if your business is a sole proprietorship or general partnership) or sue your business entity (if
your business is organized as a corporation or a limited liability company). If the lender sues you individually, it can take
your personal assets to satisfy the loan. If the lender sues your business entity, it can take the business’s assets.
Cosigners, Guarantors, and Personal Guarantees
A lender may also require that someone cosign or guarantee the loan. That means the lender will have two people rather
than one to collect from if you don't make your payments. When asking friends or relatives to cosign or guarantee a
promissory note, be sure they understand that they're risking their personal assets if you don't repay the loan.
If you’ve organized your business as a limited liability entity, such as a corporation or an LLC, the lender will probably ask
you -- the business owner -- to personally guarantee the loan and/or pledge your personal assets to guarantee repayment.
(Because small businesses have high failure rates, lenders feel more comfortable if business owners have a personal stake
in repaying the money.) Be aware that guaranteeing or personally cosigning your business’s loan circumvents your limited
liability status. All of your separate property, and either half or all of any property you jointly own with a spouse
(depending on which state you live in), could eventually be seized if you default on the loan.
Finally, if you're married, the lender may insist that your spouse cosign the promissory note. If your spouse cosigns the
loan, not only is your jointly owned property completely at risk for this joint debt, but also any assets that your spouse
owns separately -- a house, for example, or a bank account. What's more, if your spouse has a job, his or her earnings will
be subject to garnishment if the lender sues and gets a judgment against the two of you.
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Copyright 2006 Nolo

Understanding Promissory Notes


From the Nolo Business & Human Resources Center
Whether take out a loan from a bank or borrow money from someone you know, you should sign a promissory
note.
If you borrow start-up cash for your business from a commercial lender, the lender will require you to sign a promissory
note that sets out the repayment terms. If you borrow the money from a friend or relative, it's still smart to sign a
promissory note, even if the lending friend or relative assures you that such formality isn't necessary. Documenting the
loan can do no harm, and it can head off misunderstandings about whether the money is a loan or gift, when it is to be
repaid, and how much interest is owed. It also documents the terms of the loan in case the IRS comes sniffing around with
a business audit.
Types of Repayment Schedules
Banks provide their own promissory note forms. If you borrow from a friend or relative, you'll need to use a promissory
note from form books or software. The legal and practical terms of promissory notes can vary considerably, but the most
important thing is to pick a repayment plan that's right for you. Following are four different approaches.

Promissory Note Forms

Nolo's Quicken Legal Business Pro software and Legal Forms for
Starting & Running a Small Business, by Fred Steingold, provide
promissory notes with the following four repayment plans. In
addition, both the software and book offer a security agreement
to go with the promissory notes, in case collateral will be
required.

1. Amortized Payments
You've probably dealt with an amortized repayment schedule before, when paying off a car loan or a mortgage. You pay
the same amount each month (or year) for a specified number of months (or years). Part of each payment goes toward
interest, and the rest goes toward principal. When you make the last payment, the loan and interest are fully paid. In legal
and accounting jargon, this type of loan is "fully amortized" over the period that you make payments.
Once you know the terms of the loan (the amount you want to borrow, the interest rate, and the time over which you'll
make payments), you can figure out the amount of the payments using software such as Intuit's Quicken or Quickbooks or
an online calculator. Or you can use a printed amortization schedule, which are widely available from commercial lenders,
business publishers, and local libraries.

2. Equal Monthly Payments and a Final Balloon Payment


This type of repayment schedule requires you to make equal monthly payments of principal and interest for a relatively
short period of time. Then, after you make the last installment payment, you must pay the remaining principal and interest
in one large payment, called a balloon payment.
Because of the lower monthly payments during the course of the loan, you can keep more cash available for other needs.
Of course, when you're thinking about those nice low payments, don't forget the big balloon payment waiting around the
corner.
Balloon payments can have extra risks. If you plan to take out a new loan when it's time to pay the balloon
payment, you're gambling that interest rates will stay the same or go lower over the life of the loan. And if you're buying
an asset (such as a building) that you plan to sell soon to pay off the loan before the balloon payment comes due, you're
gambling that the asset will not depreciate.

3. Interest-Only Payments and a Final Balloon Payment


With an interest-only loan, you repay the lender by making regular payments of interest only over a number of months or
years. The principal does not decrease. At the end of the loan term, you must make a balloon payment to repay this
principal and any remaining interest.
The obvious advantage of this arrangement is the low payments. And, if you find yourself in the happy situation of having
extra cash, you can usually prepay principal. But over the long term, you'll pay more interest because you're borrowing the
principal for a longer time. For instance, on a $20,000 loan, paid back in four years, you would pay almost $3,000 less by
making equal amortized payments than if you made interest-only payments plus a final balloon payment.

4. Single Payment of Principal and Interest


Some loans, especially those from friends and family members, don't require regular payments of interest and/or principal.
Instead, you pay off the loan all at once, at a specified future date. This payment includes the entire principal amount and
the accrued interest. Borrowing money on these terms is best for a short-term loan, or if the lender isn't worried about on-
time repayment. You are not likely to get this kind of deal from a commercial lender.
Read the Fine Print
No matter which repayment method you choose, be sure you read your promissory note and any other loan documents
carefully. Promissory notes provided by commercial lenders in particular usually contain all kinds of legalese and scary
waivers of legal rights. For instance, make sure you can prepay the loan without paying any kind of penalty -- some states
allow a lender to charge you a fee (which is really designed to compensate the lender for the loss of future interest) for
prepaying the loan.
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Copyright 2006 Nolo

Getting a Business Loan: Getting the Lender to Say "Yes"


From the Nolo Business & Human Resources Center
When trying to get a business loan, it helps to view things from the lender's perspective.
Bankers and institutions that lend money are often overly cautious in making loans to small businesses because of their
high failure rate. As a result, these institutions have developed a lot of knowledge about the success rate of small
businesses, and they apply this knowledge when they approve and deny loans. For that reason, it makes sense to study
their approach, even though it may seem discouraging at first glance.
The Banker's Ideal
Bankers look for a loan applicant who meets these requirements:
1. For an existing business, a cash flow sufficient to make the loan payments.
2. For a new business, an owner who has a track record of profitably owning and operating the same sort of
business.
3. For all businesses, an owner with financial reserves and personal collateral sufficient to solve the unexpected
problems and fluctuations that affect all businesses.
Why does such a person need a loan, you ask? He or she probably doesn't, which, of course, is the point. Institutions who
lend money are most comfortable with people so close to their ideal loan candidate that they don't need to borrow.
However, to stay in business themselves, banks and other lenders must loan out the money deposited with them. To do
this, they must lend to at least some people whose creditworthiness is less than perfect.
Measuring Up to the Banker's Ideal
Who are these ordinary mortals who slip through bankers' fine screens of approval? And more to the point, how can you
qualify as one of them? Your job is to show how your situation is similar to the banker's ideal.
For instance, even if you haven't owned a successful business in the same field as your proposed new business, it can help
if you have worked for, or preferably managed, such a business.
Further away from a lender's ideal is the person who has sound experience managing one type of business, but proposes
to start one in a different field. Let's say you ran the most profitable hot dog stand in the Squaw Valley ski resort, and now
you want to market computer software in Silicon Valley. In your favor is your experience running a successful business. On
the negative side is the fact that computer software marketing has no relationship to hot dog selling. In this situation, you
might be able to get a loan if you hire people who make up for your lack of experience.
At the very least, you would need someone with a strong software marketing background, as well as a person with
experience managing retail sales and service businesses. Naturally, both of those people would be most impressive to
lenders if they had many years of successful experience in the software marketing business, preferably in California.
Using the Banker's Perspective
Use a skeptical attitude as a counterweight to your optimism to get a balanced view of your prospects. What is it that
makes you think you will be one of the minority of small businesspeople who will succeed? If you don't have some specific
answers, you may be in trouble. Most new businesses fail, and the large majority of survivors do not genuinely prosper.
Other Tips for Success
1. Clean up your credit report.

2. Write a business plan.

3. Apply for the right type of loan. For example, a line of credit is often used to cover seasonal ups and downs,
while a loan is better used for one-time equipment purchases.

4. State the specific purposes for which you will use the money. Your bank or lender will definitely want to
know what you plan to use the money for.
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Raising Money for Your Small Business: Loans vs. Equity Investments
From the Nolo Business & Human Resources Center
Here’s the lowdown on whether to borrow money or sell part of your business to an equity investor.
To raise money for your new business, you must decide whether you want to borrow money or sell ownership interests to
equity investors. Often, you may not have many options -- the person with money to lend or invest will obviously have a
lot to say about it. But you should understand the pros and cons of choosing one over the other.
Taking Out Business Loans
Borrowing money to fund your business has many advantages. Often, you'll borrow this money from a friend or family
member, but if you're lucky, you may be able to borrow from a commercial lender too.

Advantages of Borrowing Money


The main advantage of borrowing money is that, while the lender will charge you interest for using the money, the lender
won't have any say in how you run or manage your business. More importantly, a lender won't be entitled to any of the
profits you make; all you have to do is to repay the loan on time. In addition, you can typically deduct the interest
payments (but not principal repayments) as a business expense.
If you can borrow money from a friend or family member, you'll typically pay a lower rate of interest than if you borrow
the money from a commercial lender, and you can avoid paying the loan fees commercial lenders tend to charge. As an
added bonus, you may be able to negotiate more flexible repayment terms than a commercial lender would permit.

Disadvantages of Borrowing Money


If you borrow money, you may be committing your business to a fairly large business expense. You may have to make
loan payments when your need for cash is greatest (usually during your business's start-up or expansion). And if you have
problems paying the loan back or keeping up with the payments, you can ruin your relationship with family or friends.
If you borrow from a commercial lender, the lender may require you to pledge property as security for the loan. (If you
don't repay the loan, the lender can take the property and sell it to recoup the money.) If you pledge business property as
security for the loan, and your business slows down (or doesn't take off) and you can't make loan payments, you may lose
these valuable assets just when you need them most. Worse, if you pledge personal assets, such as your house or stock
portfolio, you risk losing them to pay a business debt.
Even if you organize your business as a corporation or a limited liability company (each of which provides owners with
limited liability for business debts), almost all commercial lenders will require you, as the owner of a new or small
business, to personally guarantee the loan and/or to pledge personal assets to cover the loan, which wipes out this limited
liability.
Accepting Investments
If you have friends, family, or other people who want to invest in your business outright (become part-owners) instead of
simply lending you money, you can raise money for your small business this way too. However, allowing people (called
equity investors) to own part of your business comes with its own set of advantages and disadvantages.

Advantages of Equity Investors


First, there's a good practical reason to take investments: Raising money through equity investors allows you to use your
cash to pay business start-up expenses rather than large loan payments. And unlike a loan, if your business loses money
or goes broke, you probably won't have to repay your investors their initial investment. As long as you've thoroughly
disclosed the risks involved in your business, your investors should understand and accept that they are not guaranteed to
get their money back.
Further, investors often have business experience and can offer you valuable advice, moral support, and assistance.

Disadvantages of Equity Investors


On the downside, equity investors usually end up taking a larger share of your business's profits than a bank or other
lender. (Since an investor is at a greater risk of losing his or her investment, you have to compensate the investor for this
risk with a bigger payoff.)
In addition, your investors will be co-owners, and they have a legal right to be informed about all significant business
events, as well as a right to ethical management. Your co-owners can (and probably will) sue you if they feel you are
compromising their rights. This means you always have a responsibility to take your investors' interests into account when
you make business decisions, even if it's not what's best for you.
In some circumstances, your investors may be considered passive investors and their investment interests "securities."
Dealing with securities creates a lot of paperwork, starting with securities registration, and brings a host of other legal
requirements down on your head. However, not all offerings of securities must be registered with the federal and state
securities exchange commissions. The following are exempted:
1. private offerings to a limited number of persons or institutions
2. offerings of limited size, and

3. intrastate offerings.

For a quick summary of these exemptions, see the SEC website at www.sec.gov.

Summary of Loans vs. Investments


Source: Loans Investments
Advantages:
The lender has no management say or direct Investors are sometimes partners or board
entitlement to profits in your business. members and often offer valuable advice and
assistance.

Your only obligation to the lender is to repay the You can be flexible about repayment
loan on time. Loans from close relatives can have requirements.
flexible repayments terms.

Interest payments (but not principal payments) are If your business loses money or goes broke,
a deductible business expense. you probably won't have to repay your
investors.

Disadvantages:
You may have to make loan repayments when your Equity investors require a greater share of your
need for cash is greatest, such as during your profits than interest on a loan.
business's start-up or expansion.

You may have to assign a security interest in your Your investors have a legal right to be informed
property to obtain a loan, which may place your about all significant business events and a right
personal assets at risk. to ethical management.

Under most circumstances, you can be sued Your investors can sue you if they feel their
personally for any unpaid balance of the loan, even rights are being compromised.
if it's unsecured.

Loans or Investments: Which Should You Choose?


If you're trying to finance a start-up venture, it's better to seek equity investments, because you generally only have to
repay investors if the business turns a profit.
For ongoing needs, loans are better for businesses with cash flow that allows for realistic repayment schedules, and for
businesses that can obtain the loan without jeopardizing personal assets.
Deciding whether to borrow money or to take on co-owners can be tricky. If you don't already know a tax advisor who
specializes in small business issues, it would be wise to find one. Your personal tax situation, the tax situation of the
people who may invest, the terms of a potential loan, and the tax status of the type of business you plan to open are all
likely to influence your choice.
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Copyright 2006 Nolo

Raising Money Through Equity Investments


From the Nolo Business & Human Resources Center
Bringing investors into your business gets you more than just money -- you get new co-owners, too.
Unlike a lender -- who temporarily provides you with money to operate your business -- equity investors actually buy a
piece of your business. For better or worse, they become your co-owners and share in the fortunes and misfortunes of
your business. Here’s a look at the pros and cons of raising money through equity investors and the different forms this
equity investment can take.
Investors' Rights
As co-owners of your company, your investors will have some say in the way you run your company. They will probably be
able to vote to elect your board of directors, and they have a legal right to be informed about all significant business
events. And they can sue you if they feel their rights are being compromised. On the other hand, investors can bring
helpful business experience with them that can strengthen your company.
Investors' Return on Investment
People who invest in your business may accept the risk of losing their entire investment and not insist that you guarantee
repayment. But to offset this risk, the investors may want to receive substantial benefits if the business is successful. For
example, an investor may insist on a generous percentage of the business profits and, to help assure that there are such
profits, may want to put a cap on your salary. The terms are always negotiable; there's no formula for figuring out what's
fair to both you and the investor. In the end, you and your investors will have to work out what you are both comfortable
with.
Your Ownership Structure
If you recruit people to invest in your sole proprietorship, your business will, by default, become a general partnership.
This means your equity investors will be considered general partners, each of whom is personally liable for business debts
and liabilities, whether or not he or she takes part in running the business.
However, your investors will probably want to insulate themselves from this personal liability for business debts,
particularly if they’re not going to actively participate in running the business. That means your investors will probably not
want to be general partners. Fortunately, there are other ways to organize your business.

Corporation
Because corporations offer shareholders protection against personal liability for business debts (called limited liability), a
shareholder of a corporation who doesn't participate in corporate activities and decision making is virtually free from
liability for corporate debt or activity. A shareholder who helps run the company can be liable to outsiders for his or her
own actions -- for example, making slanderous statements or negligently operating a piece of equipment -- but isn't
personally liable for corporate debts or the actions of corporate employees. Not everyone chooses a corporation as their
business entity because organizing and running a corporation involves some initial and ongoing paperwork, as well as
some fairly substantial start-up costs.

Limited Partnership
If you form a limited partnership and your investors become limited partners, they will have limited personal liability for
business debts. A limited partner's freedom from personal liability is similar to that of a corporate shareholder, as long as
the limited partner doesn't become actively involved in running the business. However, every limited partnership must
have a general partner who is personally liable for the debts of the business. That will probably be you, so you should
evaluate your exposure to risk before you decide to form a limited partnership.

Limited Liability Company


Another option is to form a limited liability company (LLC) and sell memberships interest in the LLC to your investors. LLCs
combine the limited personal liability of a corporation with the tax advantages of a partnership, and have become
increasingly popular in recent years.
Compliance With Securities Laws
The law treats corporate shares, limited partnership interests, and (usually) passive LLC membership interests as
securities. Federal and state securities laws regulate the issuance of these securities to investors.
This means that before you sell an investor an interest in your business, you'll need to learn more about securities laws
requirements. Fortunately, there are generous exemptions that normally allow a small business to provide a limited
number of investors an interest in the business without complicated paperwork. In the rare cases in which your business
won’t qualify for these exemptions, you have to comply with the complex disclosure requirements of the securities laws --
such as distributing an approved prospectus to potential investors -- and register the securities. In this case, it may be too
much trouble to do the deal unless a great deal of money is involved.
Even if you qualify for exemptions to the securities disclosure rules, investors may eventually accuse you of giving them
misleading assurances. Always suggest that potential investors check with their own financial and legal advisors to
evaluate the investment. The bottom line is that, although each investor will assess his or her own degree of risk, you
should disclose all the relevant information to them so they can make an intelligent, informed choice.
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Loans and Equity Investments Compared


From the Nolo Business & Human Resources Center
How to choose between getting a loan or selling part of your business to an equity investor.
To raise money for your new business, you must decide whether you would prefer to borrow money or sell part of your
venture to an equity investor. This assumes, of course, that both options are open to you. In fact, you might not find a
lender willing to lend you money or you might have a hard time convincing an investor to put money into your
business. But you should nevertheless understand the trade-offs that come with choosing one over the other.
Here's a comparison of the pros and cons of each method of raising money.
Loans
Loans are often better for businesses whose cash flow allows for realistic repayment schedules and can't require a pledge
of anyone's personal assets.

Advantages
1. The lender has no profit participation or management say in your business.
2. Your only obligation is to repay the loan on time.
3. Interest payments (not principal payments) are a deductible business expense.
4. Loans from close relatives can have flexible repayments terms.

Disadvantages
1. You may have to make loan repayments when your need for cash is greatest, such as during your business's
start-up or expansion.
2. You may have to assign a security interest in your property to obtain a loan, which may place personal assets at
risk.
3. Under most circumstances, you can be sued personally for any unpaid balance of the loan, even if it's unsecured.
Equity Investments
Equity investments are often the best way to finance start-up ventures because of the flexible repayment schedules.

Advantages
1. You can be flexible about repayment requirements.
2. Investors are sometimes partners or board members and often offer valuable advice and assistance.
3. If your business loses money or goes broke, you probably won't have to repay your investors.

Disadvantages
1. Equity investors require a larger share of the profits.
2. Your shareholders or partners have a legal right to be informed about all significant business events and a right
to ethical management. They can sue you if they feel their rights are being compromised.
If you don't already know an accountant specializing in small business affairs, you may want to find one to help you make
the decision. Your personal tax situation, the tax situation of the people who may invest, and the tax status of the type of
business you plan to open are all likely to influence your choice.
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Why You Need to Write a Business Plan


From the Nolo Business & Human Resources Center
Learn why writing a business plan is important -- even if you're not trying to raise money.
Just as a builder uses a blueprint to ensure that a building will be structurally sound, the process of creating and writing a
"blueprint" for your business -- called a business plan -- will help you determine whether your business will be strong from
the start. Without a business plan, you leave far too many things to chance.
A business plan contains a description of your business, including details about how it will operate, a section on market
research and marketing strategies, an evaluation of your main competitors and several financial forecasts.
Reasons to Create a Business Plan
Writing a well-thought-out and organized business plan dramatically increases your odds of succeeding as an
entrepreneur. The benefits of a business plan include:
1. determining whether your business has a chance of making a good profit
2. providing an estimate of your start-up costs, and how much you'll need to invest or finance
3. convincing investors and lenders to fund your business
4. providing a revenue estimate (by defining your market -- who your customers will be -- and the percentage of
the market you can expect to reach)
5. helping your business make money from the start by devising a effective marketing strategy
6. helping you compete in the marketplace (through an analysis of what your competition lacks), and

7. anticipating potential problems so you can solve them before they become disasters.

If You Need to Raise Money


If you need to raise funds for your venture, it goes without saying that you'll have to write a solid, formal business plan.
Business owners who want to borrow money or attract investors will be successful only if they have well-written, well-
researched business plans. All of your potential lenders or investors will want to understand as much as possible about
how your business will work before deciding whether to back it financially.
The Importance of Financial Forecasts
Predicting and planning your business finances can show potential investors that your business idea will fly. But preparing
financial forecasts is a good idea even if you don't need to raise start-up money.
The discipline of developing financial projections for your business plan, including an estimate of start-up costs, a break-
even analysis, a profit-and-loss forecast, and a cash flow projection, will help you decide if your business is worth starting,
or if you need to rethink some of your key assumptions. In other words, a good business plan will convince you that you're
doing the right thing -- or not. As any experienced businessperson will tell you, the business you decide not to start
because a financial projection doesn't pencil out can be more important to your long-term success than the one you bet
your economic future on.

Tempted to Skip the Financial Projections?

Some people are intimidated by financial calculations and want to skip this process, hoping
they'll be one of the lucky few who "make it." And some people are so enamored with their business
concept and desperately eager to begin that they have no patience with the economic realities
involved in their business. If you recognize either of these tendencies in yourself, it's even more
important that you prepare financial forecasts carefully -- and pay attention to what they tell
you. Don't try to get out of it by telling yourself that your financial estimates will be wildly off base
and yield useless results. If you do your best to make realistic predictions of expenses and revenues
and accept that your guestimates will not be absolutely correct, you can learn a great deal about
what the financial side of your business will look like in its early months and even years of operation.
Even a somewhat inaccurate picture of your business's likely finances will be much more helpful than
having no picture at all.

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The Essentials of a Business Plan


From the Nolo Business & Human Resources Center
All business plans must show two things: a winning idea and a clear shot at a profit.
A good business plan has two basic goals: It should describe the fundamentals of your business idea and provide financial
data to show that you will make good money. Beyond that, the content of your business plan depends on how you intend
to use it.
How Will You Use Your Business Plan?
Depending on whether you're trying to attract investors or are creating a blueprint for your own use, a business plan can
take somewhat different forms.

Attracting Investors
If you will use your business plan to borrow money or interest investors, you should carefully design your plan so that it
sells your vision to skeptical people. Normally this means your business plan should include:
1. a persuasive introduction and request for funds
2. a statement of the purpose of your business
3. a detailed description of how the business will work (including what your product or service will be, whether you'll
have employees, who will supply your goods, and where you will be located)
4. an analysis of your market (who your customers are)
5. an evaluation of your main competitors
6. a description of your marketing strategy (how your business will reach plenty of customers and fend off your
competitors)
7. a résumé setting forth your business accomplishments, and
8. detailed financial information, including your best estimates of start-up costs, revenues and expenses, and your
ability to make a profit.
Together, all the parts of your plan should reveal the beauty of your business idea. You want to show potential lenders,
investors, or people you want to work with that you've hit upon a product or service that customers really want. In
addition, you should prove that you are exactly the right person to make your fine idea a roaring success.

Get Help If You Need It

Because your business plan will be submitted to people you don't know well, the writing should
be polished and the format clean and professional. Your numbers must also be accurate and clearly
presented. But not all business people are great writers or mathematicians. Consider paying a
freelance writer with small business savvy to help you polish your plan. Similarly, if you are
challenged by numbers, find a bookkeeper or accountant to provide needed help.

Funding the Venture Yourself


If you're not looking for outside money, your financial projections will be the most important part of your business plan.
These projections will tell you the cost of your products or services, the amount of sales revenue and profit you can
anticipate, and, perhaps most importantly, how much you'll have to invest or borrow to get your business off the ground.
Because you won't use your plan to ask for money, you can create an informal business plan that omits some of the
elements listed above. For example, you don't need to worry so much about making a sales pitch or a slick presentation,
and you may decide to skip the résumé of your own business accomplishments. But think twice before leaving out too
much. Any new business will need to introduce itself to people -- for example, suppliers, contractors, employees, and key
customers -- and showing them part or all of your business plan can be a great way to do it.
Financial Projections
Forecasting the finances of your business may seem intimidating or difficult, but in reality it's not so bad. Good planning
consists of making educated guesses as to how much money you'll take in and how much you'll need to spend -- and then
using these estimates to calculate whether your business will be profitable. Here are the financial projections you should
make:

1. A break-even analysis. Here you'll use income and expense estimates to determine whether, in theory at least,
your business will bring in enough money to meet its costs.

2. A profit-and-loss forecast. Next you'll refine the sales and expense estimates that you used for your break-
even analysis into a formal, month-by-month projection of your business's profit for the first year of operations.

3. A cash flow projection. Even if your profit-and-loss forecast tells you that your business will have higher
revenues than expenses -- in other words, that it will be profitable -- those numbers won't tell you if you'll have enough
cash on hand from month to month to pay your rent or buy more inventory. A cash-flow projection shows how much
money you'll have -- or how much you'll be short -- each month. This lets you know if you'll need a credit line or other
arrangement to cover periodic shortfalls.

4. A start-up cost estimate. This is simply the total of all the expenses you'll incur before your business opens. If
you need to pay off these costs during the first year or two of business, they should be included in your month-to-month
cash-flow projection.
Again, no matter who your audience is, you should be as thorough as possible when calculating your break-even analysis
and profit-and-loss forecast. The last thing you want is to experience the very real misery of starting a business that never
had a chance to make a solid profit.
Getting Started on Your Business Plan
Your best bet is to follow a self-help business plan book that shows you how to conduct the financial forecasts described
above. Two good bets are Business Plan Pro, by Palo Alto Software, and How to Write a Business Plan, by Mike McKeever
(Nolo).

Know What's Behind the Numbers

If you use business plan or accounting software, don't rely on the numbers it spits out unless
you fully understand them. To become a truly successful business owner, you should take the time to
learn the concepts behind financial projections.
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Cybersquatting: What It Is and What Can Be Done About It


From the Nolo Business & Human Resources Center
A 1999 law and an international arbitration procedure crack down on people looking to profit from other
people's trademarks.
If you own a trademark and find that someone is holding it hostage as a domain name until you pay a large sum for it, you
may be the victim of cybersquatting. You can either sue to get your domain name -- and possibly some money damages --
under a 1999 federal law known as the Anti-Cybersquatting Consumer Protection Act, or you can initiate arbitration
proceedings under the authority of the Internet Corporation of Assigned Names and Numbers (ICANN) and win the name
back without the expense and aggravation of a lawsuit.
Cybersquatting means registering, selling or using a domain name with the intent of profiting from the goodwill of
someone else's trademark. It generally refers to the practice of buying up domain names that use the names of existing
businesses with the intent to sell the names for a profit to those businesses.

Cybersquatting Today

The practice that's come to be known as cybersquatting originated at a time when most businesses were not savvy
about the commercial opportunities on the Internet. Some entrepreneurial souls registered the names of well-known
companies as domain names, with the intent of selling the names back to the companies when they finally woke up.
Panasonic, Fry's Electronics, Hertz and Avon were among the "victims" of cybersquatters. Opportunities for
cybersquatters are rapidly diminishing, because most businesses now know that nailing down domain names is a high
priority.

Recognizing Cybersquatting
How do you know if the domain name you want is being used by a cybersquatter? As a general rule, first check to see if
the domain name takes you to a legitimate website. If the domain name takes you to a website that appears to be
functional and reasonably related in its subject matter to the domain name, you probably aren't facing a case of
cybersquatting. However, you may have a case of trademark infringement. (For more information, see What to Do If the
Domain Name You Want Is Taken.)
But if your browser produces any of the following results, you may have a case of cybersquatting on your hands:
1. you get a "can't find server" message
2. you get an "under construction" page, or

3. you get a page that appears to have no relationship to the meaning of the domain name.

Although each of these results suggests the possibility of cybersquatting, there may also be an innocent explanation,
especially if the website is still under construction. You can reserve a domain name for two years, so the fact that a
website is not up and running, even months after the name was reserved or registered, does not necessarily mean that the
registrant doesn't have perfectly legitimate plans to have a website in the future.
Before jumping to any conclusions, contact the domain name registrant. To find the name and address of a domain name
owner, you can use the "WHOIS Lookup" at whois.net. Find out whether there is a reasonable explanation for the use of
the domain name, or if the registrant is willing to sell you the name at a price you are willing to pay.
Sometimes, you may find that paying the cybersquatter is the easiest choice. It may be a lot cheaper and quicker for you
to come to terms with a squatter than to file a lawsuit or initiate an arbitration hearing: these processes cost money, and
although you may be able to recover your costs and attorney fees if you win, there is no guarantee; it's completely up to
the judge.
What You Can Do to Fight a Cybersquatter
A victim of cybersquatting in the United States can now sue under the provisions of the Anticybersquatting Consumer
Protection Act (ACPA) or can fight the cybersquatter using an international arbitration system created by the Internet
Corporation of Assigned Names and Numbers (ICANN). The ACPA defines cybersquatting as registering, trafficking in or
using a domain name with the intent to profit in bad faith from the goodwill of a trademark belonging to someone else. The
ICANN arbitration system is considered by trademark experts to be faster and less expensive than suing under the ACPA,
and the procedure does not require an attorney.

Fighting Under the ACPA


The Anticybersquatting Consumer Protection Act (ACPA) authorizes a trademark owner to sue an alleged cybersquatter in
federal court and obtain a court order transferring the domain name back to the trademark owner. In some cases, the
cybersquatter must pay money damages.
In order to stop a cybersquatter, the trademark owner must prove all of the following:
1. the domain name registrant had a bad-faith intent to profit from the trademark
2. the trademark was distinctive at the time the domain name was first registered
3. the domain name is identical or confusingly similar to the trademark, and

4. the trademark qualifies for protection under federal trademark laws -- that is, the trademark is distinctive and its
owner was the first to use the trademark in commerce.
If the person or company who registered the domain name had reasonable grounds to believe that the use of the domain
name was fair and lawful, they can avoid a court decision that they acted in bad faith. In other words, if the accused
cybersquatter can show a judge that he had a reason to register the domain name other than to sell it back to the
trademark owner for a profit, then a court will probably allow him to keep the domain name.

Using the ICANN Procedure


In 1999, after assuming control of domain name registration, ICANN adopted and began implementing the Uniform
Domain Name Dispute Resolution Policy (UDNDRP) a policy for resolution of domain name disputes. This international
policy results in an arbitration of the dispute, not litigation. An action can be brought by any person who complains
(referred to by ICANN as the "complainant") that:
1. a domain name is identical or confusingly similar to a trademark or service mark in which the complainant has
rights
2. the domain name owner has no rights or legitimate interests in the domain name, and

3. the domain name has been registered and is being used in bad faith.

All of these elements must be established in order for the complainant to prevail. If the complainant prevails, the domain
name will be canceled or transferred to the complainant, but financial remedies are not available under the UDNDRP.
Information about initiating a complaint is provided at the ICANN website.
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Pick a Winning Name for Your Business


From the Nolo Business & Human Resources Center
Choose a business name that will identify your company's products and services.
There's a lot of room for personal and professional creativity when choosing a business name, but there are three main
considerations to keep in mind:
1. Will your business name receive trademark protection?
2. Is your proposed business name available?
3. If your business will have a website, is a similar domain name available?
Will Your Business Name Receive Trademark Protection?
Trademark law will prevent another business from using a name or logo that is likely to be confused with your business
name if your business name is entitled to trademark protection. If your business is anything but a small, local, service, or
retail business, such as a dry cleaners or a fabric store, you'll probably want to take advantage of this.

Trademarks Help Companies Market Products and Services


Allowing businesses to have exclusive use of their names helps consumers identify and recognize goods in the
marketplace. For instance, when you buy Racafrax brand of wood glue, you'll know that it will be similar in quality to
the Racafrax glue you bought last time. By contrast, if any company were allowed to call their glue "Racafrax Glue," you
would never know what you were getting. By allowing just one company to use a name like Racafrax, trademark law
helps that company to build customer trust and goodwill.

Any business name used to market and identify products or services is a trademark. For example, McDonald's uses its
business name to market its hamburgers. But to qualify for trademark protection under the trademark laws, your business
name should be what trademark law considers "distinctive."

Distinctive Names Receive More Trademark Protection


Distinctive business names (such as Xerox, Quicken, and Amazon.com) are clever and memorable, and they usually
receive protection under federal and state trademark law. Common or ordinary names (such as Smith's Hardware, Tom's
Gourmet Sandwiches, and Pets.com) usually do not.
While there's no magic formula for concocting distinctive business names, they tend to be made up of surprising or fanciful
words that often have nothing to do with the underlying business, product, or service, such as Kodak film or Double
Rainbow ice cream. However, there can be a downside to coining a brand new word or using a completely arbitrary term.
Business names that have nothing to do with the underlying product or service often require extensive and expensive
marketing efforts to become established.
The best names for small businesses are those that customers can easily remember and associate with your business. For
this reason, many small businesses prefer to use words that cleverly suggest qualities about the underlying product or
service without describing them outright, such as Lending Tree for loans, Slenderella for diet food products, or The Body
Shop for personal hygiene products. These names are also considered distinctive and are therefore protected as
trademarks.

Tips for Choosing a Distinctive Business Name


Here are a few more guidelines to use in your search for a distinctive business name:

1. Make your name memorable. A creative, distinctive name will not only be entitled to a high level of trademark
protection, but it will also stick in the minds of your customers. Forgettable names are those of people (like O'Brien Web
Design), those that include geographic terms (like Westside Health Foods), and names that literally describe a product or
service (like Appliance Sales and Repair, Inc.). Remember, you want to distinguish yourself from your competitors.

2. Your name should be appealing and easy to use. Choose a name that's easy to spell and pronounce, and
that is appealing to both eye and ear. Try to pick a catchy name that people will like to repeat. Make sure that any images
or associations it evokes will suit your customer base.

3. Avoid geographical names. Besides being easy to forget, and difficult to protect under trademark law, a
geographical name may no longer fit if your business expands its sales or service area. If you open Berkeley Aquariums &
Fish, for instance, will it be a problem if you want to open a second store in San Francisco? Especially if you plan to sell
products on the Internet, you should think twice about giving your business a geographic identifier.

4. Don't limit expanded product lines. Similarly, don't choose a name that might not be representative of future
product or service lines. For instance, if you start a business selling and installing canvas awnings using the name Sturdy
Canvas Awnings, your name might be a burden if you decide to also start making other products such as canvas signs or
vinyl awnings.

5. Get feedback. Before you settle on a name, get some feedback from potential customers, suppliers and others
in your support network. They may come up with a downside to a potential name or suggest an improvement you haven't
thought of.
Is Your Proposed Business Name Available?
Once you've come up with some ideas for distinctive names, you'll need to be sure you're not stepping on an existing
name or trademark.
As a first rule, don't use part of a famous name and hope you'll get away with it because you plan to use it in a different
way, as in Microsoft Cushions, or M & M Marketing. If you attract the attention of the big guys, you'll be threatened with a
lawsuit and will most likely have to change your business name on all of your marketing material.
For not so famous names, you'll have to do a name search to find out if the same name, or similar names, are already in
use, and how they're being used. If another company is using the same or a similar name to market different products and
services, it may be fine for you to use the name for your business.
Finally, if your business is a corporation, LLC, or limited partnership, in addition to checking for existing trademarks, you
must be sure your business name isn't the same as that of an existing corporation, LLC, or limited partnership in your
state. You'll have to contact your state filing office to find out how to search their name databases.
Is a Domain Name Available That's Similar to Your Business Name?
If your business will have a website, you must decide what your domain name (the address used to identify your website)
will be. Using all or part of your business name in your domain name will make your website easier for potential customers
to find. Since many domain names are already taken, check what's available before you settle on your business name. You
can search for available domain names by visiting a domain name registrar such as register.com.

Checklist for Choosing a Business Name

Think of several business names that might suit your company and its products or services.

Check the availability of your proposed business names:

If you will do business online, check if your proposed business names are available as domain
names.

Check with your county clerk's office to see whether your proposed names are on the list of
fictitious or assumed business names in your county.

For corporations and LLCs: check the availability of your proposed names with the Secretary of
State or other corporate filing office.

Do a federal or state trademark search of the proposed names still on your list. If a proposed name
is being used as a trademark, eliminate it if your use of the name would confuse customers or if the
name is already famous.

Choose between the proposed names that are still on your list.

Register your business name:

as a fictitious or assumed business name, if necessary

as a federal or state trademark (if you'll do business regionally or nationally and will use your
business name to identify a product or service), and

as a domain name (if you'll use the name as a Web address too).

Registering Your Business Name

Once you've chosen an available business name, you may have to -- or want to -- register it with the
local, state, or federal government, depending on your circumstances. If your business is organized
as a corporation, LLC, or limited partnership, your official business name should be automatically
registered with the state when you file your articles of incorporation, articles of organization, or
statement of limited partnership. But no matter what type of business you have, you may also need
to file a fictitious or assumed business name statement and register your name for trademark
protection at the state or federal level.

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What to Do If the Domain Name You Want Is Taken
From the Nolo Business & Human Resources Center
You may find that someone else has snapped up the domain name of your dreams. Here are your options.
So you have a great idea for a domain name. It will make you millions and be the beacon by which an unprecedented
amount of Internet commerce flows your way. You're excited. You go to a domain name registrar to perform a domain
name search and, you guessed it, the name you want is already taken. What now? Don't worry, you have choices.
1. Use .net, .org, .biz, .info
If you're like most businesses, you want .com at the end of your domain name. But as you may have surmised by now,
many .com names are unavailable. However, the same choices may be available with another suffix. Some domain name
registrars will even prompt you with the .net, .biz, .info or .org choices after they tell you that your .com choice is
unavailable. However, read the caution note below to learn about the dangers of using a different suffix with a name that
is already a .com name.
2. Change the Name Slightly
A domain name is reported as not available only if the exact name is already taken. For instance, if an availability search
tells you that madprophet.com is already taken, you may find that "mad-prophet.com" or "madprophets.com" is available.
If you are not wed to the exact form of your first proposed domain name, you can experiment with minor variations until
you find an acceptable name that is available. But read the warning just below for reasons to use caution when taking this
approach.

Slight Changes to a Name Can Spell Trouble

The fact that a slightly different name is available, or that a name is not available as .com, but is
available as .net, .biz, .info or .org, doesn't necessarily mean that you can or should use it. Using a
domain name very similar to an existing one may result in trademark infringement -- the violation of
someone's trademark rights. If you infringe someone's trademark, a court might order you to stop
using the name and pay money damages to the other domain name owner.

3. Buy the Name


Domain names are bought, sold and auctioned like any other property. If the domain name you want is being used on a
successful, actively maintained commercial website, chances are slim the owner will sell it to you. However, if the name is
reserved but isn't yet being used, you may be able to get your hands on it for a price you can afford.
You can buy a domain name in a variety of ways. You can look in online classifieds, contact the owner directly and make
an offer, make a bid on an auction website (ebay.com, for example) or go through an online domain name broker, such as
GreatDomains.com.
4. Assert Your Rights If You Already Own the Trademark
If you are already in business and want to use your existing business name as your domain name, then you may have the
upper hand in a dispute with someone who's already using the name online. (Not every business name is protected by
trademark law, however. )
Under trademark law, the first person to use a trademark in commerce is considered the owner. So if you used the name
to market your products or services before the domain name registrant started using its domain name, you may be able to
prevent that registrant from continuing to use the name.
If you are a trademark holder and you want to challenge the use of a domain name, you will first need to decide on a
strategy for going after the registrant. You currently have three choices:
Use the dispute resolution procedure offered by ICANN. ICANN, the international nonprofit organization now in
charge of domain name registrations worldwide, recently implemented a process called the Uniform Domain Name Dispute
Resolution Policy (UDRP). This administrative procedure works only for cybersquatting disputes -- that is, when someone
has registered your name in a bad-faith attempt to profit from your trademark. Compared with filing a lawsuit, ICANN's
dispute resolution procedure is potentially less expensive (about $1,000 to $2,500 in fees) and quicker (just 57 days to
resolution).
File a trademark infringement lawsuit. If you take the domain name registrant to court and win, the court will order
the domain name registrant to transfer the domain name to you and may award you money damages as well. A lawsuit is
always an option, whether or not you pursue ICANN's dispute resolution process.
File a cybersquatting lawsuit. If you take a cybersquatter to court and win, you may get not only the domain name you
want, you could also win money damages from the cybersquatter.

How to Find a Domain Name Registrant

To find the name and address of a domain name owner, you can use the "WHOIS Lookup" service
at www.whois.net. Your search results will include a contact name, phone number, address and email
address for the domain name's owner.

While we've offered some suggestions here, your greatest resource will be your own imagination. For instance, perhaps a
simple letter demonstrating your ownership over the trademark, with an offer for small compensation or some other
arrangement, is all that is needed to resolve the conflict. Or, you might reach an unconventional agreement with the
holder of a desirable domain name, rather than meeting the stated purchase price. And of course, in the end, you might
just throw up your hands and decide to go back to the drawing board and make another list of names. That's fine too. Be
creative and the right solution will follow.
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Copyright 2006 Nolo

Choosing and Registering a Domain Name


From the Nolo Business & Human Resources Center
How to pick, register, and protect your website's unique address.
To do business on the Web, you'll need at least one domain name -- the .com or .net identifier that has become so
familiar (and sometimes annoying) in commercials and print advertising. You may want to take the name you use for your
business as your domain name, with .com or .net tacked on at the end -- or you might pick a new domain name that you
think will draw people to your website.
To help your website, and business, flourish, pick a domain name that:
1. is easy for Web users to remember and find
2. suggests the nature of your product or service
3. serves as a strong trademark so competitors won't be able to use a business name or domain name similar to it,
and

4. is free of legal conflicts with trademarks belonging to other businesses.

Choosing a Domain Name


The best domain names are often the simple ones -- short, memorable, clever, and easy to spell and pronounce.
Nevertheless, you must weigh the sometimes competing concerns of a Web-friendly name with the importance of obtaining
trademark protection for the name you choose.

Can You Get Trademark Protection?


Straightforward domain names that describe a business's product or service are more difficult to protect as trademarks
than distinctive and clever domain names. Many good domain names -- for instance, coffee.com, drugs.com, and
business.com -- are not eligible for much trademark protection because they aren't unique; they identify whole categories
of products or services. Likewise, domain names that use geographic identifiers or surnames are less likely to receive
trademark protection -- unless your name happens to be Dr. Koop or something equally famous.

Balance Competing Concerns to Find the Best Name


Despite limited trademark protection, ordinary domain names are potentially powerful because of the way people find
information on the Internet. For this reason, you should consider carefully whether it will benefit you more to choose a
domain name that's easy to find and difficult to protect under trademark law or one that's distinctive and easily protectible
as a trademark.
The downside to using a distinctive name created by coining a new word or using an arbitrary term (as in yahoo.com,
flooz.com, or amazon.com) is that these names require extensive marketing efforts to attract customers, since the domain
names have nothing to do with their underlying products or services.
One good balancing strategy is to choose a domain name that evokes a website's product or service but isn't too ordinary,
such as medscape.com, askjeeves.com, or inc.com. Domain names like these are eligible for trademark protection, and
customers should be able to easily remember and associate these names with your business.
Another good strategy may be to use one distinctive domain name, such as peets.com, and one generic domain name,
such as coffee.com, to represent that same site.
Finding a Name That Hasn't Been Taken
Your toughest task when picking a domain name is likely to be finding a name that's available; millions of names have
been snapped up already. For example, if your business name is Flaky Cakes, you may find that FlakyCakes.com already
belongs to someone else. In that case, you'll have to use a different domain name (and maybe change your business
name) or pursue other options for securing the domain name you want.
The best way to find out whether your business name is available as a domain name is to use the search engine at
www.networksolutions.com. Type the name you want, select an extension to the right of the box (which will be .com for
most users), and click "Search." You will then get a message telling you whether or not the name is available. If it's
unavailable, scroll down to find similar names that are available.
Your domain name is at risk if it legally conflicts with (is the same as or very similar to) any one of the millions of
commercial trademarks that already exist. To protect yourself, do a trademark search.
Registering Your Domain Name
After you've picked a domain name that's legally safe, go online to register your find with a domain name registrar, such
as register.com. (If you'd like to do some comparison shopping, a list of approved domain name registries is offered at
www.internic.net/alpha.html.) Registration costs $35 for the first year, and $30 for each following year.
In addition to registering your business name as a domain name, you may want to register the names of your products or
services, or other related names. For example, if you design and sell gourmet aprons, and your primary domain name is
countrystyle.com, you might also want to register aprons.com so that customers who are looking for aprons and enter
"aprons" into their browser will land at your site.
It's also a good idea to register common misspellings of your primary domain name and of the names that reflect the
nature of your products or services. Keep in mind, however, that it's illegal to register a domain name solely for the
purpose of blocking someone with a legitimate right to the domain name from using it.
Applying for Federal Trademark Protection
Once you settle on and register a domain name, you should apply for trademark protection with the Patent and Trademark
Office (USPTO). While you don't need to register your trademark with the USPTO to establish your rights to your domain
name, doing so strengthens your power to enforce your rights against anyone else who tries to use the name to market
similar goods and services, and prevents someone else from registering the same name with the USPTO. This may prevent
a lot of headache in the future.
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Copyright 2006 Nolo

Avoid Trademark Infringement When You Choose a Domain Name


From the Nolo Business & Human Resources Center
How to choose a domain name and stay out of trouble.
In theory, choosing a domain name is simple. If it is memorable, pronounceable, short, clever, easily spelled and suggests
the nature of the commerce on your website, you've got yourself a winner. But even if your choice is brilliant from a
marketing standpoint, it may not be so smart from a legal perspective.
If you choose a domain name that conflicts with any one of the millions of commercial names that already exist, you risk
losing it. And if you've put money and sweat into marketing your website and then are forced to give the domain name up,
your Web-based business is likely to suffer a damaging, if not fatal, blow.
The rules for understanding whether a legal conflict exists comes from trademark law. Here are the basics you need to
understand:
1. Names that identify the source of products or services in the marketplace are trademarks.
2. Trademarks that are clever, memorable or suggestive are protected under federal and state law.
3. Trademarks that are descriptive and have achieved distinction through sales and advertising can be protected
under federal and state law.
4. One trademark legally conflicts with another when the use of both trademarks is likely to confuse customers
about the products or services, or their source.
5. In case of a legal conflict with a later user, the first commercial user of a trademark owns it.
6. If a legal conflict is found to exist, the later user will probably have to stop using the mark and may even have to
pay the trademark owner damages.
Customer Confusion
Applying these principles to your domain name selection, you are at risk of losing your chosen domain name if the owner
of an existing trademark convinces a judge or arbitrator that your use of the domain name makes it likely that customers
would be confused as to the source or quality of the products.
Sometimes similar domain names can cause customers to buy different goods or services than what they intended to buy.
For instance, suppose, on the recommendation of a friend, you decide to purchase Lee's famous Flamebrain barbecue
sauce, which is sold only on the Web. You intend to type "flamebrain.com" into your browser but accidentally enter
"flamerbrain.com" instead. You get a website run by Henry, who has both copied Lee's idea to offer a barbecue sauce for
sale on the Web and, with a very minor variation, the name of Lee's sauce. You order two bottles, completely unaware that
you ordered the wrong product from the wrong website. You get a barbecue sauce that is much inferior to Lee's famous
sauce.
Protected Trademarks
Customer confusion matters only if a domain name that's similar to the one you want to use is a protected trademark. To
be protected, a trademark must be distinctive. A name may be distinctive because it is made up (chumbo.com for an
online software store), arbitrary in the context of its use (apple.com for computer products), fanciful (ragingbull.com for
investment advice) or suggestive of the underlying product or service (salon.com for an online magazine). If a domain
name uses surnames, geographic names or common words that describe some aspect of the goods or services sold on the
website (healthanswers.com for online health information) it is ineligible for trademark protection unless the owner can
demonstrate distinction through substantial sales and advertising. If the trademark owner has been able to register a
name with the U.S. Patent and Trademark Office, it is probably distinctive.
Many domain names -- for instance, coffee.com, drugs.com and business.com -- are potentially powerful domain names,
but they're generic. That is, they describe whole categories of products or services. Generic terms can never be
trademarks.
Avoiding Trouble
The way to choose a domain name that satisfies your own marketing needs and doesn't get in the way of anybody else's
trademark rights is to search as many existing trademarks as possible, spot possible conflicts and then pick a name that's
unlikely to generate a nasty lawyer's letter.
The first place to go for possible conflicts is the trademark database of the U.S. Patent and Trademark Office at
www.uspto.gov. Searching this database gives you all registered trademarks and all trademarks for which registration is
pending. You should search not only for your proposed mark but also for other marks that are logically close, such as
synonyms and variant spellings, such as barbeque and barbecue. In addition, you should also search the Internet at large
and any business name registers, such as Thomas Register Online at www.thomasregister.com.
If your search turns up any names that are the same or similar to your proposed domain name, ask these questions:
1. Will your website offer goods or services that compete with the goods or services being sold under the similar
domain name?
2. Will your website offer goods or services that typically are distributed in the same channels as the goods or
services being sold under the similar domain name? This would be the case, for instance, if you plan to offer sports
equipment on your website, and the owner of the possibly conflicting name sells sports clothing.
3. Could your website divert business away from the site with the similar name? Is your domain name so similar to
the other domain name that users might end up on your website by mistake?
4. Is the other name well known?
If the answers to all these questions are no, you can feel reasonably free to go ahead and use your domain name without
fear of creating a legal conflict. If you answer yes to any of them, there will be some risk of a legal challenge down the
road. If you aren't sure, take an informal poll of friends. Would they be confused by the simultaneous use of the two
names? Might they end up on the wrong website? Another option is to run the possible conflicts by a trademark attorney.
Although you can anticipate that the attorney will be more conservative than is actually necessary, you still may benefit
from having a trained eye go over your circumstances.

Domain Name Bullies

Sometimes a powerful company tries to force a smaller one to give up a domain name that was
legally acquired in good faith by the smaller company. Because trademark conflicts are ultimately
resolved in court, a business that can easily afford to pay lawyers is in a powerful position to sue the
smaller company for trademark infringement (assuming there is any basis for doing so, which there
usually is). When the smaller company realizes that it will cost tens of thousands of dollars to defend
the suit, the big guy proposes a settlement under which the small company parts with the name for a
relatively meager sum. In other words, the powerful company ends up getting what it wants simply
because the court system is manifestly unfair to those who can't afford attorneys.
There are strategies to fight this sort of bullying. If the small company has the resources, of course,
it can mount a defense and actually win. In addition, the Internet community has been extremely
hostile to online bullies, and out-of-court campaigns sometimes make them back down. For more on
this issue, visit the Domain Name Rights Coalition at www.domainnamerights.org
.

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Make Sure Your Proposed Business Name Is Available


From the Nolo Business & Human Resources Center
Find out if your desired business name is free for you to use.
Now that you've picked the perfect business name, can you go ahead and use it? Not without doing your homework first.
You must make sure that you aren't treading on someone else's rights to the name.
Trademark Law
To stay out of trouble, you should understand the basics of trademark law, which prevents a business from using a name
that is likely to be confused with the name of a competing business. If you choose a business name that's too similar to a
competitor's name, you might find yourself accused of violating the competitor's legal rights (called "trademark
infringement" or "unfair competition"), and you could be forced to change your business name and possibly pay money
damages.
There's only one way to ensure that you won't violate someone else's trademark rights: Do some digging to find out
whether another business is already using a name that's identical or similar to the one you want to use.
Conducting a Name Search
Unfortunately, there's no one place to look when searching for conflicting business names. In large part, this is because a
business can establish a trademark simply by using it -- and millions do just that. You must use different search tactics to
hunt for both registered and unregistered trademarks.

Do a Quick Screening Search First

Before you invest too much time and money in a formal name search, take a few minutes to
quickly screen out some of the names on your list. Type a name you're thinking of using into your
favorite search engine, such as Google or Altavista. You can quickly see whether someone else on the
Web is using a similar name to market similar products or services.

Fictitious Name Databases


First check with your county clerk's office to see whether your desired name is already on the list of fictitious or assumed
business names in your county. (In a few states, there is just one statewide fictitious name database -- if that's the case in
your state, your county clerk will tell you.) This list will contain names that you won't find in any other database -- usually
unregistered trademarks of very small companies. If you find that your chosen name (or a very similar name) is listed on a
local fictitious or assumed name register, you shouldn't use it.

Corporation, LLC, and Limited Partnership Name Databases


If you're organizing your business as a corporation, LLC, or limited partnership, you must be sure your business name isn't
the same as that of an existing corporation, LLC, or limited partnership in your state. Contact your state filing office to find
out how to search their name database. If your proposed name (or a very similar one) shows up in your state's database,
you'll have to choose another.

Unregistered Business Names


The Internet is a good place to start your search for unregistered business names. By using several Internet search
engines, such as Google and Overture, you can quickly see whether and how someone else is using a specific name.
A particularly useful (and free) resource for finding unregistered trademarks is the Thomas Register website at
www.thomasregister.com. It's a cross-industry database that includes hundreds of thousands of trademarks and service
marks. But keep in mind that any particular list you use to search for unregistered marks, including the Thomas Register,
is likely to be incomplete. It's best to use several different methods to search for unregistered trademarks.
Another easy way to look for business names online is to go to the Network Solutions website at
www.networksolutions.com and key in variations of the name you want to use. If another company has reserved a domain
name that contains your desired business name, chances are you won't be able to use it, assuming the domain name
qualifies as a trademark -- and it will as long as the underlying website is used commercially.

Registered Trademarks
Finally, everyone starting a business, no matter how small, should search the federal trademark database to determine
whether the name they want to use has already been registered with the U.S. Patent and Trademark Office (USPTO). If
you don't, and you use a trademark that's on the federal register and the trademark owner sues you, you can be liable for
what's called "willful infringement" -- that is, knowingly violating someone else's trademark, even though you didn't
actually check the federal database. Willful infringement carries more costly penalties than other types of trademark
violations. Plus, it's easy to search for federally registered trademarks.
You can search for federally registered trademarks by using the free trademark database on the USPTO's website. To start,
go to the USPTO's Trademark Electronic Business Center at http://www.uspto.gov/main/trademarks.htm and choose
"Search." Then follow the instructions you see on the screen.
In addition to checking the federal trademark register, it's a good idea to check your state's trademark database. The state
register is often part of the Secretary of State's office, though in some states it has a department of its own. You can also
check one of several sites that search for trademarks registered in all 50 states, such as trademark.com or
nameprotect.com. This is an especially good idea if you'll be doing business in more than one state.
Analyzing Your Search Results
If, after your search, you determine that the name you've chosen (or a similar name) does not already belong to someone
else, you can go ahead and use it.
On the other hand, if your search turns up an identical or similar name to the one you want to use, you may or may not be
able to use it, depending on the circumstances.
As a first rule, if your desired name uses part of a well-known or heavily marketed trademark, pick a new one right away.
Don't risk the expense of a possible fight with a big corporation, not to mention the costs of changing the name on all of
your business materials.
Also, if your desired name uses part of a name that's already registered for official trademark protection, especially at the
federal level, you should take that as a "No Trespassing" sign and pick another name -- even if the name isn't very well
known. Owners of federally registered trademarks have the right to use their trademarks anywhere in the country, and it is
easy for them to bring and win lawsuits against trademark violators.
That said, there are a few instances when taking a name that's already in use is okay (as long as the name isn't famous).
If the name is being used by a company that provides a very different product or service than the one you plan to sell,
then you can probably move forward with your plans to use the name. This is especially true if the two businesses serve
only local markets and are hundreds of miles apart.
The key here is whether your use of the name, or something similar, would confuse customers about the origin of the
product or service. For example, just because a plumbing business in Coos, Oregon, calls itself Z-Pop doesn't mean you, in
Arizona, can't use Z-Pop as the brand name for your soda pop. That plumbing business in Oregon is not your competitor
and your use of Z-Pop for soda pop will not likely confuse customers into thinking that your soda pop is related to the
plumbing business. On the other hand, if Z-Pop is being used to market another soda pop product, you should choose a
different name.

Consider Registering Your Name as a Trademark

Once you've found an available name, you may want to take advantage of the extra protection
that registering your name as a trademark can give you. While it's not required, registering your
name as a trademark can help prevent a competing business from using a name that's likely to be
confused with your business name.

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Registering Your Business Name


by Attorney Bethany K. Laurence
From the Nolo Business & Human Resources Center
You may need to register your business name with the local, state, or federal government -- especially if it's
considered fictitious.
The name of your business is one of its most important assets. Once you've done the hard work of choosing your name
and making sure that it's available for your use, you'll want to protect it in every way you can. This means following local
and state laws that govern when you must register a fictitious (or assumed) business name. It also means filing for
trademark protection at the state and federal level, if appropriate.
Registering the Name of a Corporation, LLC, or Limited Partnership
If your business is organized as a corporation, LLC, or limited partnership, in most states you automatically register your
business name when you file your articles of incorporation, articles of organization, or statement of limited partnership
with your state filing office. This ensures that no other corporation, LLC, or limited partnership in your state will be able to
use the same name.
However, even though your official business name is automatically registered, if you plan to sell products or services under
a different name, you must file a fictitious name statement with the state or county where your business is headquartered.
Registering a Fictitious Business Name
Any business that doesn't use its legal name (the official name of the person or entity that owns the business) as part of
its business name must comply with fictitious or assumed business name requirements. This means registering the name
with a government agency -- sometimes the state, but usually your county clerk's office.

Examples of Fictitious Business Names

Jason Desmond names his sole proprietorship "Perini Mountain Appellations." He must register the
name "Perini Mountain Appellations" as a fictitious business name because it doesn't contain his last
name, "Desmond."
Three partners named Gibbons, Armstrong, and Anderson are trying to decide whether to call their
partnership "South Bay Accounting" or "Gibbons & Armstrong." Either way, they will have to file a
fictitious name statement because the name won't contain the last names of all three owners.
The owners of Northern Colusa County Auto Mechanics' Ltd. Liability Co. decide to operate a repair
shop under the name "Grease Monkeys." The name "Grease Monkeys" is a fictitious business name,
and the LLC must register it.

Why You Must Register Your Fictitious Business Name


States like to keep track of fictitious business names for a couple of reasons. One is to prevent customer confusion
between two local businesses that use the same name. Another reason is to give customers a quick way to determine the
owner of a company without having to hire a private investigator. This allows customers to easily contact the owners with
a complaint or to take legal action against them.
There are plenty of reasons not to shrug off this requirement, the most practical being that many banks won't open an
account under your business name unless you have proof that you have properly registered the name. Perhaps even more
important, you won't be able to enforce any contract that you sign under the name. Finally, if you don't register your
fictitious name, you aren't giving other businesses notice that it's already in use. If a competing business can't find out
that you're already using the name, it might take it for its own -- and possibly take away some of your business as well.

How to Register Your Fictitious Business Name


In a few states you register your fictitious business name with the Secretary of State or other state agency, but in most
states, including California, you'll register it at the county level. The result is that each county in your state may have
different forms and fees for registering a name. The best thing to do is call your county clerk's office to find out its
procedures, requirements, and fees.
Though procedures vary, it's usually fairly easy to register a fictitious business name. Many states require you to begin by
searching the county or state fictitious name database to be sure that you aren't trying to register a name that's already in
use. Once you're sure the name is available, you must obtain a name registration form (over the phone, in person or from
the office's website) and submit it with the correct filing fee, typically $10 to $50. Finally, depending on your state's law,
you may have to publish your fictitious name in a newspaper and then submit an affidavit (sometimes called a proof of
publication) to the county clerk or state agency to show that you have fulfilled the publication requirement. Your local
newspaper should be able to help you with this filing if it's required in your state.
Registering Your Business Name as a Trademark
If your business is anything but a small, local service business, registering your name as a trademark is a good idea. It's
not required by law, but trademark registration can provide powerful protection if another business later tries to use your
business name, or one that's confusingly similar.
Registering your name as a trademark in your state can help prevent another business in the same state from using a
name that's likely to be confused with your business name. But if you plan to market your service or product in more than
one state -- or across territorial or international borders -- it's wise to file an application for federal trademark protection
as well. Registering your business name with the U.S. Patent and Trademark Office puts the rest of the country on notice
that the name is already taken, and it makes it easier to defend your name against would-be infringers.
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State Start-Up Requirements


From the Nolo Business & Human Resources Center
Yet another governmental level to deal with.
You can bet that the state where you’re starting your business will have bureaucratic hoops for you to jump through.
These may range from filing organizational papers and getting a license for your occupation to tax registration and
environmental compliance.
Regulated Occupations and Products
You probably know that states give licenses to people practicing the traditional professions, such as lawyers, doctors,
accountants, teachers, architects, and engineers. States also license people in a broad range of trades, from auto
mechanics and barbers to real estate agents and tax preparers. Sometimes licenses are issued to the business, while other
licenses are taken out by the individual. You can’t guess which occupation needs a license, so you’ll just have to ask. Your
state website or trade association is a good place to start.
The licensing procedures will vary, but you’ll probably have to show evidence of training in the field, and you may have to
pass a written exam. Sometimes you have to practice your trade or profession under the supervision of a more
experienced person for a while before you become fully licensed. Some licenses are good for a limited period before there
is retesting. Others require proof of continuing education in the field.
The state may also want you to get a license if you make or sell certain products, such as liquor, food, lottery tickets,
gasoline, or firearms.
Tax Registration
If you’re engaging in retail sales, you probably need to register for or get a sales tax license or seller’s permit. This lets
you collect sales taxes from your customers, which you'll pay to the state. You need this permit even if you’re also selling
goods that are exempt from your state’s sales tax. When the time comes, you’ll owe tax only on the taxable sales. If your
business both sells products and performs services, it will be important to keep your labor sales separate from sales of
goods, since sales of services aren’t usually taxed (only in some states).

Five states do not impose general sales taxes. In Alaska, Delaware, Montana, New Hampshire, and Oregon, you
may not be required to get a state sales permit. However, cities and counties in those states may issue sellers' permits and
charge sales taxes. Further, some transactions may be subject to something similar to a sales tax, although it has a
different name. Your state tax agency can tell you the specifics.
You’ll probably have to register with your state’s treasury department or department of revenue, except in the few states
that still assess no taxes on income. You may also have to register for other business taxes.
Business Entity Filings
If you’ve chosen to start out your business as a corporation , limited liability company (LLC), or limited partnership, you’ll
need to file organizational documents with your state’s Secretary of State, Department of Corporations, or similar office.
Most states have sample or form documents online.

If you share ownership of your business with investors or other owners who do not help you run the business, you
may need to comply with state (and federal) securities laws.
If you’re starting off with a partner (a partnership) or by yourself (a sole proprietorship), you may not have any state filing
to do. An ordinary partnership is created automatically when you agree to go into business with someone, so you don’t
legally have to write anything down. However, a written partnership agreement is generally a good idea, as a record of the
terms of your agreement.

Register Your Fictitious Business Name

Sometimes your business name doesn’t contain your legal name as the owner (for a
sole proprietorship or general partnership) or doesn’t match the company name
that’s on file with the state (for a corporation, limited partnership, or LLC). That’s
variously called a fictitious business name (FBN), assumed name, DBA (“doing
business as”), or trade name, and you must register it.
Depending on your state, sometimes you register directly with the state, although
you usually register with the county clerk in the county where your business is
located. (This registration may also be called a certification or filing.) The name will
go on a state FBN list.

Employer Responsibilities
If you have employees, you may have to register with your state department of labor or with the agencies that administer
the laws on unemployment compensation and workers’ compensation. In addition, if your state has a version of the federal
Occupational Safety and Health Act (OSHA), your business may need to meet certain mandated health and safety
requirements.
A business with employees or independent contractors has a number of tax requirements. To start with, you will need an
employer ID from state (and federal) tax authorities. After you get started, you’ll have to withhold income taxes and
employment taxes (Social Security/Medicare or "FICA") from the paychecks of employees. You may also need to withhold
other items, such as payments for disability insurance. You report these figures (to the employee, the state, and the IRS)
and pay the withheld taxes to the tax authorities. If you hire independent contractors, you need to report contract
payments annually on a Form 1099, which goes to the contractor and to the government.

Don’t forget to pay the taxes you withhold. Many small businesses get into big trouble by failing to pay the
employment taxes after their cash flow hits a dry spell.
Environmental Regulations
Many small businesses need to think about what they must do to avoid contaminating the environment. You may need a
special permit (and do more record keeping) if any of the following apply to your business:
1. Your equipment vents emissions into the air.
2. You need to discharge or store waste water.
3. Your business involves or produces hazardous wastes.
Environmental regulation isn’t limited to manufacturers. Small businesses, such as stained glass makers, dry cleaners, and
photo processors, need to know how to dispose of the dangerous metals or chemicals used in their work.

Helpful State Websites

Your state's Small Business Development Center (SBDC) or other agency may offer a "one-stop
shopping" website that advises you on the licenses and permits you need for your particular type of
business. For instance, California offers a website (www.calgold.ca.gov) that will provide you with a
list of all federal, state, and local permits you need for your particular business. The Small Business
Administration maintains a list of SBDCs at www.sba.gov/sbdc.

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Local Start-Up Requirements for Small Businesses
From the Nolo Business & Human Resources Center
Make sure you follow city and county rules.
When you’re starting a small business, pay attention to your town, city, and county regulations. You can begin by asking
city and county officials about license and permit requirements for your business.
Ask Your Bureaucrat
If your city does not have a centralized office that provides business start-up information (and only a few large ones do),
there are bound to be many other offices with lots of helpful information for you:
1. the city clerk and the county clerk
2. the building and safety department
3. the health department
4. the planning or zoning department
5. the tax office
6. the fire department
7. the police department, and

8. the public works department.

The assessor or treasurer can tell you about local taxes on property, fixtures, equipment, inventory, and income or gross
receipts. The health department can advise you about permits and regulations if your business involves food preparation.
It also needs to test your water if you work in an area where water comes from wells or goes into septic systems.
The police, fire or building and safety departments can help you with issues of crowd control and safe exit from your
premises. The fire department will also be concerned about combustible materials used or stored on your business
premises.

Unofficial but often extremely helpful sources of information include: the local chamber of commerce, trade
associations, contractors who remodel commercial space, other people with businesses like yours, and lawyers who advise
small businesses.
Business Licenses, a.k.a. Tax Registration Certificates
In most locations, every business needs a basic business license, sometimes called a tax registration certificate. You
usually get the business license from your city or county. However, you may need other permits and licenses as well. No
single business license ensures compliance with the numerous licenses, permits and regulatory requirements that apply to
small businesses.
Fictitious Business Names
You may have to register a fictitious business name (the name you do business under, if it does not include your name as
the owner) with the county clerk in the county where your business is located. Picking a fictitious business name that no
one else is using may involve some research.
Zoning Ordinances
Before you sign a lease, you absolutely need to know that the space is properly zoned for your usage. If it’s not, you’d
better make the lease contingent on your getting the property rezoned or on your getting a variance or conditional use
permit from the planning department. In some communities, you must have a zoning compliance permit before you start
your business in a given location. Zoning laws may also regulate:
1. off-street parking
2. water and air quality
3. waste disposal, and

4. the size, construction, and placement of signs.


If you are looking at property in a historic district, you may even need approval to change the color of paint or to modify
the building’s exterior.

Consider your position. Keep in mind that you may trigger an investigation of zoning compliance when you apply
for a construction permit for remodeling or when you file tax information with the municipality.
Building Codes
For anything but the most minor renovation, you’re likely to need at least one permit from the department that enforces
building ordinances and codes. (This is usually called the building and safety department, but sometimes another
department, or more than one department, enforces the state building code and the local ordinances.) You may need
separate permits for electrical, plumbing, heating, and ventilating work.
Building codes are amended frequently, and each revision seems to put more requirements on the building owner.
Municipalities often exempt existing businesses from having to bring their premises “up to code” at each revision. This is
sometimes called “grandfathering,” which is slang for not applying new rules retroactively.

Grandfathering can create surprises. You may look at space in an older building and figure that you’ll have no
problems doing business there because the current or most recent tenant didn’t. But the prior occupant may have been
“grandfathered in.” A change in occupancy or ownership may end the benefits of grandfathering, and a new occupant or
owner may be required to make extensive improvements. Don't get caught in this trap! An experienced contractor can help
you determine the building and safety requirements that apply to a particular space, and the probable costs of compliance.
Environmental Issues
Increasingly, environmental concerns are being addressed by regional (multi-county) agencies rather than by (or
sometimes in addition to) the state or local government. This is particularly true in the following areas:
1. air pollution
2. waste water discharge or storage, and

3. hazardous materials storage or disposal.

Your business may need a permit or license from the regional authority that governs water quality, allocation, or
treatment.
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Federal Start-Up Requirements for Small Businesses


From the Nolo Business & Human Resources Center
Big Brother loves paperwork. Find out what you have to submit to the federal government.
Before a small business can legally begin, it needs to take care of a number of pesky requirements with governmental
agencies, from the city to the state to the federal government. None of these requirements are difficult or even terribly
time-consuming. But finding out what you need to do can be like putting together a jigsaw puzzle without knowing what it
will look like. Below, we set out a general outline of these requirements at the federal level.

Why Am I Filling Out All These Forms?

The various permit and license requirements for new businesses have three main
purposes:
1. to identify your business and make sure you're accountable for your actions
2. to protect the public health and safety, and

3. to keep track of your finances for tax purposes.

Tax Registrations
You should know about two kinds of federal tax registrations. The first is the Application for an Employer Identification
Number (EIN), Form SS-4, which is available free at www.irs.gov. All corporations, limited liability companies (LLCs), and
partnerships, as well as sole proprietors who will hire employees, need to apply for EINs.
Although using an EIN is a good way to keep your business and personal affairs separate, the IRS doesn't like to give an
EIN to a sole proprietor without employees. In that case, you will probably use your own Social Security number rather
than a separate EIN.
Second, if your business is a corporation and you want to elect status as an S corporation (for special tax treatment), you
need to file Form 2553, Election by a Small Business Corporation, also available at www.irs.gov.
Licenses for Regulated Businesses
You’re not likely to need a federal license or permit unless your business activity or product is supervised by a federal
agency, such as:
1. public transportation and trucking (the Motor Carrier Safety Administration)
2. investment advice (the Securities and Exchange Commission)
3. preparation of meat products or production of drugs (the Food and Drug Administration), or

4. tobacco products, alcohol and firearms (the Bureau of Alcohol, Tobacco and Firearms in the U.S. Treasury
Department).
Environmental Regulations
It’s possible that you’ll become involved with environmental regulations at the federal level (overseen by the
Environmental Protection Agency, or EPA). For example, you may buy a piece of contaminated industrial property that
needs cleaning up, or you may need a license to dispose of toxic by-products from your manufacturing process. For more
information, go to the EPA's Small Business Gateway at www.epa.gov/smallbusiness.
Securities Registration
If you're starting out your business as a corporation, a limited liability company or a limited partnership, and you'll be
sharing ownership with people who will not be actively working in the business, you may need to comply with federal (as
well as state) securities laws.
Securities laws are meant to protect investors from unscrupulous business owners. They require businesses to register the
sale of certain kinds of ownership interests with the federal Securities and Exchange Commission (SEC). This registration
takes time. It typically involves extra legal and accounting fees.
Fortunately, many small corporations get to skip the registration process because of securities "exemptions." For example,
SEC rules don't require a corporation to register a "private offering," which is a nonadvertised sale of stock to either:
1. a limited number of people (generally 35 or fewer), or

2. those who, because of their net worth or income earning capacity, can reasonably be expected to take care of
themselves in the investment process.
If you and a few associates are setting up a business that you'll actively manage, you will no doubt qualify for an
exemption, and you will not have to file any paperwork. For more information about federal exemptions, visit the
SEC's website and read their small business Q & A at www.sec.gov/info/smallbus/qasbsec.htm.
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Pick a Legal Location and Avoid Zoning Trouble


From the Nolo Business & Human Resources Center
Be sure your chosen location allows your type of business.
Legally speaking, it's far less important whether a certain spot is a good one for your business than if it's properly zoned
for what you plan to do. The first thing to remember is that you should never sign a lease for a business space without first
knowing that you'll legally be able to do business there. (One exception to this is that it's okay to sign a contingent lease,
with a clause stating that the lease won't be binding if you don't get zoning approval.) Being forced to move your business
is a headache enough, but not nearly as catastrophic as being held liable for payment on a lease for a space that you can't
use.
As you may know, local zoning laws (often called ordinances or land use regulations) prohibit certain activities from being
conducted in particular areas. For instance, a nightclub wouldn't be allowed to operate in a district zoned for residential
use. Sure, only a fool would try to open a disco on a quiet residential street, but there are less obvious zoning no-nos that
you need to observe.
Zoning ordinances typically allow certain categories of businesses to occupy each district of a city or county; mixed
commercial and residential uses might be allowed in one district while another district allows heavy industry and
warehouses. So if you open your small jewelry-making business in a space zoned for commercial use, you could be in for a
real headache if zoning officials decide you're a light-industrial business not allowed to operate in a commercial district.
Besides regulating the types of businesses in certain areas, zoning laws also regulate specific activities. Depending on your
area, you might be subject to laws regulating parking, signs, water and air quality, waste management, noise, and visual
appearance of the business (especially in historic districts). And in addition to these regulations, some cities restrict the
number of particular types of businesses in a certain area, such as allowing only three bookstores or two pet shops in a
particular neighborhood. Finally, some zoning laws specifically regulate home businesses.

Expect Zoning Laws on Parking Spaces and Business Signs

Local zoning laws commonly require a business to provide parking. They also may regulate the size
and type of business signs. Be prepared for your city or county to look into both these issues. If
there's already a parking problem in your proposed area, you may have to come up with a plan for
how to deal with the increased traffic your business will attract. Also be ready for zoning officials to
get really nitpicky about your business sign. Many local laws limit the size of business signs (no signs
over 5 feet by 3 feet, for instance), their appearance (such as whether they're illuminated, flashing,
colorful, or made of neon), and their placement (flat against the building, hanging over the sidewalk,
or mounted on a pole). There are even some regulations attempting to limit the use of foreign
language on signs. Be sure to find out what your local regulations are before spending money on
having signs made.

One of the key things to understand about zoning laws is that more often than not, they're enforced for the sake of the
other people and companies in the neighborhood (this is particularly true of home-based businesses). While some areas
are strict about their zoning laws, most of the time you won't have a zoning official knocking unannounced on your door
unless neighbors have complained or you're in flagrant violation of the laws. Since enforcement is often triggered by
complaints, it's a good idea to get to know your neighbors and develop good relationships with them.
In most areas, zoning laws are created and monitored by city and county planning departments. Look under "planning" or
"zoning" in the government section of your phone book.

For answers to zoning questions, never rely on what the previous occupants of the space did. Don't assume
that you'll be allowed to do a certain activity simply because the previous tenants did it. For all kinds of reasons, some
businesses get away with zoning violations, even for long periods of time. Typically, however, new occupants are
scrutinized more carefully than existing businesses. It may not be fair, but it's common for a new business to be told it
can't do what an old one had long been doing.
It's also possible that the previous tenants, without violating the zoning rules, were doing something that is no longer
allowed in the area. For example, the previous occupants could have had a zoning variance (an exception to zoning laws)
for their particular business -- one that won't apply to you. And lots of times zoning laws change, but businesses that are
already in a space are allowed to keep doing what they were doing, even if the activity violates that new zoning law (a
system referred to as "grandfathering"). When a tenant with a grandfathered exception leaves and new occupants come
in, the new business will normally have to abide by the new law.

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Dealing With Zoning Problems


From the Nolo Business & Human Resources Center
If you've found a spot that's perfect -- except that it lacks the zoning you need -- you may be able to work the
situation to your favor.
Once you've found a location that meets the needs of your business, it can be quite a disappointment to discover that it
may not be properly zoned for what you want to do there. Fortunately, an unfavorable zoning situation doesn't necessarily
mean you're out of luck. There's a certain amount of administrative discretion under building codes and zoning ordinances
-- enough that it can help greatly to have the administrators on your side. Here are some ideas for accomplishing this.
Seek Support from the Business Community
If you employ local people and will contribute positively to the economy, it may pay to make contact with city or county
business development officials or even the chamber of commerce. If they see your business as an asset and don't want
you to locate in the next city, they may be helpful in steering you through the building and safety department and may
even advocate on your behalf before zoning and planning officials. Trade associations and merchants' associations may
also come to your aid if you need building and safety officials to decide in your favor in an area in which they have some
administrative discretion. Finally, contractors, lawyers, and others who are familiar with the system and the personalities
often know how to get things done and can be helpful to you.
Appealing an Adverse Ruling
The decision of a zoning or building official isn't necessarily final. If you get an adverse decision from the local Planning
Commission, for example, you may be able to have a board of zoning adjustment or board of appeals interpret the zoning
ordinance in a way that's favorable to you. Alternatively, you may be able to obtain a variance (a special exception to a
zoning law) if a strict interpretation of the ordinance causes a hardship. In some cases, you can get a conditional use
permit, which lets you use the property in question for your kind of business as ling as you meet certain conditions set
down by the administrative panel.
In dealing with administrators and especially with appeals boards, it's important to have the support of neighbors and
others in your community. A favorable petition signed by most other businesses in your immediate area or oral
expressions of support from half a dozen neighbors can make the difference between success and failure at an
administrative hearing. Conversely, if objectors are numerous and adamant, you may not get what you're after. So if you
sense opposition developing from those living or doing business nearby, try to resolve your differences before you get to a
public hearing -- even if it means you must make compromises on the details of your proposal.
Going to Court
Every day, hundreds if not thousands of interpretations and applications of building and zoning laws are worked out
through negotiation with administrators and through administrative appeals. But if these channels fail, it's possible in many
instances to go to court. This can be very expensive and time-consuming. What good is it if you win your battle for a
permit to remodel your premises but you waste two years getting to that point? Still, there are times when what you're
seeking is so valuable and your chances of success are so great that you can afford both the time and money to get a
definitive ruling from the courts. And in some instances, you can get a court to consider your dispute fairly quickly. If, for
example, you submitted plans to the city that complied with all building and safety codes, and the building official refused
to issue a building permit unless you agreed to put in some additional improvements you believe are not required by the
ordinance, you could quickly go to court asking for an order of "mandamus" based on the fact that the administrator
wasn't following the law.
Before you consider court action, however, get as much information as you can about the cost of litigation, how long it will
take (you can win in the court trial, but the city might decide to appeal), and the likelihood of your ultimate success. This
is a specialized corner of the law, so you're going to need someone who's had experience in the field -- and there may not
be that many to choose from in any given location. Look for a lawyer who's represented a similar business in a dispute
with the city or someone who formerly worked as a city attorney and knows all the ins and outs of the local ordinances.

Example: How Strategic Planning Pays Off

Shelby, owner of Small World Books, is delighted to learn that the drugstore next door is going out of
business. He immediately seeks to buy or sign a long-term lease for the building so he can expand
his profitable business. The future looks rosy.
Not so fast. Shelby learns that for his new business use of the building, he'll have to supply eight
parking spaces to get a permit. Doing this in his desperately crowded neighborhood is totally
impossible at anything approaching an affordable price.
Instead of giving up, Shelby asks the city planning commission for a variance to waive the parking
spaces rule. A public hearing is scheduled. Shelby knows he has to put on a persuasive case, so he:
1. Calls hundreds of local writers, publishers, critics, educators and book lovers to pack the
hearing and testify that an expanded bookstore will be a great community resource.
2. Documents the prohibitive cost of buying or leasing the required parking spaces.
3. Offers to validate at a parking at a lot four blocks away, just outside the worst of the
congested area.
4. Hires an architect who determines that a heavily used, nearly public garage can
accommodate 20 more cars if the parking spaces are striped differently.
5. Offers to pay for the re-striping.
Shelby gets the variance.

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Tips for Assessing the Cost of the Rental


From the Nolo Business & Human Resources Center
The true cost of a rental is not always the monthly rent.
Once you’ve found space that looks promising and worth pursuing, it’s time to figure out the true cost of the rental. You
might ask, isn’t the monthly rent all you need to know? Unfortunately, it’s not that simple. For starters, with commercial
space, the monthly rent can be a complicated figure, composed of various factors and calculated in downright Byzantine
ways. And there are other expenses, which may not be called rent, but nevertheless feel like rent when you pay them on a
regular basis. On the positive side, if you’re lucky, there may even be some savings -- like free rent for the first month or
two -- that should be taken into account.
There are at least two important reasons to determine the true cost of leasing a given space. First, you need to make sure
that the cost fits your budget. Second, if you’re comparing two or three different spaces, you need to know the true cost of
each space if your comparisons are to mean anything. Once you understand how a prospective landlord measured the
space and what kind of rent computation you’re being offered, you’ll be ready to roughly compare the rental costs for two
or more places you’re considering.
The following tips cover important steps to take determine the true cost of the rental.
1. Determine how the landlord has measured the square feet. Commercial space is often advertised and rented on a
cost-per-square-foot basis, rather than a descriptive basis (such as “the first floor”). For example, an ad might describe
space as “2,000-Square-Foot Office Suite in New Building” or “2,000 Square Feet of Prime Retail Space.” However, 2,000
square feet doesn’t always mean that you’ll pay for and occupy exactly 2,000 square feet.

Strange as it may seem, many landlords -- especially in office buildings -- take their measurements from the middle or
even the outside of exterior walls. It’s a bit like the butcher who charges you for the bone and fat as well as the edible
portion of the steak. Obviously, if a landlord uses this method of measurement, you’ll wind up paying not only for usable
space but also for some or all of the thickness of the walls.
2. Determine whether and how much you’ll be paying for common areas. In many buildings, there are parts of the
structure or grounds that you’ll share with other tenants. For example, you and other tenants may share lobbies, hallways,
elevator shafts, bathrooms, and parking lots. When you add these spaces up, they can amount to a hefty chunk of the
property. Don’t assume that the landlord is going to let you use these shared facilities for free.
3. Don’t discount the importance of the layout. The way that a space is laid out -- not just its size -- will have a lot to
do with whether you’re getting your money’s worth. For example, awkward angles, interrupted workspaces, or narrow
corridors will be less useful than wide-open areas and passageways that can accommodate bookshelves, office equipment,
dividers, and well-designed work areas. Your rental cost may be less for a $20-per-square-foot space that’s efficiently laid
out than for an $18-per-square-foot space with an awkward configuration, simply because you’ll need less of the $20-per-
square-foot space.
4. Ask whether you will be required to pay for extras. If this is your first foray into the world of commercial leasing,
you may be surprised to learn that the rent doesn’t necessarily mean what it does when you rent an apartment or house.
In a residential situation, rent is normally one fixed amount. You’re rarely asked to pay additional rent -- sums to cover
operating expenses such as building insurance, maintenance, or real estate taxes. These costs are, of course, taken into
consideration when the landlord sets the rent for an apartment, but they’re not added on as separate charges. In a
commercial situation, however, you may be asked to pay for some or all of these additional sums.
5. Ask if the landlord will want a percentage of your profits. Shopping center landlords often demand a share of a
retail tenant’s profits in addition to the monthly rent. If you have a retail business and are headed for the mall, you may be
asked to pay what’s known as "percentage rent."
Want to Learn More?

For help negotiating rent, see Negotiate the Best Lease for Your Business, by attorneys Janet
Portman and Fred S. Steingold.

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How Commercial Leases Are Made


From the Nolo Business & Human Resources Center
A landlord’s proposed lease is just the starting point from which you can negotiate changes.
The lease that you and your landlord sign defines your legal relationship. Along with your insurance policy and your loan
documents, your lease will be one of the most important legal documents in your filing cabinet.
What does the lease do? The lease is a contract in which:
1. You agree to pay rent for a certain period of time.
2. You agree to abide by other conditions (such as using the space for a consulting business only, or not displaying
outside signs unless the landlord first approves them).
3. Your landlord agrees to let your business occupy the space for a set amount of time.
4. Your landlord may agree to physically alter the space to fit your business, or provide amenities such as on-site
parking and weekly janitorial service.
The landlord usually starts the process. Typically, you’ll be working with a lease form that’s been written by the
landlord or the landlord’s lawyer -- and you can bet that neither one of them will be looking out for your best legal or
business interests. In order to level the playing field, you need to learn a bit about the terms of a business lease, so that
the landlord’s proposed lease is just the starting point from which you’ll negotiate changes.
There are no standard leases. Contrary to what a landlord may have you believe, there is no such thing as a “standard”
commercial lease. Even if the landlord brings out a form that’s widely used in your community or printed by a legal forms
publisher, it can always be modified. The only constraints on your landlord’s ability to negotiate come from pre-existing
promises to other tenants in the building and obligations to lenders or insurers.
There’s always room to negotiate. No matter how official-looking the document that comes out of the landlord’s or
broker’s briefcase, keep in mind that it’s negotiable. Just how negotiable depends on decidedly non-legal issues such as
how tight the market is for your desired space, how badly the landlord wants to rent the space to you, and how badly you
want it. Within the range of negotiability, however, your knowledge of lease clauses and the market will determine the
success of the lease negotiation.
You'll need to decipher the meaning of lease clauses. Leases are full of legalese. Lawyers often dress up lease
clauses in dense legal verbiage or burden them with mile-long sentences.The chart below may help you match a clause
title to its subject matter.

Clause Name What It’s About

Parties or Lessor and Lessee The names of the landlord and tenant

Premises A description of the space you’re renting

Rent Explains how the rent is calculated

Term When the lease begins and how long it will run

Deposit The security deposit demanded by the landlord in case


you damage the space

Hold Over What happens if you don’t move out as planned at the
end of your lease
Use Restrictions and requirements on how you use your
rented space

Utilities Explains how utilities are metered and how costs are
apportioned

Taxes Describes which taxes you will have to pay for, and how
much

Insurance & Indemnity Covers which insurance policies you must take out or pay
for

Security Covers the building security and who pays for it

Parking Describes available parking and how it’s paid for

Maintenance Covers the common area maintenance (CAM) costs you


have to pay for

Alterations & Repairs Explains which alterations you may make and whether
you need permission, plus delegates repair duties

Assignment & Subletting Describes the conditions under which you can turn space
over to another tenant

Options Covers your rights to extend, expand, or contract the


amount of space you rent or the lease term; may also
cover your right to buy the property

Defaults & Remedies Explains what happens if you or the landlord fails to live
up to the lease

Destruction Covers what will happen if all or part of the building is


destroyed

Condemnation Describes what happens to your lease if the building is


condemned by a government

Subordination, Nondisturbance, & Attornment Financing clauses covering what happens if your
landlord’s lender forecloses on a loan that’s secured by
the building

Estoppel Explains your duty to provide a signed statement that you


and the landlord are complying with the lease terms

Attorney Fees Your agreement as to who pays the winner’s fees and
costs if a disagreement ends in litigation

Guaranty Your promise that you will provide someone who will
guarantee your financial duties under the lease. (This
guarantor must also sign the lease.)

Dispute Resolution The mechanism for settling disputes, short of resorting to


a lawsuit

Want to Learn More?

To learn about the ins and outs of negotiating each of the above lease clauses, see Negotiate the
Best Lease for Your Business, by attorneys Janet Portman and Fred S. Steingold.

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Copyright 2006 Nolo
Choosing a Successful Location for Your Business
From the Nolo Business & Human Resources Center
Here's how to choose affordable space for your business that suits your company's needs.
Because there's no universal rule for choosing a good business location, it's important for every business owner to figure
out how location will (or won't) contribute to the success of the business -- and to choose a spot accordingly. While there
are many issues to consider when you're looking for space to house your business, make sure you ask yourself these four
important questions:
1. Is location important for the success of your business?
2. What type of location is best for your business?
3. How much rent can you afford?
4. Is your proposed location appropriate for what you plan to do there?
Is Location Important for the Success of Your Business?
For some businesses, the classic advice "location, location, location" is right on the mark -- location can mean the
difference between feast or famine. But for other enterprises, location may be much less important than finding affordable
rental space. In fact, location is almost irrelevant for some businesses: service businesses that do all their work at their
customers' locations (such as roofers and plumbers) and businesses that have little contact with the public (such as mail-
order companies, Internet-based businesses, and wholesalers). If these types of companies can pass on rent savings to
their customers and their profit margin, picking a low-cost spot in an out-of-the-way area might be an advantage.
What Type of Location Is Best for Your Business?
The key to picking a profitable location is determining the factors that will increase customer volume for your business. Ask
yourself questions such as:
1. Will customers come on foot?
2. Will customers drive and, if so, where will they park?
3. Will more customers come if you locate near other similar businesses?
4. Will the reputation of the neighborhood or even of a particular building help draw customers?
Keep in mind that different types of businesses attract customers in different ways. One key distinction is foot traffic
versus automobile traffic. For example, if you're opening an urban coffee shop, you may assume your customer volume
will be highest if there's lots of pedestrian traffic nearby during the hours you plan to be open. On the other hand, for an
auto repair shop, the choicest locale is a well-traveled street where the shop will be seen by many drivers who can easily
pull into the lot.
Also consider whether it would benefit your business to be around similar businesses that are already drawing the type of
customers that you want. A women's clothing store, for example, would no doubt profit from being near other clothing
shops, since many people shopping for clothes tend to spend at least a few hours in a particular area.
Ultimately, the perfect location for any business is a very individual matter. Spend some time figuring out the habits of the
customers you want to attract, and then choose a location that fits.
How Much Rent Can You Afford?
Chances are that you'll rent rather than buy a space for your business. Most small start-ups don't have the funds to
purchase real estate, and it's usually not a good idea to saddle your business with high interest payments in any case.
One obvious and important concern when looking for commercial space to lease is finding a place that you can afford.
When you projected your financials (as part of your business plan), you should have estimated how much rent your
business would be financially able to pay each month, given its projected revenues and its other expenses.

How to Determine the Average Rent in Your Area

Brokers and agents are great sources of information on rental costs in various neighborhoods.
They'll generally give you an average figure for the cost of commercial space per square foot per year
in a given area. Once you have this figure, you can compare it to the costs of other spaces you're
considering.

If you haven't done so already, research the average rental costs in your area to make sure the amount you budgeted for
rent makes sense, given the cost of commercial space in your area and how important location is for your business. For
example, if you determined that location is very important to your business, make sure your budget will allow you to rent
good space given the average cost of space in your area. If not, you may have to rework your business plan.
Is Your Proposed Location Appropriate for What You Plan to Do There?
When choosing business space, the biggest consideration is sometimes not where it is but what it is. The building facilities
need to be appropriate for (or adaptable to) your business. For example, if you're planning to open a coffeehouse, you
need a place with at least minimal kitchen facilities. Unless you can convince the landlord to put in the needed equipment
-- plumbing, electrical work, and the rest -- it's highly unlikely that laying out the cash to do it yourself will be worth it. In
short, if a building lacks something major that is essential to your business operation, you should probably look for
something else.

Communications Wiring
Another consideration that's important for many businesses these days is having modern phone and other data lines
available to the business. When you're considering a specific space, ask the agent or the landlord for information about
communications wiring, such as whether the space is connected to a fiber optic network or is wired for DSL or a T1 line
(high-volume Internet connections). Also, find out to whom the landlord has sold the rights to the risers (wire conduits) in
the building. A commercial landlord cannot enter into exclusive contracts with a single telecommunications provider such
as MCI or AT&T. However, to bring in another provider of your choosing could be expensive.

Electricity and Air Conditioning


Besides high-tech communications wiring, don't overlook plain-old electrical power as an important consideration in
choosing a business space. Make sure that any space you're looking at has enough power for your needs, both in terms of
the number of outlets in your space and the capacity of the circuits. If you'll be running machinery or other electricity-
hungry equipment, find out from the landlord how much juice the circuits can handle and whether a generator is available
during power outages. Also, if you'll keep sensitive computer equipment at your office, ask the landlord how many hours of
air conditioning are included in the terms of your lease, and negotiate longer hours if necessary.

Parking
Adequate parking is another common need for many businesses. If a significant percentage of your customers will come by
car and there isn't enough parking at your chosen spot, it's probably best to look elsewhere. In fact, the city planning or
zoning board might not allow you to operate in a space that doesn't have adequate parking.

Zoning Rules
Finally, the location that you choose needs to be legally acceptable for whatever you plan to do there. A certain spot may
be good for business, but if it's not zoned for what you plan to do, you're asking for trouble.
You should never sign a lease without being sure you'll be permitted to operate your business in that space. Your city
planning or zoning board determines what activities are permissible in a given location. If your zoning board has a problem
with any of your business activities, and it's not willing to work out a way to accommodate your business, you may have to
find another space.

Planning to Work From Home?

Working from home can be much simpler than renting a separate office space, but it might put you in
violation of zoning and other laws that regulate residential and business spaces. Be sure you're
familiar with the laws that affect home businesses, as well as other legal issues such as the home-
office tax deduction.

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Copyright 2006 Nolo
Understanding Common Commercial Lease Terms
From the Nolo Business & Human Resources Center
Understand the meaning of the landlord’s lease clauses before you negotiate.
Once you’ve found suitable space and you and the landlord have agreed on the key features of the lease, such as how
much rent you’ll pay and how long the lease will run, it’s time to formally spell out your deal in a binding, written lease.
Most important? Head into the lease negotiations understanding the meaning of the landlord’s lease clauses. A thorough
understanding of common commercial lease clauses will help you avoid hidden, onerous traps. It will also help you bargain
for modifications in your favor.
The list below introduces you to the most common lease clauses.
Parties
Leases generally begin by naming the landlord and the tenant, in a clause entitled “Parties.” Or, the clause may be entitled
“Landlord and Tenant” or “Lessor and Lessee” (the landlord is the lessor and the tenant is the lessee). Although you might
not think so at first, it’s important to look at these names carefully. For example, if you are a corporation or an LLC, you’ll
want to make sure that your name on the lease is your legal name, such as “Able Investments, LLC,” or “Macro Industries,
Inc.” An error in the way you or the landlord is identified can have serious repercussions. If you are an LLC or corporation
and you list your personal, not corporate name, you may become personally responsible under the lease (avoiding
personal liability is probably one of the reasons you incorporated your business or became an LLC).
Premises Clause
Somewhere near the beginning of your lease, often right after the Parties clause, you’ll see a clause that identifies the
space that you’ll be occupying. This clause is often titled “Premises.” If you’re leasing an entire building, the clause should
simply give the street address (and should describe any outbuildings or lots that come with it). If you’re leasing less than
an entire building, you and the landlord need to describe the space more precisely. In particular, if you will have access to
storage rooms, conference rooms, parking, kitchen facilities, and the like, you should spell this out.
The Use Clause and Exclusive Clause
A use clause limits how you’ll use the rented space. The limitations can be as broad as what business you’ll conduct there,
as narrow as what specific services or products you’ll offer, or as nebulous as the quality level of your operation. Landlords
can impose use restrictions for any of these reasons:
1. The landlord has promised other tenants that no one will compete with them.
2. The landlord is worried about liability if you conduct certain kinds of businesses.
3. The landlord has a personal aversion to certain kinds of business activities.
In general, you’ll want to avoid strict restrictions on your use of the rented space. Most of the time, you’ll count yourself
lucky if the lease handed to you by the landlord does not include a use clause.

An exclusive clause is a promise by the landlord that only you and no one else in the mall or building may engage in a
particular type of business or carry a certain type of merchandise. (Naturally, other tenants will have use clauses that
prevent them from conducting business activities that would violate your “exclusive.”) Typically, only powerful “anchor”
tenants get exclusives.
Term Clause
Near the beginning of the lease, you’ll see a clause entitled “Term.” This clause describes the length of your lease and
specifies the starting and ending dates. You may be tempted to cruise right through it -- after all, if you want a five-year
lease and the Term clause gives you five years, where’s the complication? Alas, there’s more than one tricky wrinkle and
they’re apt to be hidden and dangerous. For example, some leases start as of the date the lease is signed, even though
you haven’t conducted business for even a day. Though you might not be responsible for rent right away, you will be
responsible for other obligations in the lease, such as the requirement that you carry insurance. Done properly, leases
should have many “start” dates, corresponding to when you can enter to set up, when your rent is due, when you become
responsible for securing insurance, when you can open for business, and so on.
Rent
For most small businesses, the amount of the monthly rent obligation is a very important issue. It’s important to look
carefully at the landlord’s lease clauses to see whether your rent estimates will pan out and to determine any new costs or
savings, such as:
1. expenses that you didn’t anticipate -- make sure you understand which parts of the landlord’s operating costs will
be passed-on to you
2. savings that may make it possible to shoulder other expenses -- for example, the landlord may offer a “tenant
improvement allowance,” which you will use to get the space ready for your operations, or

3. issues that you want to renegotiate, such as the landlord’s expectation that the rent will increase by a certain
amount on a stated date.
Security Deposits
Your landlord may ask for a security deposit to assure that cash will be available if you fail to pay the rent or don’t make
other payments required under the lease. Unlike residential landlords, who in many states may not ask for more than two
months’ rent as a deposit, commercial landlords may demand whatever amount they think they need as a cushion to cover
rent and other tenant financial obligations.
Or, instead of a security deposit, your landlord may ask for a “Letter of Credit” from your bank, in which the bank puts
aside an agreed-upon amount of your funds for use by the landlord should you not carry-out your financial obligations.

Improvements and Alterations


If your new space will have to be customized to fit your needs, a big chunk of your lease should address this issue. You
and the landlord will have to reach an agreement about who does the design, who does the work, when it gets done, and
who pays for it. And if you’re going to occupy space in a building not yet completed, you’ll want to be sure that you pay for
as little of the finish-up work as possible.
Maintenance, Utilities, and Code Compliance
The landlord’s lease will undoubtedly contain a Maintenance clause that concerns your duties to care for your own rented
space (or for the entire building, if you are the sole tenant). If you’re a tenant in a multi-tenant building, you and the
landlord will also have to settle on how the utilities will be billed and paid for, so you’ll often see a Utilities clause near the
Maintenance clause in the lease. Finally, the landlord may expect you to keep the building “up to code” -- whatever that
means (it often isn’t clear), in a lease clause sometimes titled “Compliance” or “Compliance with Laws.”
Parking, Signs, Landlord’s Entry, and Security
You’re likely to find several clauses in the lease that concern practical understandings you have with your landlord, about
such things as parking and business signs. As you negotiate these clauses, you and the landlord will be trying to smoothly
integrate your needs to run your businesses wisely. Although these clauses may not pack the punch of a Rent or
Maintenance clause, they can be very important to a successful and convenient tenancy.
Insurance Clauses
Several kinds of insurance are available to cover the risks of leasing commercial space, including property and liability
insurance, rental interruption insurance (this covers you if your business is unexpectedly interrupted, as would happen
after a natural disaster), and leasehold insurance (this coverage protects you if your lease is canceled due to
circumstances beyond your control and you have to rent elsewhere at a higher rent). You’ll need to evaluate each type of
insurance coverage in the context of your lease and your landlord’s requirements, your business needs, and the property
-- and negotiate accordingly. An insurance broker can help too, especially when it comes to choosing adequate levels of
coverage.

Other Clauses

Other common and important clauses in business leases include Option to Renew or Sublet (and
other Flexibility Clauses), Breaking the Lease, Disputes, Attorney Fees, Foreclosures, Condemnations,
and Guarantors. Nolo’s Negotiate the Best Lease for Your Business, by attorneys Janet Portman and
Fred S. Steingold, explains these clauses in detail.

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Copyright 2006 Nolo

Negotiating the Best Commercial Lease Terms


From the Nolo Business & Human Resources Center
Negotiating a good lease can save you money. Learn where landlords are willing to make concessions.
When you get serious about an available business space, chances are you'll be presented with a typed or printed
commercial lease prepared by the landlord or the landlord's lawyer. As you read the lease, keep these points in mind:

1. Rule 1: Understand that the terms almost always favor the landlord.

2. Rule 2: Know that with a little effort you can almost always negotiate significant improvements to the terms.
In theory, all terms of a lease are negotiable. But your negotiating power depends on whether your local rental market is
hot or cold. If plenty of commercial space is available, you can probably win many landlord concessions. If your area's
rental market is tight or you are chasing a unique space, you'll have considerably less leverage.
Length of the Lease
One area of the lease you should always focus on is its length -- also called its "term." A short-term lease is almost always
to your benefit. Shorter leases give you more flexibility if the needs of your business change -- for example, you want
more space or decide that a different location would be better. There is a trade-off here, of course. A long-term lease
ensures that you'll have an affordable business space for a predictable period of time. And landlords are often willing to
make more concessions on longer-term leases.
If your business isn't particularly location-sensitive (a mail-order business or software testing lab, for example) and plenty
of commercial space is available in your area, then a short-term lease makes sense. Even if the landlord doesn't renew
your lease, finding comparable space won't be a problem.
On the other hand, if you have found an especially favorable location for a retail shop, restaurant or other business where
location is key, deciding on the best lease term is more problematic. If your business does well, you'll want the right to
stay on for an extended period. On the other hand, you'll probably be nervous about signing a four-year lease in case your
business goes kaput.
A good solution is to bargain for a short initial lease with one or more options to renew -- perhaps a one- or two-year lease
with an option to renew for two or three more years. Typically, an option to renew gives you the right to exercise your
option to stay by notifying your landlord in writing a certain number of days or months before the initial lease period
expires.
If you ask for an option, expect the landlord to want a higher rent for the renewal period. If the property is particularly
desirable, the owner may also want an extra fee in exchange for giving you the option of staying or leaving after your
initial term is up. This is a common arrangement, and if the space is important to the success of your business, seriously
consider paying it.
Rent and Rent Increases
Another primary issue to consider when leasing space is how much rent you'll pay. It's sensible to check out rates for
comparable spaces. If the rent seems unjustifiably high, try asking for a reduction. Many landlords, however, usually won't
consider lowering the rent (except in poor economic times or areas), but you may be able to get a few months of reduced
rent to compensate for moving costs.
Landlords will usually include an annual increase to your rent in your lease terms. If the landlord insists on keeping the
clause, try to get a cap on the amount of each year's increase, and try to exclude a rent increase for the first year.
When you're shopping around, look carefully at whether the landlord will pay utilities, repairs, taxes and insurance. With a
"gross lease," your rent includes these costs. By contrast, with a " net lease" you pay for them separately -- potentially a
large sum. In fact, the best approach may be to offer to pay a higher amount for rent in exchange for eliminating these
extras.
Tenant Improvements
If you'll need lots of improvements to the space, you may want to use the lion's share of your bargaining power to have
the landlord provide them at no cost to you. If you're willing to sign a long-term lease, the landlord will be more willing to
pay for improvements to the property.
Subleases and Assignments
Ask for the right to sublease or assign your space. That way, if you need to move out, you'll be able to have another
tenant take your space and pay the rent, without having to break the lease. Or, if you rent enough space to grow into, you
can sublease some of the space until you're ready to use it.
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Copyright 2006 Nolo

Finding the Right Commercial Space


From the Nolo Business & Human Resources Center
Know the questions to ask when you're looking for commercial space.
Since you probably don’t have unlimited time available to choose a business space, you need to make the search process
as efficient as possible. This means you’ll want to focus on the space that meets your highest priorities. Don’t waste time
on places that are overpriced, too small, or in second-rate locations. Follow these tips on how to ask the right questions
and look in the right places for any space you’re seriously considering.
1. Come prepared. Make an appointment with the landlord’s broker and come equipped with a street map, notebook, pen
or pencil (or your laptop or handheld computer), pocket calculator, tape measure (to make sure your square footage
computations match those of the landlord and to check if your furniture or equipment will fit), graph paper, and a digital
camera.
2. Evaluate the outward appearance. Look carefully at the impression the building will make on your customers and
clients. If it looks shabby to you, it will look shabby to others. But appearances don't count in some businesses. For
example, customers won’t expect a salvage yard to be spic and span -- they’ll be delighted if the yard has what they want,
no matter what pile it’s found under.
3. Check for defects. Watch for obvious problems such as loose steps, torn carpet, missing floor tiles, or light fixtures
that don’t work. Defects that you can easily remove, fix, or cover are less important than those that are expensive to
repair or over which you have no control, such as a poor roof.
4. Evaluate security. Think about how secure the space is in view of the crime history of the neighborhood and the
likelihood that your business will be a target. Make sure the doors and locks are in good shape and sturdy enough to deter
would-be intruders. Visit a potential site at different times of the day and evening. Is there adequate street and other
lighting? Are there any other business establishments open in the evening? Is it going to be safe in the evening if you or
your employees are working late?
5. Examine the heating, cooling, and ventilation systems. Find out if there is adequate ductwork to serve all areas,
including those that might be enclosed by new walls. Note where the thermostat is located and if there are multiple
thermostats for different zones. Determine if you can control the temperature. And make sure that heating, cooling, and
ventilation are available outside of normal working hours if this is important to your business or to your business
equipment.
6. Evaluate access and convenience. Walk around the building and check out the elevators, stairways, storage areas,
and lobbies. Think about whether disabled people will be able to make their way around without unusual difficulty (you
may be obligated to make the space accessible under the Americans With Disabilities Act). Investigate the parking
situation and, in the case of on-site parking, observe how convenient the space is, whether it’s crowded, and whether
spaces are set aside for individual tenants in multi-tenant buildings.
7. Consider improvements. Assuming that the space has some possibilities for you, try to evaluate how difficult (and
expensive) it will be to fix any problems. Cosmetic changes such as painting the walls are easy and inexpensive. Installing
a much wider entry door or reinforcing the floor to accommodate your equipment may be more difficult and costly if it
involves structural changes. While tenants and landlords often negotiate substantial improvements in the space
(sometimes landlords give tenants money to accomplish these changes, called an “improvement allowance”), it’s normally
better to deal with space that requires relatively little renovation.
8. Investigate zoning compliance.Once you decide that a particular space holds promise, think about local ordinances,
which can affect your ability to use the space the way you’d like to. For example, a zoning ordinance that allows offices in
a certain district may not permit retail uses, and vice versa. The landlord or broker should be familiar with how the
property is zoned. Still, it pays to check with a zoning official at City Hall -- they’re usually part of the planning or building
department -- to confirm that the space you’re considering is zoned for your business. If the zoning provisions exclude
your business, you may decide to try to get an exception (called a variance), but you’ll probably need some legal
assistance. Like counting your chickens, it’s almost always a bad idea to sign a lease before a variance is a reality.
9. Plan for licenses or permits. Depending on the nature of your business, you may need to get a special permit or
license before you can open shop. (Don’t confuse zoning and permits: Zoning laws regulate where a business can set up
shop; permits and licenses control whether they can go into operation.) If you plan to open a restaurant, for example,
you’ll need to be sure your kitchen gets health department approval and perhaps fire department approval as well. You
may also need a liquor license. Before settling on a particular space, find out how long it will take you to obtain these
permits -- you don’t want to commit to a space and then not be able to open up because you’re waiting for permits.
10. Consult with experts if necessary. Your careful visits to a prospective site should give you a good sense of the
space’s physical condition. But sometimes you need information from someone more experienced in structural matters --
for example, a structural engineer or architect. Getting expert advice is wise if you think you’ll need substantial
renovations -- you need to know if the proposed changes are feasible and can be done at reasonable expense. And if your
lease will require you to pay some or all of the maintenance and repair costs, you’ll want an expert’s opinion on what to
anticipate. This information will also be invaluable when you negotiate with the landlord over who pays for your
improvements.
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Copyright 2006 Nolo
Understanding Commercial Leases
From the Nolo Business & Human Resources Center
Before you rent space for your business, be sure you understand these basic facts about commercial leases.
Renting commercial space is a big responsibility -- the success or failure of your business may ride on certain terms of the
lease. Before you approach a landlord, you should understand how commercial leases differ from the more common
residential variety. And before you sign anything, make sure you understand and agree with the basic terms of the lease,
such as the amount of rent, the length of the lease and the configuration of the physical space.
How Commercial Leases Differ From Residential Leases
It's crucial to understand from the get-go that, practically and legally speaking, commercial leases and residential leases
are quite different. Here are the main distinctions between them:

1. Fewer consumer protection laws. Commercial leases are not subject to most consumer protection laws that
govern residential leases -- for example, there are no caps on security deposits or rules protecting a tenant's privacy.

2. No standard forms. Many commercial leases are not based on a standard form or agreement; each commercial
lease is customized to the landlord's needs. As a result, you need to carefully examine every commercial lease agreement
offered to you.

3. Long-term and binding. You cannot easily break or change a commercial lease. It is a legally binding contract,
and a good deal of money is usually at stake.

4. Negotiability and flexibility. Commercial leases are generally subject to much more negotiation between the
business owners and the landlord, since businesses often need special features in their spaces, and landlords are often
eager for tenants and willing to extend special offers.
Making Sure the Lease Will Fit Your Business
Before you sign a lease agreement, you should carefully investigate its terms to make sure the lease meets your
business's needs.
First, consider the amount of rent -- make sure you can afford it -- and the length of the lease. You probably don't want to
tie yourself to a five- or ten-year lease if you can help it; your business may grow faster than you expect or the location
might not work out for you. A short-term lease with renewal options is usually safer.
Also think about the physical space. If your business requires modifications to the existing space -- for example, adding
cubicles, raising a loading dock, or rewiring for better communications -- make sure that you (or the landlord) will be able
to make the necessary changes.
Other, less conspicuous items spelled out in the lease may be just as crucial to your business's success. For instance, if
you expect your camera repair business to depend largely on walk-in customers, be sure that your lease gives you the
right to put up a sign that's visible from the street. Or, if you are counting on being the only sandwich shop inside a new
commercial complex, make sure your lease prevents the landlord from leasing space to a competitor.

Critical Lease Terms

The following list includes many items that are often addressed in commercial leases. Pay attention
to terms regarding:
1. the length of lease (also called the lease term), when it begins and whether there are
renewal options
2. rent, including allowable increases (also called escalations) and how they will be computed
3. whether the rent you pay includes insurance, property taxes, and maintenance costs (called
a gross lease); or whether you will be charged for these items separately (called a net lease)
4. the security deposit and conditions for its return
5. exactly what space you are renting (including common areas such as hallways, rest rooms,
and elevators) and how the landlord measures the space (some measurement practices include the
thickness of the walls)
6. whether there will be improvements, modifications (called build outs when new space is
being finished to your specifications), or fixtures added to the space; who will pay for them, and who
will own them after the lease ends (generally, the landlord does)
7. specifications for signs, including where you may put them
8. who will maintain and repair the premises, including the heating and air conditioning
systems
9. whether the lease may be assigned or subleased to another tenant
10. whether there's an option to renew the lease or expand the space you are renting
11. if and how the lease may be terminated, including notice requirements, and whether there
are penalties for early termination, and

12. whether disputes must be mediated or arbitrated as an alternative to court.

The Americans with Disabilities Act. The Americans with Disabilities Act (ADA) requires all
businesses that are open to the public or that employ more than 15 people to have premises that are
accessible to disabled people. Make sure that you and your landlord are in agreement about who will
pay for any needed modifications, such as adding a ramp or widening doorways to accommodate
wheelchairs.

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Copyright 2006 Nolo

Renting Real Estate for Your Business: Overview


From the Nolo Business & Human Resources Center
To get the best space for the best price, do your homework on business space and commercial leases.
Your business has become successful, and you're ready to move into a better place. Or you’ve decided to streamline your
operations and rent a more efficient space. Perhaps your home business is bursting out of the garage and needs its own
location. Whatever you reason for seeking to rent a space for your business, it's important to understand as much as
possible about commercial leases to get the best space for the best price.
As you enter into the process of searching for and renting office space, the following pointers will help you.
Determining Your Needs and Setting Priorities
What kind of space do you need? Commercial space comes in a multitude of sizes and configurations, from the to-be-
built building to a plain-vanilla office suite to a quirky older building. If you know what you're looking for, you can
efficiently go after it.
Where do you want to be located? Being in one part of town may be important; but if it's not, you will have more to
choose from.
Is appearance important to you? If you're dealing with the public, the outward show of the building will no doubt
matter.
Do you want to be located near other businesses that complement yours? Sometimes it's a plus to be among your
own (such as in the "high tech district").
What kinds of services do you want near your place of business? You may conclude that you and your customers or
clients will benefit from certain close neighbors -- a dentist, for example, may want to be within walking distance of a
special X-ray lab.
Finding and Evaluating Space
Can you find a space on your own? In markets that are hot or sophisticated, you may need the help of a broker, who
may have contacts that tenants won't know about. It's best to work with a broker who represents mainly tenants. Think
very carefully before working with a broker who also represents the landlord -- such dual representation will rarely be to
your benefit.
How does the landlord measure square feet? Believe it or not, it’s perfectly acceptable to include the thickness of the
exterior walls, and even the interior walls, stairwells, and elevator shafts, in square foot measurements. Make sure you
know how your landlord computes your rented space.
Does the place require percentage rent? In a percentage rent situation, you pay for the size of the rental, plus a
portion of your profits once they exceed a certain amount. In essence, you are sharing your income with the landlord when
you reach that point of profitability. Large retail operations are typically the only tenants who pay percentage rent.
Is there expansion/purchase potential? Looking down the line, you may be thinking about the possibility of buying
your own building. One way to determine whether a location should become a permanent one is to lease with an option to
buy, which is a particular type of rental arrangement to be on the look-out for.
Developing a Negotiating Strategy
How much clout do you have? Your ability to secure a favorable lease depends on the state of the market. If there are
lots of vacancies in your area, you’ll stand a better chance of landing the rental on advantageous terms than if space like
this is scarce.
Should you sign a letter of intent? Sometimes when landlords and tenants are in the midst of serious negotiations,
they want to put their understandings down on paper -- but they usually don't expect that their writings will be the
equivalent of a lease. A letter of intent is just that -- a communication indicating what the landlord and tenant would like to
see happen in a lease. If the landlord asks you to sign a letter of intent, you should sign it to show you're serious about the
space. But take care to make it clearly nonbinding, or else it can end up obligating you.
Are you aware that there is no such thing as a "standard" business lease? Unlike many other aspects of business,
there are surprisingly few legal constraints on what tenants and landlords agree to do. Commercial leases can and should
reflect the give-and-take between the landlord and tenant -- one size simply doesn't fit all. Even if the landlord starts with
a form that's accepted by other tenants who lease from this landlord or printed and distributed by a big real estate
management firm, it can always be modified.
Negotiating the Lease
Is the landlord asking for a "gross" or a "net" lease? In a gross lease, tenants pay a set amount per month, much
like a residential lease. Depending on whether a whole building or part of one is being rented, the tenant will also pay all or
a portion of the utilities. In a net lease, tenants pay for their square footage, plus a portion of the landlord's operating
expenses, including the building insurance and taxes, plus utilities.
How long do you want your lease to last? Commercial leases typically last from two or three years to ten or fifteen.
Only well-established businesses should commit to very long lease terms.
Do you need a lawyer to review your lease? Paying for a few hours of a lawyer’s time is usually a very wise move. The
lawyer may spot potential problems that you may not have thought about. Look for someone who has represented you (or
someone you know) successfully in the past, or ask other businesspeople whom you respect for recommendations.

Want to Learn More?

Nolo’s Negotiate the Best Lease for Your Business, by attorneys Janet Portman and Fred S. Steingold,
has more information about every item listed above.

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Copyright 2006 Nolo

Ten Steps to Determining the Space You Need for Your Business
From the Nolo Business & Human Resources Center
Prioritize your needs before you look for commercial space to rent.
Whether you’re a small start-up or an established business, you should begin each search by carefully thinking through
your needs. A clear understanding of what you do (and don’t) want for your business will save precious time and money,
commodities that you undoubtedly want to plow into the business itself. So before you hit the pavement or engage a
broker to help you find the right spot, go through the points below and analyze what’s most important to you in a business
rental.
First, before you plunge headlong into the search for suitable commercial space, think carefully about whether you really
need to find space now. It may make more sense to run your business from your home. If you’re just starting out in a
business that doesn’t require significant space or ready access to the public, maybe you can keep expenses low by working
out of your house or apartment.
Or, if you’re already renting space but looking to move, you might consider ways to improve your current lease situation
and avoid the expense and inconvenience of relocating. Take another look at your lease -- does it have an option clause,
enabling you to expand into available space?
1. Priorities. If you’re convinced that now is the time to move, think carefully about what you need, would like, and won’t
abide. Take out a sheet of paper and list items in three columns: "Must Have," "Nice to Have," and "Won’t Have." Your goal
is to end up with a concise statement expressed in words (“downtown area”) or numbers (“maximum $3,000 rent”). When
you begin to consider available space, you can use this list to quickly and concisely evaluate its suitability.
2. Rent. The first issues to consider are the most obvious and, for many, the most important. Figure out the maximum
rent your business can afford to pay per month. And if the landlord asks you to put down a security deposit before you
move in, think about whether your reserves can handle a particularly big hit in the first month. Finally, consider how much
money you can afford to spend to alter the space to fit your needs and tastes.
3. Location. The physical location of your business is likely to be important to you, your employees, your customers or
clients, and/or your suppliers. The more people and groups you need to please, the smaller the number of possible rentals
that will fit the bill. Consider the neighborhood, commuting time, and access to public transportation.
4. Length of the lease. It may be important for you to secure a space that will be yours for a long time to come -- or you
might want the flexibility of a shorter lease. Do you need to find a place right away? Or do you have the luxury of shopping
around until you see the perfect spot? You need to assign a value -- a priority -- to the length of the lease and when it’s
available.
5. Size and physical features. Almost every tenant is concerned about the size of the rental. You’ll want enough space,
but to keep the rent down, limit the size to what you really need. You’ll want the space to be well laid-out, comfortable,
and welcoming to employees, clients, and customers.
6. Parking. For many businesses, it’s essential to have ample parking -- whether in a designated lot on the building site,
on the street, or in a nearby parking garage. Parking may be a high priority for several reasons. If public transit is
inadequate, people will need to drive to your business. If your business involves selling or servicing large items such as
stereo equipment, customers will need nearby parking.
7. Building security. If crime is a known problem in the neighborhood and customers or employees are assaulted or
robbed, you may be found partially responsible if you have not taken reasonable steps to prevent criminal incidents, or at
least warn of them. Your landlord, too, may ultimately bear some responsibility, but the portion of a jury award or
settlement figure that you end up paying is hardly the point. You never want to be in a position of worrying about
customers’ and employees’ safety. So think carefully about the security of the neighborhood, and if you conclude that the
risk is too high, look elsewhere.
8. Image and maintenance. The way a building looks -- and how it’s maintained -- will be important to some and
practically irrelevant to others. In general, the more your business serves the public, the more important is the building’s
appearance. If no one ever sees or visits your business, it may not matter much, except to you and your employees.
9. Expansion or purchase potential. If you plan on growing your business or would like to own your building in the
future, you may want to rent space that has the potential for expansion or purchase. You’ll save yourself the hassle and
expense of another search and move to new space, and you may be able to lock in favorable expansion or purchase terms
now, in your lease. Look for a a lease with an option to renew or an option to buy.
10. Neighboring tenants. It may be important to be in a building with certain types of tenants -- for example,
businesses that complement yours or provide a needed service. Lawyers, for example, may want to locate in a building
where there are accountants or title insurance providers. Healthcare professionals may want to be near a hospital,
pharmacy, or lab. Whatever your business, you may want to find a building that houses a health club, coffee shop, or a
fast copy service that you, your employees, or customers will find handy.

Want to Learn More?

Nolo’s Negotiate the Best Lease for Your Business, by attorneys Janet Portman and Fred Steingold,
contains in-depth information about determining what space is best for your business, evaluating
vacancies, and negotiating the best price.

Click here for related information and products from Nolo


Copyright 2006 Nolo
Choosing the Best Ownership Structure for Your Business
From the Nolo Business & Human Resources Center
The right structure -- corporation, LLC, partnership, or sole proprietorship -- depends on who will own your
business and what its activities will be.
When you start a business, you must decide whether it will be a sole proprietorship, partnership, corporation, or limited
liability company (LLC).
Which of these forms is right for your business depends on the type of business you run, how many owners it has, and its
financial situation. No one choice suits every business: Business owners have to pick the structure that best meets their
needs. This article introduces several of the most important factors to consider, including:
1. the potential risks and liabilities of your business
2. the formalities and expenses involved in establishing and maintaining the various business structures
3. your income tax situation, and

4. your investment needs.

Risks and Liabilities


In large part, the best ownership structure for your business depends on the type of services or products it will provide. If
your business will engage in risky activities -- for example, trading stocks or repairing roofs -- you'll almost surely want to
form a business entity that provides personal liability protection ("limited liability"), which shields your personal assets
from business debts and claims. A corporation or a limited liability company (LLC) is probably the best choice for you.
Formalities and Expenses
Sole proprietorships and partnerships are easy to set up -- you don't have to file any special forms or pay any fees to start
your business. Plus, you don't have to follow any special operating rules.
LLCs and corporations, on the other hand, are almost always more expensive to create and more difficult to maintain. To
form an LLC or corporation, you must file a document with the state and pay a fee, which ranges from about $40 to $800,
depending on the state where you form your business. In addition, owners of corporations and LLCs must elect officers
(usually, a president, vice president, and secretary) to run the company. They also have to keep records of important
business decisions and follow other formalities.
If you're starting your business on a shoestring, it might make the sense to form the simplest type of business -- a sole
proprietorship (for one-owner businesses) or a partnership (for businesses with more than one owner). Unless yours will
be a particularly risky business, the limited personal liability provided by an LLC or a corporation may not be worth the cost
and paperwork required to create and run one.
Income Taxes
Owners of sole proprietorships, partnerships, and LLCs all pay taxes on business profits in the same way. These three
business types are "pass-through" tax entities, which means that all of the profits and losses pass through the business to
the owners, who report their share of the profits (or deduct their share of the losses) on their personal income tax returns.
Therefore, sole proprietors, partners, and LLC owners can count on about the same amount of tax complexity, paperwork,
and costs.
Owners of these unincorporated businesses must pay income taxes on all net profits of the business, regardless of how
much they actually take out of the business each year. Even if all of the profits are kept in the business checking account
to meet upcoming business expenses, the owners must report their share of these profits as income on their tax returns.
In contrast, the owners of a corporation do not report their shares of corporate profits on their personal tax returns. The
owners pay taxes only on profits they actually receive in the form of salaries, bonuses, and dividends.
The corporation itself pays taxes, at special corporate tax rates, on any profits that are left in the company from year to
year (called "retained earnings"). Corporations also have to pay profits on dividends paid out to shareholders, but this
rarely affects small corporations, which seldom pay dividends.
This separate level of taxation adds a layer of complexity to filing and paying taxes, but it can be a benefit to some
businesses. Owners of a corporation don't have to pay personal income taxes on profits they don't receive. And, because
corporations enjoy a lower tax rate than most individuals for the first $50,000 to $75,000 of corporate income, a
corporation and its owners may actual have a lower combined tax bill than the owners of an unincorporated business that
earns the same amount of profit.
Investment Needs
Unlike other business forms, the corporate structure allows a business to sell ownership shares in the company through its
stock offerings. This makes it easier to attract investment capital and to hire and retain key employees by issuing
employee stock options.
But for businesses that don't need to issue stock options and will never "go public," forming a corporation probably isn't
worth the added expense. If it's limited liability that you want, an LLC provides the same protection as a corporation, but
the simplicity and flexibility of LLCs offer a clear advantage over corporations. For more help on choosing between a
corporation and an LLC, read the article Corporations vs. LLCs.
Next Steps

Nolo's book LLC or Corporation? How to Choose the Right Form for Your Business, by attorney
Anthony Mancuso, provides lots of real-world scenarios that demonstrate how these options work for
different types of companies.

After learning the basics of each business structure and considering the factors discussed above,
you may still find that you need help deciding which structure is best for your business. A good small
business or tax lawyer can help you choose the right one, given your tax picture and the possible
risks of your particular situation.

Changing Your Mind


Your initial choice of a business structure isn't set in stone. You can start out as sole proprietorship or partnership and
later, if your business grows or the risk of personal liability increases, you can convert your business to an LLC or a
corporation.
Click here for related information and products from Nolo
Copyright 2006 Nolo

Types of Ownership Structures


From the Nolo Business & Human Resources Center
Learn about the corporation, LLC, partnership, and sole proprietorship.
Before you can decide how you want to structure your business, you'll need to know what your options are. Here's a brief
rundown on the most common ways to organize a business:
1. sole proprietorship
2. partnership
3. limited partnership
4. limited liability company (LLC)
5. corporation (for-profit)
6. nonprofit corporation (not-for-profit), and

7. cooperative.

Sole Proprietorships and Partnerships


For many new businesses, the best initial ownership structure is either a sole proprietorship or -- if more than one owner is
involved -- a partnership.

Sole Proprietorships
A sole proprietorship is a one-person business that is not registered with the state like a limited liability company (LLC) or
corporation. You don't have to do anything special or file any papers to set up a sole proprietorship -- you create one just
by going into business for yourself.
Legally, a sole proprietorship is inseparable from its owner -- the business and the owner are one and the same. This
means the owner of the business reports business income and losses on his or her personal tax return and is personally
liable for any business-related obligations, such as debts or court judgments.

Partnerships
Similarly, a partnership is simply a business owned by two or more people that hasn't filed papers to become a corporation
or a limited liability company (LLC). You don't have to file any paperwork to form a partnership -- the arrangement begins
as soon as you start a business with another person. As in a sole proprietorship, the partnership's owners pay taxes on
their shares of the business income on their personal tax returns and they are each personally liable for the entire amount
of any business debts and claims.
Sole proprietorships and partnerships make sense in a business where personal liability isn't a big worry -- for example, a
small service business in which you are unlikely to be sued and for which you won't be borrowing much money for
inventory or other costs.
Limited Partnerships
Limited partnerships are costly and complicated to set up and run, and are not recommended for the average small
business owner. Limited partnerships are usually created by one person or company (the "general partner"), who will
solicit investments from others (the "limited partners").
The general partner controls the limited partnership's day-to-day operations and is personally liable for business debts
(unless the general partner is a corporation or an LLC). Limited partners have minimal control over daily business decisions
or operations and, in return, they are not personally liable for business debts or claims. Consult a limited partnership
expert if you're interested in creating this type of business.
Corporations and LLCs
Forming and operating an LLC or a corporation is a bit more complicated and costly, but well worth the trouble for some
small businesses. The main benefit of an LLC or a corporation is that these structures limit the owners' personal liability for
business debts and court judgments against the business.
What sets the corporation apart from all other types of businesses is that a corporation is an independent legal and tax
entity, separate from the people who own, control and manage it. Because of this separate status, the owners of a
corporation don't use their personal tax returns to pay tax on corporate profits -- the corporation itself pays these taxes.
Owners pay personal income tax only on money they draw from the corporation in the form of salaries, bonuses, and the
like.
Like corporations, LLCs provide limited personal liability for business debts and claims. But when it comes to taxes, LLCs
are more like partnerships: the owners of an LLC pay taxes on their shares of the business income on their personal tax
returns.
Corporations and LLCs make sense for business owners who either 1) run a risk of being sued by customers or of piling up
a lot of business debts, or 2) have substantial personal assets they want to protect from business creditors.
Nonprofit Corporations
A nonprofit corporation is a corporation formed to carry out a charitable, educational, religious, literary ,or scientific
purpose. A nonprofit can raise much-needed funds by soliciting public and private grant money and donations from
individuals and companies. The federal and state governments do not generally tax nonprofit corporations on money
they take in that is related to their nonprofit purpose, because of the benefits they contribute to society.
Cooperatives
Some people dream of forming a business of true equals -- an organization owned and operated democratically by its
members. These grassroots business organizers often refer to their businesses as a "group," "collective," or "co-op" -- but
these are often informal rather than legal labels. For example, a consumer co-op could be formed to run a food store, a
bookstore, or any other retail business. Or a workers' co-op could be created to manufacture and sell arts and crafts. Most
states do have specific laws dealing with the set-up of cooperatives, and in some states you can file paperwork with the
secretary of state's office to have your cooperative formally recognized by the state. Check with your secretary of state's
office for more information.

Next Steps

You may want to also read LLC or Corporation? How to Choose the Right Form for Your Business, by
Anthony Mancuso (Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo

Risky Businesses
From the Nolo Business & Human Resources Center
Businesses that take chances start out with a strike against them.
Starting a business is always risky. In some businesses, however, the risks are particularly extreme. If you're planning to
launch an investment firm or start a hazardous waste management company, there's little doubt that you'll need all the
protection you can get, including limited personal liability as well as adequate insurance. Other businesses are not so
obviously risk-laden, but could still land you in trouble if fate strikes you a blow.
Here are a few red flags to watch for when analyzing the risks involved in your business:
1. using hazardous materials, such as dry cleaning solvents or photographic chemicals, or hazardous processes,
such as welding or operating heavy machinery
2. manufacturing or selling edible goods
3. building or repairing structures or vehicles
4. caring for children or animals
5. providing or allowing access to alcohol
6. driving as the main part of the job
7. allowing activities that may result in injury, such as weightlifting or skateboarding, and

8. repairing or working on items of value, such as cars or antiques.

If your business will face one or more risks like those listed here, consider whether business insurance will provide
adequate protection. Some risky activities, such as job-related driving, are good candidates for insurance and don't
necessarily warrant incorporating. But if insurance can't cover all of the risks involved in your business, you should
consider forming an LLC or a corporation, which will protect your personal asserts from claims and judgments against your
business.
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Copyright 2006 Nolo

Corporations vs. LLCs


From the Nolo Business & Human Resources Center
How do you know whether a corporation or LLC is right for your business?
Let's assume that you've concluded it would be advantageous to operate your small business through an entity that limits
the personal liability of all the owners -- even if following this strategy involves a bit more paperwork, complexity and
possible expense. You have two main choices -- either the tried and true corporation or the new and streamlined limited
liability company (LLC). Which is better? There's no answer to this question that applies to every business. Nevertheless,
some general principles may be helpful.
When an LLC May Make Sense
For the majority of small businesses, the relative simplicity and flexibility of the LLC makes it the better choice. This is
especially true if your business will hold property, such as real estate, that's likely to increase in value. That's because
regular corporations (sometimes called C corporations) and their shareholders are subject to a double tax (both the
corporation and the shareholders are taxed) on the increased value of the property when the property is sold or the
corporation is liquidated. By contrast, LLC owners (called members) avoid this double taxation because the business's tax
liabilities are passed through to them; the LLC itself does not pay a tax on its income.
When a Corporation May Make Sense
An LLC isn't always the best choice, however. Occasionally, other factors will be present that may tip the balance toward a
corporation. Such factors include the following:

1. You expect to have multiple investors in your business or to raise money from the public. While an LLC
works fine when you have just a few investors -- especially those who will be active in the day-to-day operations of the
business -- it may get more awkward when the number of investors increases. For example, you'll likely run into resistance
from potential investors if you can't offer them the corporate stock certificates that they consider tangible evidence of their
partial ownership of the business. Rather than wasting your time trying to overcome this resistance, it's probably better to
structure your business as a corporation.

2. You'd like to provide extensive fringe benefits to owners. Often, when you form a corporation, you expect
to be both a shareholder (owner) and an employee. The corporation can, for example, hire you to serve as its chief
executive officer, pay you a tax-deductible salary, and provide fringe benefits as well. These benefits can include the
payment of health insurance premiums and direct reimbursement of medical expenses.
The corporation can deduct the cost of these benefits and they are not treated as taxable income to the employees, which
can be an attractive feature of doing business through a regular corporation. With an LLC, you can only deduct a portion of
medical insurance premium payments, and other fringe benefits provided to members do not receive as favorable tax
treatment.

1. You want to entice or keep key employees by offering stock options and stock bonus incentives.
Simply put, LLCs don't have stock; corporations do. While it's possible to reward an employee by offering a membership
interest in an LLC, the process is awkward and likely to be less attractive to employees. Therefore, if you plan to offer
ownership in your business as an employee incentive, it makes sense to incorporate rather than form an LLC.
When an S Corporation May Make Sense
Self-employment taxes can tip the balance toward S corporations, since LLC owners may pay more. What are self-
employment taxes? Well, you know that taxes are withheld from employees' paychecks. In 2006, employers must withhold
7.65% of the first $94,200 of an employee's pay for Social Security and Medicare taxes, and 1.45% of earnings above that
amount for Medicare taxes alone. The employer adds an equal amount and sends these funds to the IRS. (The total sent to
the IRS is 15.3% on the first $94,200 of wages and 2.9% on anything above that.) You may not be aware that the IRS
collects a similar 15.3% tax on the first $94,200 earned by a self-employed person and a 2.9% tax on earnings above that
amount. This is the self-employment tax.
For an S corporation, the rules on the self-employment tax are well established: as an S corporation shareholder, you pay
the self-employment tax on money you receive as compensation for services, but not on profits that automatically pass
through to you as a shareholder. For example, if your share of S corporation income is $100,000 in 2005 and you perform
services for the corporation reasonably worth $65,000, you will owe the 15.3% self-employment tax on the $65,000 but
not on the remaining $35,000.
By contrast, the self-employment tax may be imposed on an LLC owner's entire share of LLC profits. However, the rules
for members of an LLC are murky.
Proposed IRS regulations (which Congress has placed on indefinite hold) would impose the self-employment tax on an LLC
owner's entire share of LLC profits in any of the following situations:
1. The LLC owner participates in the business for more than 500 hours during the LLC's tax year.
2. The LLC provides professional services in the fields of health, law, engineering, architecture, accounting, actuarial
science or consulting (no matter how many hours the owner works).
3. The LLC owner is empowered to sign contracts on behalf of the LLC.
Until the IRS clarifies the rules on self-employment tax for members of an LLC, you should assume that 100% of an LLC
member's earnings will be subject to the tax.
Therefore, an S corporation shareholder may pay less self-employment tax than an LLC member with similar income. You'll
need to decide if this potential tax saving is enough to offset such LLC advantages as less formal record keeping and
flexibility in management structure and in the method of distributing profits and losses.

Want to Learn More?

You will probably find that you need more help deciding which structure is best for your business. A
good small business or tax lawyer can help you choose the right one, given your tax picture and the
possible risks of your particular situation. You might also benefit from reading Nolo's new book, LLC
or Corporation? How to Choose the Right Form for Your Business, by attorney Anthony Mancuso.

Click here for related information and products from Nolo


Copyright 2006 Nolo

Chart: Ways to Organize Your Business


From the Nolo Business & Human Resources Center
This chart lists the pros and cons of corporations, LLCs, partnerships, sole proprietorships, and more.

Type of Entity Main Advantages Main Drawbacks


Sole Proprietorship Simple and inexpensive to create and Owner personally liable for business debts
operate
Owner reports profit or loss on his or
her personal tax return

General Partnership Simple and inexpensive to create and Owners (partners) personally liable for business debts
operate
Owners (partners) report their share
of profit or loss on their personal tax
returns

Limited Partnership Limited partners have limited personal General partners personally liable for business debts
liability for business debts as long as
More expensive to create than general partnership
they don't participate in management
Suitable mainly for companies that invest in real estate
General partners can raise cash
without involving outside investors in
management of business

Regular Corporation Owners have limited personal liability More expensive to create than partnership or sole
for business debts proprietorship
Fringe benefits can be deducted as Paperwork can seem burdensome to some owners
business expense
Separate taxable entity
Owners can split corporate profit
among owners and corporation,
paying lower overall tax rate

S Corporation Owners have limited personal liability More expensive to create than partnership or sole
for business debts proprietorship
Owners report their share of corporate More paperwork than for a limited liability company which
profit or loss on their personal tax offers similar advantages
returns
Income must be allocated to owners according to their
Owners can use corporate loss to ownership interests
offset income from other sources
Fringe benefits limited for owners who own more than 2% of
shares

Professional Owners have no personal liability for More expensive to create than partnership or sole
Corporation malpractice of other owners proprietorship
Paperwork can seem burdensome to some owners
All owners must belong to the same profession

Nonprofit Corporation doesn't pay income taxes Full tax advantages available only to groups organized for
Corporation charitable, scientific, educational, literary or religious
Contributions to charitable corporation
purposes
are tax-deductible
Property transferred to corporation stays there; if
Fringe benefits can be deducted as
corporation ends, property must go to another nonprofit
business expense

Limited Liability Owners have limited personal liability More expensive to create than partnership or sole
Company for business debts even if they proprietorship
participate in management
State laws for creating LLCs may not reflect latest federal
Profit and loss can be allocated tax changes
differently than ownership interests
IRS rules now allow LLCs to choose
between being taxed as partnership or
corporation

Professional Limited Same advantages as a regular limited Same as for a regular limited liability company
Liability Company liability company
Members must all belong to the same profession
Gives state licensed professionals a
way to enjoy those advantages

Limited Liability Mostly of interest to partners in old Unlike a limited liability company or a professional limited
Partnership line professions such as law, medicine liability company, owners (partners) remain personally liable
and accounting for many types of obligations owed to business creditors,
lenders and landlords
Owners (partners) aren't personally
liable for the malpractice of other Not available in all states
partners
Often limited to a short list of professions
Owners report their share of profit or
loss on their personal tax returns

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Copyright 2006 Nolo

Small Business Insurance


From the Nolo Business & Human Resources Center
No matter what type of business structure you choose, it pays to buy adequate insurance.
While business insurance is not generally required, it's a good idea to purchase enough insurance to cover your company's
assets. Even if you form a corporation or an LLC, which shields your personal assets from business liabilities, you still risk
losing your business if disaster strikes. Insurance can greatly reduce this risk. The two most common and generally useful
types of business insurance policies are property insurance and liability insurance.
Property Insurance
As the name implies, property insurance covers your business for damage or loss to your business property. A good
property insurance policy should cover:
1. property fixtures, such as lighting systems or carpeting
2. equipment and machinery
3. office furniture
4. computers and accessories (monitors, CD-ROM drives, modems, printers)
5. inventory and supplies, and

6. personal property that's kept at the business site.

In addition to establishing what property is covered under a property insurance policy, you'll need to understand which
types of losses are covered. Most commercial property insurance policies provide either "basic," "broad" or "special" form
coverage, with special form policies offering the broadest coverage and basic the narrowest.
A basic form policy commonly covers fire, explosions, storms, smoke, riots, vandalism and sprinkler leaks. A broad form
policy typically adds damage from broken windows and other structural glass, falling objects and water damage to the list
of covered items. (Note that theft isn't typically covered under either a basic or broad form policy, a fact that surprises
many business owners.)
Special form coverage offers the widest range of protection, as it typically covers all risks (including theft), unless
specifically excluded from the policy. While premiums for special form policies are more expensive, it may be worth the
expense if your business faces multiple or unusual risks. Before purchasing any insurance policy, read it carefully to
determine what types of damage are covered.
Also, make sure you understand the coverage limits on various policies, any deductibles or co-payments required, and how
the insurance company pays claims. "Guaranteed replacement cost" insurance will reimburse you what it costs you to
replace the property, not merely its current (depreciated) value. If your computer equipment is destroyed, for instance,
this type of coverage will pay you as much as you'll need to replace it -- at today's cost.

Comply with Your Lease or Homeowner's Policy


If you rent your business space, your lease may require that you obtain a specific amount or
type of property coverage. Be sure to check your lease for any insurance requirements before you
purchase a policy.
If you have a home-based business, you may need to adjust your homeowner's policy. Check to see
whether your homeowner's insurance is limited or voided entirely if you run a business from home. If
so, upgrade your insurance policy to include business use of the home and business-related claims.

Liability Insurance
Liability coverage protects your business against situations like the notorious slip-and-fall accident: someone injures
himself on your premises and sues you. A general liability policy (versus a product liability or vehicle liability policy) covers
damages that your business is ordered to pay to an individual (customer, supplier, business associate) who is injured on
your property.
A related, though technically different, type of insurance is product liability insurance, which protects you from lawsuits by
customers who claim to be hurt by a product you provided. If your business offers a product to the public, you might
consider this type of insurance. It can be expensive, but much less so than a multi-million dollar award to a victorious
plaintiff.
Finally, auto liability insurance covers damage that you or an employee cause in a business-related accident. Auto liability
coverage is not included in general liability policies, and is legally required for drivers in all but four states (Mississippi,
New Hampshire, Tennessee and Wisconsin). Even if this type of insurance is not required in your state, it's foolish not to
protect yourself against the potentially devastating risk of an auto accident. Make sure you insure any vehicles used in
your business, including employees' personal cars that are used for business purposes.

Insurance Doesn't Cover Business Debts

Liability insurance will never insulate you from regular business debts. If you think there's a
chance that your business will fall into serious debt, an LLC or corporation is probably the best
business structure for you.

Finding and Buying Insurance


Insurance brokers who gather information from different insurance companies can help you decipher policies and
determine the best deal for you. Be sure to find a reputable broker, however, since they receive commissions from
insurance companies. You need to be sure you have an agent that is looking out for your needs at least as much as his or
her own.
Make sure your broker understands the nuances of your specific business activities and the risks that are, or may be,
involved. Preferably, use a broker who specializes in policies for your type of business.
You may be surprised to learn that specially tailored policies exist for your type of business. For instance, a "producer's
package policy" for filmmakers covers several risks unique to the film business, such as the costs of a production -- often
in the tens or hundreds of thousands of dollars -- in case your negatives are destroyed. An insurance broker who knows
your type of business will be able to direct you to these specialized policies, while a run-of-the-mill broker may not.
You'll probably encounter insurance companies that offer package deals, which can be cheaper than buying several
individual policies separately. As long as all your needs are met, these package deals can be a good way to go. As always,
be sure you understand the extent of coverage in each area rather than relying on any promises that a particular package
covers "all your business needs."

Insurance Requirements for Employers

If you are an employer, you will be subject to a number of additional insurance requirements --
you must typically pay for workers' compensation insurance, unemployment insurance and state
disability insurance. These insurance programs are specifically for employers and are largely
regulated at the state level. To find out more, contact your state employment department.

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Sole Proprietorship Basics
From the Nolo Business & Human Resources Center
If you're going into business on your own, the simplest legal structure is the sole proprietorship.
A sole proprietorship is a one-person business that is not registered with the state as a corporation or a limited liability
company (LLC).
Sole proprietorships are so easy to set up and maintain that you may already own one without knowing it. For instance, if
you are a freelance photographer or writer, a craftsperson who takes jobs on a contract basis, a salesperson who receives
only commissions, or an independent contractor who isn't on an employer's regular payroll, you are automatically a sole
proprietor.
However, even though a sole proprietorship is the simplest of business structures, you shouldn't fall asleep at the wheel.
You may have to comply with local registration, business license, or permit laws to make your business legitimate. And you
should look sharp when it comes to tending your business, because you are personally responsible for paying both income
taxes and business debts.
Personal Liability for Business Debts
A sole proprietor can be held personally liable for any business-related obligation. This means that if your business doesn't
pay a supplier, defaults on a debt, or loses a lawsuit, the creditor can legally come after your house or other possessions.

Examples

Example 1: Lester is the owner of a small manufacturing business. When business prospects look
good, he orders $50,000 worth of supplies and uses them in creating merchandise. Unfortunately,
there's a sudden drop in demand for his products, and Lester can't sell the items he has produced.
When the company that sold Lester the supplies demands payment, he can't pay the bill. As sole
proprietor, Lester is personally liable for this business obligation. This means that the creditor can
sue him and go after not only Lester's business assets, but his personal property as well. This can
include his house, his car, and his personal bank account.
Example 2: Shirley is the owner of a flower shop. One day Roger, one of Shirley's employees, is
delivering flowers using a truck owned by the business. Roger strikes and seriously injures a
pedestrian. The injured pedestrian sues Roger, claiming that he drove carelessly and caused the
accident. The lawsuit names Shirley as a co-defendant. After a trial, the jury returns a large verdict
against Shirley as owner of the business. Shirley is personally liable to the injured pedestrian. This
means the pedestrian can go after all of Shirley's assets, business and personal.

By contrast, the law provides owners of corporations and limited liability companies (LLCs) with what's called "limited
personal liability" for business obligations. This means that, unlike sole proprietors and general partners, owners of
corporations and LLCs can normally keep their house, investments, and other personal property even if their business fails.
If you will be engaged in a risky business, you may want to consider forming a corporation or an LLC.
Paying Taxes on Business Income
In the eyes of the law, a sole proprietorship is not legally separate from the person who owns it. The fact that a sole
proprietorship and its owner are one and the same means that a sole proprietor simply reports all business income or
losses on his or her individual income tax return -- IRS Form 1040, with Schedule C attached.
As a sole proprietor, you'll have to take responsibility for withholding and paying all income taxes -- something an
employer would normally do for you. This means you'll have to pay a "self-employment" tax, which consists of
contributions to Social Security and Medicare, and pay estimated taxes throughout the year.
Registering Your Sole Proprietorship
Unlike an LLC or a corporation, you generally don't have to file any special forms or pay any fees to start working as a sole
proprietor. All you have to do is state that your business is a sole proprietorship when you complete the general
registration requirements that apply to all new businesses.
Most cities and many counties do require businesses -- even tiny home-based sole proprietorships -- to register with them
and pay at least a minimum tax. In return, your business will receive a business license or tax registration certificate. You
may also have to obtain an employer identification number from the IRS (if you have employees), a seller's license from
your state, and a zoning permit from your local planning board.
If you do business under a name different from your own (such as "Custom Coding" instead of "Jim Smith Graphics"), you
usually must register that name -- known as a fictitious, or assumed, business name -- with your county.
In practice, lots of businesses are small enough to get away with ignoring these requirements. But if you are caught, you
may be subject to back taxes and other penalties.
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Copyright 2006 Nolo

Running a Business With Your Spouse


From the Nolo Business & Human Resources Center
Your spouse can participate in your sole proprietorship -- a little.
If you are going into business for yourself and your spouse will help out occasionally, you don't necessarily need to hire
your husband or wife as an employee or independent contractor, nor do you need to form a partnership, LLC, or
corporation. If you follow certain guidelines, you can continue to operate as a sole proprietorship (a one-owner business).
You Can Still File a Joint Return
The IRS does not officially recognize any form of sole proprietorship that informally has more than one owner. However,
you can maintain your sole-owner status even if you file a joint tax return with your spouse at the end of the year. On your
joint return, simply list all of your business income on Schedule C. The IRS then treats all of your business income as
belonging to both of you, and you'll have just one tax bill. While technically the IRS expects sole proprietorships to have
just one owner, it's quite common for mom and pop businesses to operate this way.
When you use a joint tax return, your business still has just one formal owner for IRS purposes -- that is, whoever is listed
on Schedule C and on the business registration forms you file with your city or county. That means you and your spouse
don't have to form a partnership or deal with partnership taxes. The IRS also ignores the fact that, in most states, you and
your spouse technically co-own the company because of marital property laws that give your spouse a property interest in
your business.
If you and your spouse file separate tax returns, your tax return will show you as the sole owner of the business.
Employment Taxes
Your spouse can volunteer occasionally at the business without being classified as an employee, which frees the business
from the expense of payroll taxes. This set-up not only saves you money but, if you have no other employees, it also
allows you to avoid the time-consuming record keeping that comes with being an employer. But be advised that volunteers
don't rack up credit in their Social Security accounts for the time they spend working without pay. And, if the IRS does not
accept your characterization of this work as "volunteer" -- for instance, because it is frequent and regular, or involves
contact with the public or signing documents on behalf of the business -- you may be socked with back employment taxes
and penalties, whether the IRS decides to characterize your spouse as a partner or an employee.
If you'd like to pay your spouse for services you might otherwise hire an outsider to do, consider hiring him or her as an
independent contractor who pays his or her own self-employment taxes. This looks even better if your spouse already has
a private business providing these services to others.
Choosing Equal Ownership
If you and your spouse both want formal ownership of your company, each with an official say in management and a
distinct share of the business's profits and losses, you should create a business entity that allows two formal owners --
such as a partnership, LLC, or corporation -- even though this will mean filing more complicated tax returns and other
business paperwork. Having two official owners need not change the fact that, in practice, one of you continues to run the
business, while the other only helps out occasionally. But it allows your spouse to participate as needed, without doubts
about his or her status.
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How Sole Proprietors Are Taxed
From the Nolo Business & Human Resources Center
Sole proprietors pay taxes on business income on their personal tax returns.
As a sole proprietor you must report all business income or losses on your personal income tax return; the business itself
is not taxed separately. (The IRS calls this "pass-through" taxation, because business profits pass through the business to
be taxed on your personal tax return.)
Here's a brief overview of how to file and pay taxes as a sole proprietor -- and an explanation of when incorporating your
business can save you tax dollars.
Filing a Tax Return
The main difference between reporting income from your sole proprietorship and reporting wages from a job is that you
must list your business's profit or loss information on Schedule C (Profit or Loss from a Business), which you will submit to
the IRS along with Form 1040.
You'll be taxed on all profits of the business -- that's total income minus expenses -- regardless of how much money you
actually withdraw from the business. In other words, even if you leave money in the company's bank account at the end of
the year (for instance, to cover future expenses or expand the business), you must pay taxes on that money.
You can deduct your business expenses just like any other business. You are allowed to expense (deduct) much of the
money you spend in pursuit of profit, including operating expenses, product and advertising costs, travel expenses, and
some of the cost of business-related meals and entertainment. You can also write off certain start-up costs and the cost of
business equipment and other assets you purchase for your business.
But you'll need to keep accurate records for your business that are clearly separate from your personal expenses. One
good approach is to keep separate checkbooks for your business and personal expenses -- and pay for all of your business
expenses out of the business checking account.
Estimated Taxes
Because you don't have an employer to withhold income taxes from your paycheck, it's your job to set aside enough
money to pay taxes on any business income you bring in during the year. To do this, you must estimate how much tax
you'll owe at the end of each year and make quarterly estimated income tax payments to the IRS and, if required, your
state tax agency.
Self-Employment Taxes
Sole proprietors must make contributions to the Social Security and Medicare systems; taken together, these contributions
are called "self-employment taxes." Self-employment taxes are equivalent to the payroll tax for employees of a business.
While regular employees make contributions to these two programs through deductions from their paychecks, sole
proprietors must make their contributions when paying their other income taxes.
Another important difference between employees and sole proprietors is that employees only have to pay half as much into
these programs because their contributions are matched by their employers. Sole proprietors must pay the entire amount
themselves (although they can deduct half of the cost).
The self-employment tax rate for 2006 is 15.3% of the first $94,200 of income and 2.9% of everything over $94,200. Self-
employment taxes are reported on Schedule SE, which a sole proprietor submits each year along with a 1040 income tax
return and Schedule C.
Incorporating Your Business May Cut Your Tax Bill
Unlike a sole proprietorship, a corporation is considered a separate entity from its owners for income tax purposes. Owners
of corporations don't pay tax on the corporation's earnings unless they actually receive the money as compensation for
services (salaries and bonuses) or as dividends. The corporation itself pays taxes on all profits left in the business.
Corporate owners who need or want to leave some profits in the business can benefit from lower corporate tax rates, at
least for the first $75,000 of profits. The corporate tax rate is only 15% on the first $50,000 of profit and 25% on the next
$25,000 of profit. These rates are usually lower than shareholders' personal income tax brackets.
For example, if your Web design company wants to build up a reserve to buy new equipment, or your small label
manufacturing company needs to accumulate inventory as it expands, you may choose to leave money in the business --
let's say $50,000. If you operate as a sole proprietor, those "retained" profits would be taxed at your marginal individual
tax rate, which is probably more than 25%. But if you incorporate, that $50,000 would be taxed at the lower 15%
corporate rate.
However, corporate taxation is definitely more complicated than the pass-through taxation of a sole proprietorship, and the
savings -- probably a few thousand dollars -- may not be worth the hassle of forming a corporation and filing a corporate
tax return.
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Copyright 2006 Nolo

How Partnerships Are Taxed


From the Nolo Business & Human Resources Center
Learn the essentials of this complicated subject before you file your tax return.
For many small businesses, paying income tax means struggling to master double-entry bookkeeping and employee
withholding rules while ferreting out every possible business deduction. For partnerships, paying taxes also involves
understanding difficult terms like "distributive share," "special allocation," and "substantial economic effect." Here, we
demystify some of these complexities and explain the basics of how partnerships are taxed.
How Partnership Income Is Taxed
Generally, the IRS does not consider partnerships to be separate from their owners for tax purposes; instead, they are
considered "pass-through" tax entities. This means that all of the profits and losses of the partnership "pass through" the
business to the partners, who pay taxes on their share of the profits (or deduct their share of the losses) on their individual
income tax returns. Each partner's share of profits and losses is usually set out in a written partnership agreement.

Filing Tax Returns


Even though the partnership itself does not pay income taxes, it must file Form 1065 with the IRS. This form is an
informational return the IRS reviews to determine whether the partners are reporting their income correctly. The
partnership must also provide a Schedule K-1 to the IRS and to each partner, which breaks down each partner's share of
the business's profits and losses. In turn, each partner reports this profit and loss information on his or her individual tax
return (Form 1040), with Schedule E attached.

Estimating and Paying Taxes


Because there is no employer to compute and withhold income taxes, each partner must set aside enough money to pay
taxes on his share of annual profits. Partners must estimate the amount of tax they will owe for the year and make
payments to the IRS (and usually to the appropriate state tax agency) each quarter -- in April, July, October, and January.
Profits Are Taxed Whether Partners Receive Them or Not
The IRS requires each partner to pay income taxes on his "distributive share." This is the portion of profits to which the
partner is entitled under a partnership agreement -- or under state law if the partners didn't make an agreement. The IRS
treats each partner as though he or she received his distributive share each year. This means that you must pay taxes on
your share of the partnership's profits -- total sales minus expenses -- regardless of how much money you actually
withdraw from the business.
The practical significance of the IRS rule about distributive shares is that even if partners need to leave profits in the
partnership -- for instance, to cover future expenses or expand the business -- each partner will owe income tax on his or
her rightful share of that money. (If your business will regularly need to retain profits, you should consider incorporating --
corporations offer some relief from this particular tax bite. To learn more, see "Incorporating Your Business May Cut Your
Tax Bill," below.)

Establishing the Partners' Distributive Shares


Unless business partners make a written partnership agreement that says otherwise, state law usually allocates profits and
losses to the partners according to their ownership interests in the business. This allocation determines each partner's
distributive share. For instance, if Andre owns 60% of a partnership and Jenya owns the other 40%, Andre will be entitled
to 60% of the partnership's profits and losses and Jenya will be entitled to 40%. (In addition, state law assumes that each
partner's interest in the business is in proportion to the value of his or her initial contribution to the partnership.)
If you'd like to split up profits and losses in a way that is not proportionate to the partners' percentage interests in the
business, it's called a "special allocation," and you must carefully follow IRS rules.
Self-Employment Taxes
If you are actively involved in running a partnership, in addition to income taxes, the IRS requires you to pay "self-
employment" taxes on all partnership profits allocated to you. Self-employment taxes consist of contributions to the Social
Security and Medicare programs, similar to the payroll taxes employees must pay.
There are some differences between the contributions regular employees make and the contributions partners must make.
First, because no employer withholds these taxes from partners' paychecks, partners must pay them with their regular
income taxes. Also, partners must pay twice as much as regular employees, because employees' contributions are
matched by their employers. However, partners can deduct half of their self-employment tax contribution from their
taxable income, which lowers their tax bill a bit.
The self-employment tax rate for 2006 is 15.3% of the first $94,200 of income and 2.9% of everything over $94,200.
Partners report their self-employment taxes on Schedule SE, which they submit annually with their personal income tax
returns.
Expenses and Deductions
You may be wondering how you will survive financially, after paying income taxes, Social Security taxes, and Medicare
taxes on your share of business income, even if you don't withdraw it out from your business. Luckily, you don't have to
pay taxes on most of the money your business spends to make a buck.
You and your partners can deduct your legitimate business expenses from your business income, which will greatly lower
the profits you have to report to the IRS. Deductible expenses include start-up costs, operating expenses, travel costs, and
product and advertising outlays, as well as a portion of the money you spend on business-related meals and
entertainment.

Get Expert Help

If you're confused by partnership taxes, you're not alone. A good way to learn the basics is to

read Tax Savvy for Small Business, by tax attorney Fred Daily (Nolo). Then, plan to get the help you
need from a tax advisor who specializes in partnership taxation, to make sure you comply with the
complex tax rules that apply to your business and stay on the good side of the IRS.

Incorporating Your Business May Cut Your Tax Bill


Unlike a partnership, a corporation pays its own taxes on all corporate profits left in the business. Owners of corporations
pay income taxes only on money they receive as compensation for services (salaries and bonuses) or as dividends.
While many small businesses would rather not file a corporate tax return, incorporating can offer business owners a tax
advantage over a partnership's "pass through" taxation. This is especially true for businesses that expect to retain profits
in the business from year to year.
If you need to keep profits (called "retained earnings") in your business, you may benefit from lower corporate tax rates,
at least for the first $50,000 - $75,000 of profits per year. For example, if your retail outfit needs to stock up on expensive
inventory, you might decide to leave $30,000 in your business at the end of a year. If you operate as a partnership, these
retained profits will likely be taxed at your marginal individual tax rate, which is probably more than 25%. But if you
incorporate, that $30,000 will be taxed at a lower 15% corporate rate.
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Copyright 2006 Nolo

Creating a Partnership Agreement


From the Nolo Business & Human Resources Center
Don't wait another minute to put your partnership agreement in writing.
If you and your partners don't spell out your rights and responsibilities in a written partnership agreement, you'll be ill-
equipped to settle conflicts when they arise, and minor misunderstandings may erupt into full-blown disputes. In addition,
without a written agreement saying otherwise, your state's laws will control many aspects of your business.
How a Partnership Agreement Helps Your Business
A partnership agreement allows you to structure your relationship with your partners in a way that suits your business.
You and your partners can establish the shares of profits (or losses) each partner will take, the responsibilities of each
partner, what will happen to the business if a partner leaves, and other important guidelines.

The Uniform Partnership Act

Each state (with the exception of Louisiana) has its own laws governing partnerships, contained in what's usually called
"The Uniform Partnership Act" or "The Revised Uniform Partnership Act" (or the "UPA" or "Revised UPA"). These
statutes establish the basic legal rules that apply to partnerships and will control many aspects of your partnership's life
unless you set out different rules in a written partnership agreement.
Don't be tempted to leave the terms of your partnership up to these state laws. Because they were designed as one-
size-fits-all fallback rules, they may not be helpful in your particular situation. It's much better to have an agreement in
which you and your partners state the rules that will apply to your business.

What to Include in Your Partnership Agreement


Here's a list of the major areas that most partnership agreements cover. You and your partners-to-be should consider
these issues before you put the terms in writing:

1. Name of the partnership. One of the first things you must do is agree on a name for your partnership. You can
use your own last names, such as Smith & Wesson, or you can adopt and register a fictitious business name, such as
Westside Home Repairs. If you choose a fictitious name, you must make sure that the name isn't already in use and then
file a fictitious business name statement with your county clerk.

2. Contributions to the partnership. It's critical that you and your partners work out and record who's going to
contribute cash, property, or services to the business before it opens -- and what ownership percentage each partner will
have. Disagreements over contributions have doomed many promising businesses.

3. Allocation of profits, losses, and draws. Will profits and losses be allocated in proportion to a partner's
percentage interest in the business? Will each partner be entitled to a regular draw (a withdrawal of allocated profits from
the business) or will all profits be distributed at the end of each year? You and your partners may have different financial
needs and different ideas about how the money should be divided up and distributed, so this is an area to which you
should pay particular attention.

4. Partners' authority. Without an agreement to the contrary, any partner can bind the partnership (to a contract
or debt, for example) without the consent of the other partners. If you want one or all of the partners to obtain the others'
consent before obligating the partnership, you must make this clear in your partnership agreement.

5. Partnership decision making. Although there's no magic formula or language for making decisions among
partners, you'll head off a lot of trouble if you try to work it out beforehand. You may, for example, want to require a
unanimous vote of all the partners for every business decision. Or if that leaves you feeling fettered, you can require a
unanimous vote for major decisions and allow individual partners to make minor decisions on their own. In that case, your
partnership agreement will have to describe what constitutes a major or minor decision. You should carefully think through
issues like these before you and your partners have to make important decisions

1. Management duties. You might not want to make ironclad rules about every management detail, but you'd be
wise to work out some guidelines in advance. For example, who will keep the books? Who will deal with customers?
Supervise employees? Negotiate with suppliers? Think through the management needs of your partnership and be sure
you've got everything covered.

2. Admitting new partners. Eventually, you may want to expand the business and bring in new partners.
Agreeing on a procedure for admitting new partners will make your lives a lot easier when this issue comes up.

3. Withdrawal or death of a partner. At least as important as the rules for admitting new partners to the
business are the rules for handling the departure of an owner. You should set up a reasonable buyout scheme in your
partnership agreement.

4. Resolving disputes. If you and your partners become deadlocked on an issue, do you want to go straight to
court? It might benefit everyone involved if your partnership agreement provides for alternative dispute resolution, such as
mediation or arbitration.
As you can see, there are many issues to consider before you and your partners open for business -- and you shouldn't
wait for a conflict to arise before hammering out some sound rules and procedures. A good self-help book, such as The
Partnership Book: How to Write a Partnership Agreement, by attorneys Denis Clifford and Ralph Warner (Nolo), can help
you think through the details and put them in writing.
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Copyright 2006 Nolo
Making Special Allocations
From the Nolo Business & Human Resources Center
You must carefully follow IRS rules if you want to divide profits and losses in a way that's disproportionate to
the owners' interests in the business. If a business splits up profits and losses in a way that does not correspond to
the owners' percentage interests in the business, it's called a "special allocation." The IRS pays careful attention to special
allocations to be sure business owners aren't playing hide and seek with potential tax dollars -- for example, by allocating
all business losses to the owner in the highest income tax bracket.
If the IRS rejects your special allocation, it will tax you and your co-owners as if you had divided profits and losses in
proportion to your ownership interests, regardless of what your partnership agreement or operating agreement says.
Substantial Economic Effect
To be certain that a special allocation is legitimate, the IRS checks to see whether the allocation has what it calls
"substantial economic effect." This jargon means that a special allocation must reflect the owners' actual economic
circumstances, not an effort to shift income around to reduce taxes.

Example

John and Anna set up an LLC to operate their consulting business. John puts up all the cash, while
Anna signs a promissory note to contribute her share in installments over the first two years of the
business. Their operating agreement says that John and Anna each have a 50% ownership interest in
the LLC, but it also says that John will be allocated 75% of the LLC's profits (and losses) for the first
two years, and Anna will be allocated 25% of the LLC's profits (and losses) during this initial period.
After the first two years, the agreement says that both members will split LLC allocations of profits
and losses 50-50 -- that is, in proportion to their ownership interests. Because there are legitimate
financial reasons for the uneven split, the IRS should respect this special allocation.

Get Expert Help


Unfortunately, the IRS regulations covering substantial economic effect are complicated. If you want to set up a special
allocation, you'll need expert help to make sure that your allocation will pass muster with the IRS. A good accountant or
tax lawyer -- one who provides advice on this area of tax law as a regular part of her practice -- can draft special language
for your partnership agreement or operating agreement to ensure that the IRS will accept your special allocation.
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Copyright 2006 Nolo

Partnership Basics
From the Nolo Business & Human Resources Center
Learn more about the simplest business structure for companies with more than one owner.
By definition, a partnership is a business with more than one owner that has not filed papers with the state to become a
corporation or LLC (limited liability company). There are two basic types of partnerships: general partnerships and limited
partnerships. This article discusses general partnerships, the more common structure in which every partner has a hand in
managing the business.
The partnership is the simplest and least expensive co-owned business structure to create and maintain. However, there
are a few important facts you should know before you begin.
Personal Liability for All Owners
First, partners are personally liable for all business debts and obligations, including court judgments. This means that if the
business itself can't pay a creditor, such as a supplier, lender, or landlord, the creditor can legally come after any partner's
house, car, or other possessions.
There are a few exceptions to this personal liability. Some of the partners can have limited personal liability if the
partnership is set up as a limited partnership. This is a partnership in which only the general partner, who runs the
business, has personal liability, while the limited partners, who are basically passive investors, can lose no more than their
stake in the partnership. Also, some states allow special limited liability partnerships (LLPs). More commonly, though,
businesspeople who are particularly concerned about personal liability choose to incorporate their business or operate as a
limited liability company (LLC).

Joint Authority
In addition, any individual partner can usually bind the whole business to a contract or other business deal. For instance, if
your partner signs a year-long contract with a supplier to buy inventory at a price your business can't afford, you can be
held personally responsible for the money owed under the contract.
There are just a few limits on a partner's ability to commit the partnership to a deal -- for instance, one partner can't bind
the partnership to a sale of all of the partnership's assets. But generally, unless an outsider has reason to know of any
limits the partners have placed on each other's authority in their partnership agreement, any partner can bind the others
to a deal.

Joint Liability
Each individual partner can be sued for -- and required to pay -- the full amount of any business debt. If this happens, an
individual partner's only recourse may be to sue the other partners for their shares of the debt.
Because of this combination of personal liability for all partnership debt and the authority of each partner to bind the
partnership, it's critical that you trust the people with whom you start your business.
Partnership Taxes
A partnership is not a separate tax entity from its owners; instead, it's what the IRS calls a "pass-through entity." This
means the partnership itself does not pay any income taxes on profits. Business income simply "passes through" the
business to the partners, who report their share of profits (or losses) on their individual income tax returns. In addition,
each partner must make quarterly estimated tax payments to the IRS each year.
While the partnership itself doesn't pay taxes, it must file IRS Form 1065, an informational return, each year. This form
sets out each partner's share of the partnership profits (or losses), which the IRS reviews to make sure the partners are
reporting their income correctly.
Creating a Partnership
You don't have to file any paperwork to establish an ordinary partnership -- just agreeing to go into business with another
person will get you started.
Of course, partnerships must meet the same local registration requirements as any new business. Most cities and counties
require businesses to register with them and pay at least a minimum tax. You may also have to obtain an employer
identification number from the IRS, a seller's license from your state, and a zoning permit from your local planning board.
In addition, your partnership may have to register a fictitious or assumed business name. If your business name doesn't
contain all of the partners' last names (for instance, you want to use "London Landscapes" instead of "Harper & Reed
Landscapes"), you usually must register that name -- known as a fictitious or assumed business name -- with your county
clerk.
While the owners of a partnership are not legally required to have a written partnership agreement, it makes good sense
to put the details of ownership, including the partners' rights and responsibilities and their share of profits, into a written
agreement.
Ending a Partnership
One disadvantage of partnerships is that when one partner wants to leave the company, the partnership generally
dissolves. In that case, the partners must fulfill any remaining business obligations, pay off all debts, and divide any assets
and profits among themselves.
If you want to prevent this kind of ending for your business, you should create a buy-sell agreement, or buyout
agreement, which can be included as part of your partnership agreement. A buy-sell/buyout agreement helps partners
decide and plan for what will happen when one partner retires, dies, becomes disabled, or leaves the partnership to pursue
other interests. For example, such an agreement might allow the partners to buy out a departing partner's interest, so
business can continue as usual.
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Owner Buyout Agreements: Plan Ahead for Changes in Partnership Ownership
by Attorney Bethany K. Laurence
From the Nolo Business & Human Resources Center
Your partnership agreement isn't complete without a buyout agreement stating what will happen when a
partner leaves the business.
Many new partners neglect to make a buyout, or buy-sell, agreement, but they are critical to protect your investment in a
partnership. When you create buyout provisions for your partnership agreement, you and your partners will be prepared if
one partner wants to leave the business, or worse, dies, goes bankrupt, or gets divorced.
What Is a Buyout, or Buy-Sell, Agreement?
Contrary to popular belief, a buy-sell agreement is not about buying and selling companies. It is a binding contract
between business partners about the future ownership of the business. Because of this confusion in terminology, we will
use the term buyout agreement from now on.
A buyout agreement can stand on its own or can be several provisions in your written partnership agreement that control
the following business decisions:
1. whether a departing partner must be bought out
2. what price will be paid for the departing partner's interest in the partnership
3. who can buy the departing partner's share of the business (this may include outsiders or be limited to other
partners), and

4. what other events may trigger a buyout.

It may help to think of a buyout agreement as a sort of "premarital agreement" between you and your partners: Although
you might think that your partnership will last as long as you all shall live, the buyout determines what will happen if
things don't go exactly as you planned.
Events Covered Under a Buyout Agreement
Typically, the events that trigger a buy out of a partner's interest under a buyout agreement are:
1. the retirement or resignation of a partner
2. an attractive offer from an outsider to purchase a partner's interest in the company
3. a divorce settlement in which a partner's ex-spouse stands to receive a partnership interest in the company
4. the foreclosure of a debt secured by a partnership interest
5. the personal bankruptcy of a partner, or

6. the disability, death, or incapacity of a partner.

Why You Need a Buyout Agreement


Your buyout agreement will instruct and remind you and your partners how you have agreed to handle the sale or buyback
of an ownership interest when one partner's circumstances change. Without one, if one partner quits to move to another
city or leaves to start another business, your partnership might, by law, be dissolved, forcing you to divide any assets and
profits among the partners and decide whether to start a new partnership with the remaining partners.
Even if your partnership doesn't end, you may still have an argument over whether you should buy out the departing
partner's ownership interest, and for how much. If you don't anticipate and plan for circumstances like these, you risk
serious personal and business discord -- perhaps even court battles and the loss of your business.
In addition, a buyout agreement can control who can buy into the partnership. Otherwise, you might be stuck sharing
control of the company with someone you would rather not run a business with.
How to Create a Buyout Agreement
For a fill-in-the-blank buyout agreement and instructions on how to incorporate it into your partnership agreement, see
Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K.
Laurence (Nolo).
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Copyright 2006 Nolo
Running a Corporation: Keeping the Minutes
From the Nolo Business & Human Resources Center
If you don't keep adequate records and minutes of meetings, you could lose your limited liability protection.
As the owner of a corporation, you are required to hold shareholders' and directors' meetings, maintain corporate records,
and document major corporate decisions. If you neglect these formalities and your business runs into legal trouble, a court
may decide to disregard your corporate status -- and hold you personally responsible for the corporation's debts.
The good news is that many states have streamlined the procedures for operating a small corporation, permitting owners
to make decisions quickly, without jumping through needless procedural hoops.
Who Makes Corporate Decisions?
To understand the corporate decision-making process, let's look at the different legal roles people traditionally play in a
corporation: shareholder, director, officer, and employee. As we consider these roles, keep in mind that you can set up a
corporation in which one or two people play all of them.

Shareholders
Shareholders own stock (called shares or ownership interests) in the corporation. Shareholders have the exclusive right to:
1. elect and remove directors
2. amend the articles of incorporation and bylaws
3. approve the sale of all or substantially all of the corporate assets
4. approve mergers and reorganizations, and

5. dissolve the corporation.

State laws typically require the shareholders to hold an annual meeting. However, many states allow shareholders to do
this through a "written consent" or "consent resolution" -- a document signed by all of the shareholders -- instead of a
face-to-face meeting.

Directors
The board of directors sets policy for the corporation and makes major financial decisions. Among other things, the
directors:
1. authorize the issuance of stock
2. elect the corporate officers
3. set officer and key employee salary amounts
4. decide whether to mortgage, sell, or lease real estate, and

5. approve loans to or from the corporation.

While many states require directors to hold regular meetings, it's often simpler and just as effective for the directors to
take actions by signing a consent resolution or written consent. Alternatively, most states allow directors' meetings to be
held by telephone.
While the organizational structure of corporations separates the rights and duties of shareholders and directors, this
separation isn't much of an issue for small corporations because most shareholders are also directors and officers.
However, even if you are both a shareholder and director of your corporation, you must still observe the formalities
required by law, which means wearing different hats at different times. For instance, sometimes you'll have to sign a
document in your capacity as director; at other times, you'll sign as a shareholder.

Officers
Officers are responsible for the day-to-day operation and management of the corporation. State laws usually require the
corporation to have at least a president, a secretary, and a treasurer (sometimes called a chief financial officer). But in
most states, the same person can hold all of the required offices.
The president is usually the chief operating officer (COO) of the corporation. The secretary is responsible for the corporate
records. The treasurer, or chief financial officer (CFO), of course, is responsible for the corporate finances, although it's
common to delegate everyday fiscal duties to a bookkeeper.

Employees
In small corporations, the owners are usually also employees of the corporation. Owners of small corporations receive
most of their financial benefits through the salary and other compensation they receive as corporate employees.
Documenting Corporate Decisions
While you don't need to document routine business decisions, you should prepare written minutes or consent resolutions
for events or decisions that require formal board of director or shareholder participation. These include:
1. the proceedings of annual meetings of directors and shareholders
2. the issuance of stock to new or existing shareholders
3. the purchase of real property
4. the approval of a long-term lease
5. the authorization of a substantial loan or line of credit
6. the adoption of a stock option or retirement plan, and

7. the making of important federal or state tax decisions.

If you document important corporate decisions, whether through formal written minutes or less formal consent resolutions,
you'll protect your limited liability status -- and you'll have solid documentation if key decisions are later questioned by
creditors, the courts, or the IRS. In addition, keeping good corporate records allows you to note the reasons for making
critical decisions; this can head off controversy and dissension in your ranks in the future.
To learn more about corporate decision making and record keeping, and to obtain blank minutes, written consents, and
resolutions forms, use The Corporate Minutes Book, by Anthony Mancuso (Nolo).
In addition to keeping records of important business decisions, your corporation must record financial transactions in a
double-entry bookkeeping system and keep other necessary financial records, so it can file an annual corporate tax return.
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Shareholder Buyout Agreements: Plan Ahead for Changes in Corporate Ownership


by Attorney Bethany K. Laurence
From the Nolo Business & Human Resources Center
Buyout, or buy-sell, agreements cover what happens when an owner wants out.
Buyout, or buy-sell, agreements are often overlooked, even by shareholders who have diligently filed their articles of
incorporation and adopted their corporate bylaws. But this can be a costly mistake: Without a buyout agreement, if a
shareholder wants to leave the company, there's no contract that says whether the remaining shareholders or the
corporation must buy him out, or for how much.
By creating a buyout agreement, the owners of a small, privately held corporation can be prepared when a shareholder
wants to be bought out, or worse, dies, goes bankrupt, or gets divorced.
What Are Buyout, or Buy-Sell, Agreements?
Contrary to popular belief, buy-sell agreements don't have anything to do with buying and selling companies. Instead, they
control when and how shares in a corporation can be bought and sold. Buy-sell agreements are also sometimes called
shareholders' agreements or stock agreements. Because of this confusion over terminology, we will stick to the term
buyout agreement from now on.
Typically, a buyout agreement controls the following decisions:
1. whether a departing shareholder must be bought out
2. who can buy a departing shareholder's stock (this may include outsiders or be limited to other shareholders)
3. what price will be paid for a shareholder's interest in the corporation, and
4. what other events will trigger a buyout.

It may help to think of a buyout agreement as a sort of "premarital agreement" between co-owners: It determines what
will happen if your corporation's owners decide not to stay together 'til death do they part.
What Events Should Be Covered in a Buyout Agreement?
Typically, the events that trigger the buyout of a shareholder's interest are:
1. the retirement or resignation of a shareholder
2. an attractive offer from an outsider to purchase a shareholder's interest in the corporation
3. a divorce settlement in which a shareholder's ex-spouse stands to receive all or part of a shareholder's stock of
the corporation
4. the foreclosure of a debt secured by a shareholder's stock
5. the personal bankruptcy of a shareholder, or

6. the disability, death, or incapacity of a shareholder.

Why You Need a Buyout Agreement


It's a huge mistake to ignore the fact that sooner or later your business will change. Chances are, one of your founding co-
owners will eventually want to leave the company (and take his investment with him) before the rest of the shareholders
are ready to call it quits.
When one shareholder quits to move to another city or leaves to start another business, without an agreement, who
decides whether the remaining owners have to buy out the departing shareholder, and for much? If you don't anticipate
and plan for circumstances like these, you're risking serious personal and business discord -- perhaps even court battles
and the loss of your business.
In addition, a buyout agreement puts limits on who can buy shares in the corporation. Otherwise, you could be forced to
share control of the company with someone you'd rather not run a business with.
Creating a Buyout Agreement
To create a buyout agreement, you can use either a self-help resource or see a lawyer -- or both. One good tool is
Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany Laurence
(Nolo). The book contains a disk with a fill-in-the-blank buyout agreement and guides co-owners through a discussion
of their options. Even if you plan on using a lawyer, the book can help you decide on your own time -- not your lawyer's --
what you want to include in your agreement.
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Copyright 2006 Nolo

Corporation Basics
From the Nolo Business & Human Resources Center
Forming a corporation limits your personal liability for business debts, but running one takes work.
Most people have heard that forming a corporation provides "limited liability" -- that is, it limits your personal liability for
business debts. What you may not know is that there's more to creating and running a corporation than filing a few
papers. You'll need to keep good records to handle the more complicated corporate tax return and, in order to retain your
limited liability, you must follow corporate formalities involving decision making and record keeping. In short, you've got to
be organized.
Limited Personal Liability
One of the main advantages of incorporating is that the owners' personal assets are protected from creditors of the
corporation. For instance, if a court judgment is entered against your corporation saying that it owes a creditor $100,000,
you can't be forced to use personal assets, such as your house, to pay the debt. Because only corporate assets need be
used to pay business debts, you stand to lose only the money that you've invested in the corporation.

Exceptions to Limited Liability


There are some circumstances in which limited liability will not protect an owner's personal assets. An owner of a
corporation can be held personally liable if he or she:
1. personally and directly injures someone
2. personally guarantees a bank loan or a business debt on which the corporation defaults
3. fails to deposit taxes withheld from employees' wages
4. does something intentionally fraudulent or illegal that causes harm to the company or to someone else, or

5. treats the corporation as an extension of his or her personal affairs, rather than as a separate legal entity.

This last exception is the most important. In some circumstances, courts can rule that a corporation doesn't really exist
and that its owners should not be shielded from personal liability for their acts. This might happen if you fail to follow
routine corporate formalities such as:
1. adequately investing money in ("capitalizing") the corporation
2. formally issuing stock to the initial shareholders
3. regularly holding meetings of directors and shareholders, or

4. keeping business records and transactions separate from those of the owners.

Liability Insurance
Incorporating should never take the place of good business insurance. Even though forming a corporation protects your
personal assets, you should use insurance to guard your corporate assets from lawsuits and claims.
A solid liability insurance policy can protect you against many of the risks of doing business. For instance, if you operate a
clothing store, good business insurance should adequately cover the bill if someone slips and falls in your store.
Also, insurance can protect you where the limited liability feature will not. For example, if you personally injure someone
while doing business for the corporation, say by causing a car accident, liability insurance will usually cover the accident so
that you won't have to use either corporate or personal assets to pay the bill. However, insurance won't help if
your corporation doesn't pay the bills: commercial insurance usually does not protect personal or corporate assets from
unpaid business debts, whether or not they're personally guaranteed.
Paying Corporate Income Tax
If an owner of a corporation works for the corporation, that owner is paid a salary, and possibly bonuses, like any other
employee. The owner pays taxes on this income just like regular employees, reporting and paying the tax on his or her
personal tax return.
The corporation pays taxes on whatever profits are left in the businesses after paying out all salaries, bonuses, overhead,
and other expenses. To do this, the corporation files its own tax return, Form 1120, with the IRS and pays taxes at a
special corporate tax rate.
Alternatively, corporate shareholders can elect what's called "S corporation" status by filing Form 2553 with the IRS. This
means that the corporation will be treated like a partnership (or LLC) for tax purposes, with business profits and losses
"passing through" the corporation to be reported on the owners' individual tax returns.
Forming a Corporation
To form a corporation, you must file "articles of incorporation" with the corporations division (usually part of the secretary
of state's office) of your state government. Filing fees are typically $100 or so.
For most small corporations, articles of incorporation are relatively short and easy to prepare. Most states provide a
simple form for you to fill out, which usually asks for little more than the name of your corporation, its address, and the
contact information for one person involved with the corporation (often called a "registered agent"). Some states also
require you to list the names of the directors of your corporation.
In addition to filing articles of incorporation, you must create "corporate bylaws." While bylaws do not have to be filed with
the state, they are important because they set out the basic rules that govern the ongoing formalities and decisions of
corporate life, such as how and when to hold regular and special meetings of directors and shareholders and the number of
votes that are necessary to approve corporate decisions.
Finally, you must issue stock certificates to the initial owners (shareholders) of the corporation and record who owns the
ownership interests (shares or stock) in the business.
Retaining Corporate Status
Corporations and their owners must observe certain formalities to retain the corporation's status as a separate entity.
Specifically, corporations must:
1. hold annual shareholders' and directors' meetings
2. keep minutes of shareholders' and directors' major decisions
3. make sure that corporate officers and directors sign documents in the name of the corporation
4. maintain separate bank accounts from their owners
5. keep detailed financial records, and
6. file a separate corporate income tax return.

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Professional Corporations
From the Nolo Business & Human Resources Center
In many states, professionals who want to incorporate their practices must create what's called a professional
corporation.
In many states, people in certain occupations (for example, doctors, lawyers or accountants) who want to incorporate their
practice can do so only through a "professional corporations" or "professional service corporations." In other states, some
professionals have a choice of incorporating as either a professional corporation or a regular corporation. And in all states,
certain professionals are allowed to form professional corporations or professional service corporations.
The list of professionals required to incorporate as a professional corporation is different in each state. Usually, though,
mandatory professional incorporation requirements apply to these professionals:
1. accountants
2. engineers
3. health care professionals such as audiologists, dentists, nurses, opticians, optometrists, pharmacists, physical
therapists, physicians and speech pathologists
4. lawyers
5. psychologists
6. social workers

7. veterinarians.

You'll need to call your state's corporate filing office (usually the Secretary of State or Corporation Commissioner) to see
which professions are required to form professional corporations in your own state.
Professional corporations aren't as popular as they used to be. The main reason for professionals to incorporate --
favorable corporate taxation rules -- has disappeared. Before 1986, professionals who incorporated could shelter more
money from taxes than sole proprietors or partners could. This has all changed. Most professional corporations are
classified as "personal service corporations" by the IRS, which means that their corporate income is taxed at a flat 35%.
So there's no longer any advantage to be gained by the two-tiered tax structure that allows ordinary corporations to save
taxes on some retained earnings.
Are there any reasons left for professionals to form professional corporations? Perhaps. Professional corporations provide a
limit on the owners' personal liability for business debts and claims. Incorporating can't protect a professional against
liability for his or her negligence or malpractice, but it can protect against liability for the negligence or malpractice of an
associate.

Example 1

Dr. Anton and Dr. Bartolo are surgeons who practice as partners. Dr. Bartolo leaves an instrument
inside a patient, who bleeds to death. The jury returns a $2 million verdict against Dr. Bartolo and
the partnership. There is only $1 million in malpractice insurance to cover the judgment. Dr. Anton
(along with Dr. Bartolo) would be personally liable for the $1 million not covered by insurance.

Example 2

Drs. Anton and Bartolo create a professional corporation. Dr. Bartolo commits the malpractice
described in Example 1. Dr. Anton, a corporate employee, would not be personally liable for the
portion of the verdict not covered by insurance. Dr. Bartolo, however, would still be personally
responsible for the $1 million excess, because he was the one guilty of malpractice. (In some states,
Dr. Anton would be free from personal liability only if the professional corporation carried at least the
minimum amount of insurance mandated by state law.)
As an alternative to incorporating, professionals wishing to limit their personal liability should consider forming a limited
liability company (LLC).
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S Corporation Facts
From the Nolo Business & Human Resources Center
S corporations are similar to LLCs in that they provide owners with limited liability protection while offering
the tax structure of a partnership.
Many entrepreneurs have two goals when choosing a structure for their business: Protecting their personal assets from
business claims (limited liability) and having business profits taxed on their individual tax returns. Not long ago, an S
corporation was the only choice for these business owners. In recent years, however, S corporations have been largely
replaced by limited liability companies (LLCs). Still, some businesses can benefit by organizing as S corporations.
What Is an S Corporation?
An S corporation is a regular corporation that has elected "S corporation" tax status. Forming an S corporation lets you
enjoy the limited liability of a corporate shareholder but pay income taxes as if you were a sole proprietor or a partner.
In a regular corporation (also known as a C corporation), the company itself is taxed on business profits. The owners pay
individual income tax only on money they receive from the corporation as salary, bonuses, or dividends.
By contrast, in an S corporation, all business profits "pass through" to the owners, who report them on their personal tax
returns (as in sole proprietorships, partnerships, and LLCs). The S corporation itself does not pay any income tax, although
an S corporation with more than one owner must file an informational tax return like a partnership or LLC, to report each
shareholder's portion of the corporate income.
Most states follow the federal pattern when taxing S corporations: They don't impose a corporate tax, choosing instead to
tax the business's profits on the shareholders' personal tax returns. About half a dozen states, however, tax an S
corporation like a regular corporation. The tax division of your state treasury department can tell you how S corporations
are taxed in your state.
Should You Elect S Corporation Status?
Operating as an S corporation may be wise for several reasons:
1. Forming an S corporation generally allows you to pass business losses through to your personal income tax
return, where you can use it to offset any income that you (and your spouse, if you're married) have from other sources.
2. When you sell your S corporation, your taxable gain on the sale of the business can be less than it would have
been had you operated the business as a regular corporation.
3. S corporation shareholders are not subject to self-employment taxes (active LLC owners are). These taxes, which
add up to more than 15% of your income, are used to pay your Social Security and Medicare taxes.
Aside from the benefits, S corporations impose strict requirements. Here are the main rules:
1. Each S corporation shareholder must be a U.S. citizen or resident.
2. S corporations may not have more than 100 shareholders.
3. S corporation profits and losses may be allocated only in proportion to each shareholder's interest in the
business.

4. An S corporation shareholder may not deduct corporate losses that exceed his or her "basis" in corporate stock --
which equals the amount of the shareholder's investment in the company plus or minus a few adjustments.
5. S corporations may not deduct the cost of fringe benefits provided to employee-shareholders who own more than
2% of the corporation.
Fortunately, a decision to elect to be an S corporation isn't permanent. If your business later becomes more profitable and
you find there are tax advantages to being a regular corporation, you can drop your S corporation status after a certain
amount of time.
How to Elect S Corporation Status
To create an S corporation, you must first create a regular corporation by filing articles of incorporation with your secretary
of state's office or your state's corporations division. Then, to be treated as an S corporation, all shareholders must sign
and file IRS Form 2553.

Want Some Help?

If you're ready to incorporate, Nolo offers the following helpful guides, which come with forms on CD-
ROM:
1. Incorporate Your Business: A Legal Guide to Forming a Corporation in Your State, by
attorney Anthony Mancuso, or
2. How to Form Your Own California Corporation, by attorney Anthony Mancuso.
Nolo also publishes Incorporator Pro, software that will create articles of incorporation and bylaws for
you.

S Corporation Alternatives
You can get the benefits of limited liability and pass-through taxation by creating a limited liability company (LLC).
Because an LLC offers its owners the significant advantage of greater flexibility in allocating profits and losses, and
because LLCs aren't subject to the many restrictions of S corporations, forming an LLC is often the better choice.
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Copyright 2006 Nolo

How to Form a Corporation


From the Nolo Business & Human Resources Center
To form your own corporation, you must take these essential steps.
If you've sorted through the many types of business structures and decided to create a corporation, you're facing a list of
important -- but manageable -- tasks. Here's what you must do:
1. Choose an available business name that complies with your state's corporation rules.
2. Appoint the initial directors of your corporation.
3. File formal paperwork, usually called "articles of incorporation," and pay a filing fee that ranges from $100 to
$800, depending on the state where you incorporate.
4. Create corporate "bylaws," which lay out the operating rules for your corporation.
5. Hold the first meeting of the board of directors.
6. Issue stock certificates to the initial owners (shareholders) of the corporation.
7. Obtain any licenses and permits that are required for your business.
Choosing a Corporate Name
The name of your corporation must comply with the rules of your state's corporation division. You should contact your
state's office for specific rules, but the following guidelines usually apply:

1. The name cannot be the same as the name of another corporation on file with the corporations office.

2. The name must end with a corporate designator, such as "Corporation," "Incorporated," "Limited," or an
abbreviation of one of these words (Corp., Inc., or Ltd.).
3. The name cannot contain certain words that suggest an association with the federal government or restricted
type of business, such as Bank, Cooperative, Federal, National, United States, or Reserve.
Your state's corporations office can tell you how to find out whether your proposed name is available for your use. Often,
for a small fee, you can reserve your corporate name for a short period of time until you file your articles of incorporation.
Besides following your state's corporate naming rules, you must make sure your name won't violate another company's
trademark.
Once you've found a legal and available name, you usually don't need to file the name of your business with your state.
When you file your articles of incorporation, your business name will be automatically registered.
However, if you will sell your products or services under a different name, you must file a "fictitious" or "assumed" name
statement with the state or county where your business is headquartered.
Appointing Directors
Directors make major policy and financial decisions for the corporation. For example, the directors authorize the issuance
of stock, appoint the corporate officers and set their salaries, and approve loans to and from the corporation. Directors are
typically appointed by the initial owners (shareholders) of the corporation before the business opens. Often, the owners
simply appoint themselves to be the directors, but directors do not have to be owners.
Most states permit a corporation to have just one director, regardless of the number of owners. In other states, a
corporation may have one director only if it has one owner; a corporation with two owners must have at least two
directors, and a corporation with three or more owners must have three or more directors.
Filing Articles of Incorporation
After you've chosen a name for your business and appointed your directors, you must prepare and file "articles of
incorporation" with your state's corporate filing office. Typically, this is the department or secretary of state's office,
located in your state's capital city. While most states use the term "articles of incorporation" to refer to the basic document
creating the corporation, some states use other terms, such as "certificate of incorporation" or "charter."
No state requires a corporation to have more than one owner. For single-owner corporations, the sole owner simply
prepares, signs, and files the articles of incorporation himself. For co-owned corporations, the owners may either all sign
the articles or appoint just one person to sign them. Whoever signs the articles is called the "incorporator" or "promoter."
Articles of incorporation don't have to be lengthy or complex. In fact, you can usually prepare articles of incorporation in
just a few minutes by filling out a form provided by your state's corporate filing office. Typically, the articles of
incorporation must specify just a few basic details about your corporation, such as its name, principal office address, and
sometimes the names of its directors.
You will probably also have to list the name and address of one person -- usually one of your directors -- who will act as
your corporation's "registered agent" or "agent for service of process." This person is on file so that members of the public
know how to contact the corporation -- for example, if they want to sue or otherwise involve the corporation in a lawsuit.
Drafting Corporate Bylaws
Bylaws are the internal rules that govern the day-to-day operations of a corporation, such as when and where the
corporation will hold directors' and shareholders' meetings and what the shareholders' and directors' voting requirements
are. To create bylaws, you can either follow the instructions in a self-help resource or hire a lawyer in your state to draft
them for you. Typically, the bylaws are adopted by the corporation's directors at their first board meeting.

Plan for Ownership Changes With a Shareholders' Agreement

A shareholders' agreement helps owners of a small corporation decide and plan for what will happen
when one owner retires, dies, becomes disabled, or leaves the corporation to pursue other interests.

Holding a First Meeting of the Board of Directors


After the owners appoint directors, file articles of incorporation, and create bylaws, the directors must hold an initial board
meeting to handle a few corporate formalities and make some important decisions. At this meeting, directors usually:
1. set the corporation's fiscal or accounting year
2. appoint corporate officers
3. adopt the corporate bylaws
4. authorize the issuance of shares of stock, and

5. adopt an official stock certificate form and corporate seal.

Additionally, if the corporation will be an S corporation, the directors should approve the election of S corporation status.
Issuing Stock
You should not do business as a corporation until you have issued shares of stock. Issuing shares formally divides up
ownership interests in the business. It is also a requirement of doing business as a corporation -- and you must act like a
corporation at all times to qualify for the legal protections offered by corporate status.

Securities Registration
Issuing stock can be complicated; it must be accomplished in accordance with securities laws. This means that large
corporations must register their stock offerings with the federal Securities and Exchange Commission (SEC) and the state
securities agency. Registration takes time and typically involves extra legal and accounting fees.
Exemptions to Securities Registration
Fortunately, most small corporations qualify for exemptions from securities registration. For example, SEC rules do not
require a corporation to register a "private offering" -- that is, a non-advertised sale to a limited number of people
(generally 35 or fewer) or to those who can reasonably be expected to take care of themselves because of their net worth
or income earning capacity. And most states have enacted their own versions of this SEC exemption. In short, if your
corporation will issue shares to a small number of people (generally ten or less) who will actively participate in running the
business, it will certainly qualify for exemptions to securities registration.

Passive Shareholder Rules

If you're selling shares of stock to passive investors (people who won't be involved in running

the company), complying with state and federal securities laws gets complicated. Get help from a
good small business lawyer.

For more information about federal securities laws and exemptions, visit the SEC website at www.sec.gov. For more
information on your state's exemption rules, go to your secretary of state's website. (You can find links to every state's
site at the website of the National Association of Secretaries of State, www.nass.org.)

Issuing the Shares


When you're ready to issue the actual shares, you'll need to document the following:
1. the names of the initial shareholders
2. the number of shares each shareholder will buy, and

3. how each shareholder will pay for his or her shares.

Finally, you'll prepare and issue the stock certificates. In some states you may also have to file a "notice of stock
transaction" or similar form with your state corporations office.
Obtaining Licenses and Permits
After you've filed your articles, created your bylaws, held your first directors' meeting, and issued stock, you're almost
ready to go. But you still need to obtain the required licenses and permits that anyone needs to start a new business, such
as a business license (also known as a tax registration certificate). You may also have to obtain an employer identification
number from the IRS, a seller's permit from your state, or a zoning permit from your local planning board.

Next Steps

If you're ready to incorporate your business, Nolo offers the following helpful guides, which come
with a CD-ROM of the forms you need:

1. Incorporate Your Business: A Legal Guide to Forming a Corporation in Your State, by


attorney Anthony Mancuso, or

2. How to Form Your Own California Corporation, by attorney Anthony Mancuso

Nolo also publishes Incorporator Pro, software that will create articles of incorporation and bylaws for
you.

Click here for related information and products from Nolo


Copyright 2006 Nolo

Cut Taxes With Corporate Income Splitting


From the Nolo Business & Human Resources Center
You can reduce overall income taxes by taking advantage of lower corporate tax rates.
The owners of a profitable small corporation can often save thousands of dollars in overall income taxes by keeping a
modest amount of profits in the corporation and paying out the rest to themselves as employee salaries and bonuses.
Called "income splitting," this works because corporate tax rates on the first $75,000 of corporate income are typically
lower than the owners' personal income tax rates.
How Income Splitting Works
As you already know, a corporation is a separate legal entity from its owners, and it pays its own income taxes. This
means that if the owners keep some income in the corporation (profits that are not paid out to the owners in the form of
salaries and bonuses), it will be taxed at corporate income tax rates, not at the individual income tax rates of its owners.
Income that is kept in the corporation is shown as "retained earnings" on a corporation's balance sheet, and is reported on
IRS Form 1120 each year.
Federal corporate income tax rates on the first $75,000 of corporate income are often lower than the federal individual
income tax rates on that same amount of personal income -- particularly if the person has additional income from other
sources (see the chart below). This means that the corporation's owners might face a lower overall tax bill if they leave
some income in the corporation as retained earnings. (These rates do not apply to professional corporations, which are
taxed at a flat rate of 35%.)

Corporate vs. Individual Tax Rates

2006 Corporate Rates

1
$0 to $50,000 5
%

2
$50,001 to $75,000 5
%

3
$75,001 to $100,000 4
%

2006 Individual Rates - Single

1
$0 to $7,550 0
%

1
$7,551 to $30,650 5
%

2
$30,651 to $74,200 5
%

2
$74,201 to $154,800 8
%

3
$154,801 to $336,550 3
%

2006 Individual Rates - Married Filing


Jointly

1
$0 to $15,100 0
%

$15,101 to $61,300 1
5
%

2
$61,301 to $123,700 5
%

2
$123,701 to $188,450 8
%

3
$188,451 to $336,550 3
%

Using Salaries to Control Income Splitting


You can use owner salaries and bonuses to control how much income is taxed at the corporate rate and how much is taxed
at individual rates. Every dollar you pay yourself increases your personal taxable income and reduces the corporation's
taxable income -- that is, the amount of business income taxed at corporate tax rates. (Because the corporation can
deduct 100% of salaries and bonuses, every dollar you pay yourself is a dollar on which the corporation won't have to pay
tax.)
On the flip side, if you lower your salary and bonuses and leave this money in the corporation, your personal taxable
income will decrease, and the corporation's taxable income will rise.
Using salaries in this way allows for great flexibility when you're searching for ways to save tax dollars.

Example

Ken owns and operates Balanced Interiors, Inc., a newly incorporated interior decorating business.
Ken keeps the first year’s net income of $75,000 in the business, living on savings that he
accumulated (on which he has already paid taxes) prior to incorporating. Balanced Interiors pays
$13,750 in corporate income taxes on this retained corporate income. This is almost $1,600 less than
the $15,331.50 individual income taxes Ken would have paid on the same net income if he took all of
the income out of the business as salary.

Practical Management of Earnings


Reducing taxes is just one of several things you should consider when deciding how to split your corporation's income.
Many other practical and economic needs determine the amount of money that should stay in a corporation. Owners need
salaries on which they can live comfortably, and the corporation needs money to cover its expenses. In addition, the IRS
places limits on the amount of money your corporation can retain. Here are some of the non-tax reasons you may need
to retain or pay out earnings in a corporation.

Start-Up Costs
Especially in the early days of a business, owners typically find that they must retain some profits in the corporation to buy
inventory and equipment, meet payroll costs, develop new products, and cover other expenses of a growing business.
Fortunately, up to $75,000 of these profits will be taxed at the lower corporate tax rates.

Increased Profitability
As a business matures and begins earning more than it needs to fund growth, the owners will no doubt want to pay out
more corporate profits to themselves in the form of salaries and bonuses. Regardless of the possible continued savings
from income splitting, owners are likely to increase their salaries or declare bonuses if the corporation's cash reserves are
adequate to meet foreseeable needs. Plus, the possibility of savings from income splitting decreases as more profits are
kept in the corporation -- rarely will a corporation save money by retaining more than $100,000 of profits in the
corporation each year.

IRS Limits on "Accumulated Earnings"


The IRS may limit the amount of money your corporation can retain. Usually, you can keep a total of $250,000 of
"accumulated earnings" in the business at any one time, no questions asked (for professional corporations, this amount is
limited to $150,000).
You can retain more earnings if you have a valid business reason, but if the IRS decides you are simply trying to lower
your taxes by keeping profits in the corporation, you can be hit with a penalty tax. This penalty can easily wipe out any
benefit you received by keeping excess money in the corporation.

More Information About Income Splitting


To learn more about saving taxes by splitting income between you and your corporation, including
examples of how you can accomplish tax savings, see Save Taxes With Corporate Income Splitting,
by attorney Anthony Mancuso (Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo

How Corporations Are Taxed


From the Nolo Business & Human Resources Center
Learn the benefits and drawbacks of corporate taxation before you decide how to structure your business.
Corporations are taxed differently than other business structures: A corporation is the only type of business that must pay
its own income taxes on profits. In contrast, partnerships, sole proprietorships, and limited liability companies (LLCs) are
not taxed on business profits; instead, the profits "pass through" the businesses to their owners, who report business
income or losses on their personal tax returns.
Understanding Corporate Taxation
Because a corporation is a separate legal entity from its owners, the company itself is taxed on all profits that it cannot
deduct as business expenses. Generally, taxable profits consist of money kept in the company to cover expenses or
expansion (called "retained earnings") and profits that are distributed to the owners (shareholders) as dividends.

Tax-Deductible Expenses
To reduce taxable profits, a corporation can deduct many of its business expenses -- money the corporation spends in the
legitimate pursuit of profit. In addition to start-up costs, operating expenses, and product and advertising outlays, a
corporation can deduct the salaries and bonuses it pays and all of the costs associated with medical and retirement plans
for employees.

Corporate Tax Payments


The corporation must file a corporate tax return, IRS Form 1120, and pay taxes at a corporate income tax rate on any
profits. If a corporation will owe taxes, it must estimate the amount of tax due for the year and make quarterly payments
to the IRS in April, June, September, and January.

Shareholder Tax Payments


If the corporation's owners work for the corporation, they pay individual income taxes on their salaries and bonuses, like
regular employees of any company. Salaries and bonuses are deductible business expenses, so the corporation does not
pay taxes on them.

Tax on Dividends
If a corporation distributes dividends to the owners, they must report and pay personal income tax on these amounts. And
because dividends, unlike salaries and bonuses, are not tax-deductible, the corporation must also pay taxes on them. This
means that dividends are taxed twice -- once to the corporation and again to the shareholders. Smaller corporations rarely
face this problem: Because their owners typically work for the corporation as employees, the corporation can pay them in
the form of tax-deductible salaries and bonuses, rather than taxable dividends.

S Corporation Taxes

The scheme of taxation described in this article applies only to regular corporations, called "C
corporations." By contrast, a corporation that has elected "S corporation" status pays taxes like a
partnership or limited liability company (LLC): All corporate profits or losses "pass through" the
business and are reported on the owners' personal income tax returns.

Benefits of the Separate Corporate Income Tax


Although reporting and paying taxes on a separate corporate tax return can be time consuming, there are some benefits to
having a separate level of taxation. Here we explain a few of them, but you should see a tax expert for a complete
explanation of the pros and cons of corporate taxation as it applies to your situation. This is a very complicated area, and
for some companies -- especially those that may experience losses, are involved in investing, or may soon be sold --
corporate taxation can be a real disadvantage.

Retained Earnings
Many corporations will want or need to retain some profits in the business at the end of the year -- for instance, to fund
expansion and future growth. If it does, that money will be taxed to the corporation at corporate income tax rates.
Because initial corporate income tax rates (15% - 25% on profits up to the first $75,000) are lower than most owners'
marginal income tax rates for the same amount of income, a corporation's owners can save money by keeping some
profits in the company. (This does not apply to professional corporations, however, as they are taxed at a flat rate of
35%.) In contrast, owners of sole proprietorships, partnerships, and LLCs must pay taxes on all business profits at their
individual income tax rates, whether they take the profits out of the business or not.
The IRS will allow you to leave profits in your corporation, up to a limit: Most corporations can safely keep a total of
$250,000 (at any one time) in the corporation without facing tax penalties (some professional corporations may not retain
more than $150,000).

Fringe Benefits
Another tax benefit of forming a corporation is that the company can deduct the full cost of fringe benefits provided to
employees -- almost always including the business's owners -- and the owner-employees are not taxed on these benefits.
Other types of business entities can also deduct the cost of many fringe benefits as a business expense, but owners who
receive these benefits will ordinarily be taxed on their value.
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Copyright 2006 Nolo

When Your Spouse Helps Out With Your LLC


From the Nolo Business & Human Resources Center
Your spouse can be an employee, an independent contractor, or a member of your LLC (limited liability
company).
If you own a single-member LLC, you can run into liability and tax headaches if your spouse helps out regularly.
As a practical matter, spouses can help out in a small family business without getting into any legal hot water, as long as
they pitch in informally, infrequently, and without being paid. However, you really should add your spouse on as a member
(co-owner) if any of the following are true:
1. Your spouse is being paid.
2. Your spouse helps out regularly.
3. Your spouse is very involved with your LLC.
4. Your spouse interacts with the public or your business contacts on behalf of the LLC.
A Participating Spouse Might Have Personal Liability
Probably one of the main reasons you chose to do business as an LLC was to protect your personal property from liability
for business debts. This is a major advantage of the LLC business structure over the sole proprietorship. But if your spouse
is involved in your business, your spouse might not get this benefit of the LLC business structure, and could be personally
liable for business judgments and debts.
There are several ways that the law might view your spouse’s position in your LLC, and each has different consequences
for both you and your spouse. Here are a few of the possibilities:

1. Agent. Your spouse could be viewed as an agent of the LLC. The LLC is typically responsible for authorized
actions by its agent. However, the LLC structure usually protects the owners' personal property from claims related to an
agent's acts. The agent (your spouse) also would not be personally liable for his or her actions, as long as they fell within
the scope of his or her authority to act for the LLC.

2. Employee. Your spouse could be viewed as an employee of the LLC. An employee is personally liable only for
certain extreme and unauthorized acts, such as assault or other criminal behavior. The LLC structure should protect your
personal property from liability for the acts of an employee. (But the IRS could come after you for back payroll taxes,
withholding, and penalties -- see below.)
3. An independent contractor. Your spouse could be viewed as acting as an independent contractor. An
independent contractor could be held personally liable for just about anything he or she does. That means that although
the LLC protects your own personal property, your personal marital property and your spouse’s personal property could be
at risk.

4. A general partner. Your spouse could be treated as an individual who has gone into a general partnership with
the LLC. As a general partner, your spouse would have personal liability for business debts.
Any scenario in which your spouse has personal liability is a bad one, because a successful claimant might try to collect a
judgment from your spouse’s personal property -- which will usually include your jointly owned personal property, such as
bank accounts and your house.
One way to avoid these possibly negative characterizations is to make your spouse an LLC member (co-owner). An LLC
member can pitch in as much or as little as the members agree, and the LLC protects each member’s personal property
from business liability. See "How a Spouse Becomes an LLC Member," below.
A Participating Spouse Could Create Tax Liability
The degree to which your spouse participates in the business could also affect your tax obligations. If your spouse chips in
very occasionally and isn't paid, you probably won't have any tax issues to worry about.
However, if your spouse works regularly for the business and receives compensation, the IRS could decide that your
spouse is an employee. If you haven't been following the rules that apply to businesses with employees, the IRS could
come after you for back payroll taxes, withholding, and penalties.
How Your Spouse Can Avoid Liability
There are a couple of ways to avoid these problems: the simplest is just to make your spouse a member of the LLC (see
below). Or, if your spouse is not worried about personal liability, you could hire your spouse as an independent contractor,
who is responsible for paying his or her own income and self-employment taxes.
You can make your spouse an official employee from the get-go, but it may not be worth the paperwork and record-
keeping hassles unless your LLC already has other employees. For any employee, the LLC must withhold taxes, report
state and federal income tax, report and pay employment taxes, pay workers’ compensation insurance, comply with
workplace-safety reports, and (in some states) pay unemployment insurance.

How a Spouse Becomes an LLC Member

Your spouse cannot become an LLC member automatically, even though the LLC might qualify
as marital property that belongs jointly to you and your spouse, and even though you and your
spouse report LLC income on your joint tax return.
LLCs have formal operating requirements, which govern how new members can be admitted (among
other things). This is true whether the LLC has drafted its own operating agreement or is subject to
state default rules that apply in the absence of an operating agreement. When your spouse becomes
a new member, you'll need to follow the rules that apply to your LLC.
At the very least, you'll have to make a written record of the decision to admit your spouse as a
member. In addition, if your LLC operates under an operating agreement, you will probably need to
amend the operating agreement to reflect the capital, profits, and voting interests of the new
member and the changes in the existing members’ interest.

Don't set your spouse's capital rights and voting rights at zero. If you do, a court or the
IRS might call the membership a sham.
Once your spouse is a member, you will both report LLC income on your personal tax return. Both of
you will pay quarterly estimated income taxes and self-employment taxes. Plus, you have to carry
out the LLC formalities for member voting according to your operating agreement (if you have one)
or under state law.

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Copyright 2006 Nolo
Owner Buyout Agreements: Plan Ahead for Changes in LLC Ownership
by Attorney Bethany K. Laurence
From the Nolo Business & Human Resources Center
Every business needs a buyout, or buy-sell, agreement to decide what will happen if an owner wants out.
Many LLC owners neglect to create buyout agreements, but buyout provisions are critical when you co-own an LLC with
other members. A buyout, or buy-sell, agreement states what will happen when one member wants to leave the company,
or worse, dies, goes bankrupt, or gets divorced.
What Is a Buyout, or Buy-Sell, Agreement?
Contrary to popular belief, buy-sell agreements are not about buying and selling companies. Instead, they are binding
contracts between co-owners of a business that govern what will happen when an owner wants to leave or a new owner
wants to join. Because of this confusion over terminology, we will use the term "buyout agreement" from here on.
A buyout agreement controls the following business decisions:
1. Can a departing member force the other members or the LLC to buy him or her out?
2. Who can buy a departing member's share of the business? (This may include outsiders or be limited to other LLC
members.)
3. What is the price for a member's interest in the LLC?
4. What other events can trigger a buyout?
A buyout agreement is a sort of "premarital agreement" between you and your co-owners: If your happy union doesn't
last, the buyout agreement spells out, in advance, what will happen to the business you own together.
What Events Are Covered Under a Buyout Agreement?
Typically, the events that trigger the buyout of a member's interest under a buyout agreement are:
1. a member's retirement or resignation
2. an attractive offer from an outsider to purchase a member's interest in the company
3. a divorce settlement in which a member's ex-spouse stands to receive a membership interest in the company
4. the foreclosure of a debt secured by an membership interest
5. the personal bankruptcy of a member, or

6. the disability, death, or incapacity of a member.

Why You Need a Buyout Agreement


It's a huge mistake to ignore the fact that sooner or later your circumstances will change. The odds are good that a
member will want to leave the company before the other members are ready to sell or close the business down. Without a
buyout agreement, the LLC might be automatically dissolved when one member leaves, forcing the assets to be sold and
divided among the LLC members. If the other members wish to continue the business, there are no rules determining in
advance whether and how departing members will be bought out -- or for how much. This can lead to serious personal and
business discord -- perhaps even court battles and the loss of the business.
A buyout agreement also places controls on who can buy a membership interest in the company and how new members
can join your ranks. Without this provision, another member could sell his or her share to someone you would rather
not be in business with.
In addition to avoiding potential problems in the future, writing a buyout agreement has a very real immediate benefit: It
will force you and the other members of your ownership team to talk about your hopes and expectations for the business.
This type of honest, open communication will put your LLC on the right track from the very start.
Creating a Buyout Agreement
A buyout agreement can consist of several clauses in your written operating agreement or it can be a separate agreement
that stands on its own. To create one, you can either use a self-help resource or see a lawyer -- or both. One good tool is
Nolo's Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K.
Laurence. This book contains a CD with fill-in-the-blank buyout clauses and instructions on how to incorporate them into
your operating agreement. For those who want the services of a lawyer, this book can guide discussions with your co-
owners so you can decide on your own time -- not your lawyer's -- what the terms of your agreement should be.
Click here for related information and products from Nolo
Copyright 2006 Nolo
How LLCs Are Taxed
From the Nolo Business & Human Resources Center
Like the owners of sole proprietorships and partnerships, LLC owners report business income and losses on
their personal tax returns.
An LLC is not a separate tax entity like a corporation; instead, it is what the IRS calls a "pass-through entity," like a
partnership or sole proprietorship. All of the profits and losses of the LLC "pass through" the business to the LLC owners
(called members), who report this information on their personal tax returns. The LLC itself does not pay federal income
taxes, but some states impose an annual tax on LLCs.
Income Taxes
The IRS treats your LLC like a sole proprietorship or a partnership, depending on the number of members in your LLC. If
you've already done business as a sole proprietorship or partnership, you're ahead of the game because you know many of
the rules already. If not, here are the basics:

Single-Owner LLCs
The IRS treats one-member LLCs as sole proprietorships for tax purposes. This means that the LLC itself does not pay
taxes and does not have to file a return with the IRS.
As the sole owner of your LLC, you must report all profits (or losses) of the LLC on Schedule C and submit it with your
1040 tax return. Even if you leave profits in the company's bank account at the end of the year -- for instance, to cover
future expenses or expand the business -- you must pay income tax on that money.

Multi-Owner LLCs
The IRS treats co-owned LLCs as partnerships for tax purposes. Like one-member LLCs, co-owned LLCs do not pay taxes
on business income; instead, the LLC owners each pay taxes on their lawful share of the profits on their personal income
tax returns (with Schedule E attached). Each LLC member's share of profits and losses, called a distributive share, should
be set out in the LLC operating agreement.
Most operating agreements provide that a member's distributive share is in proportion to his or her percentage interest in
the business. For instance, if Jimmy owns 60% of the LLC, and Luana owns the other 40%, Jimmy will be entitled to 60%
of the LLC's profits and losses, and Luana will be entitled to 40%. If you'd like to split up profits and losses in a way that is
not proportionate to the members' percentage interests in the business, it's called a "special allocation," and you must
carefully follow IRS rules.
However members' distributive shares are divvied up, the IRS treats each LLC member as though the member receives his
or her entire distributive share each year. This means that each LLC member must pay taxes on his or her whole
distributive share, whether or not the LLC actually distributes all (or any of) the money to the members. The practical
significance of this IRS rule is that, even if LLC members need to leave profits in the LLC -- for instance, to buy inventory
or expand the business -- each LLC member is liable for income tax on the member's rightful share of that money.
Even though a co-owned LLC itself does not pay income taxes, it must file Form 1065 with the IRS. This form, the same
one that a partnership files, is an informational return that the IRS reviews to make sure that LLC members are reporting
their income correctly. The LLC must also provide each LLC member with a Schedule K-1, which breaks down each
member's share of the LLC's profits and losses. In turn, each LLC member reports this profit and loss information on his or
her individual Form 1040, with Schedule E attached.

LLCs Can Elect Corporate Taxation

If your LLC will regularly need to retain a significant amount of profits in the company, you (and
your co-owners, if you have any) may be able to save money by electing to have your LLC taxed as a
corporation. For details, see "Can Corporate Taxation Cut Your LLC Tax Bill?" at the end of this
article.

Estimating and Paying Income Taxes


Because LLC members considered self-employed business owners rather than employees of the LLC, they are not subject
to tax withholding. Instead, each LLC member is responsible for setting aside enough money to pay taxes on that
member's share of the profits. The members must estimate the amount of tax they'll owe for the year and make quarterly
payments to the IRS (and to the appropriate state tax agency, if there is a state income tax) -- in April, June, September,
and January.
Self-Employment Taxes
Because LLC members are not employees, no contributions to the Social Security and Medicare systems are withheld from
their paychecks. Instead, most LLC owners are required to pay these taxes -- called "self-employment taxes when paid by
a business owner -- directly to the IRS.
The current rule is that any owner who works in or helps manage the business must pay this tax on his or her distributive
share (rightful share of profits). However, owners who are not active in the LLC -- that is, those who have merely invested
money but don't provide services or make management decisions for the LLC -- may be exempt from paying self-
employment taxes on their share of profits. The regulations in this area are a bit complicated, but if you actively manage
or work in your LLC, you can expect to pay the self-employment tax on all LLC profits allocated to you.
Each owner who is subject to the self-employment tax reports the amount due on Schedule SE, which must be submitted
annually with his or her tax return. LLC owners (and sole proprietors and partners) pay twice as much self-employment tax
as regular employees, because regular employees' contributions to the self-employment tax are matched by their
employers. (However, they also get to deduct half of the total amount from their taxable income, which saves a few tax
dollars.) The self-employment tax rate for 2006 for business owners is 15.3% of the first $94,200 of income and 2.9% of
everything over $94,200.

Expenses and Deductions

As you no doubt already know, you don't have to pay taxes -- income taxes or self-employment
taxes -- on most of the money that your business spends in pursuit of profit. You can deduct ("write
off") your legitimate business expenses from your business income, which can greatly lower the
profits you must report to the IRS. Deductible expenses include start-up costs, automobile and travel
expenses, equipment costs, and advertising and promotion costs.

State Taxes and Fees


Most states tax LLC profits the same way the IRS does: The LLC owners pay taxes to the state on their personal returns,
while the LLC itself does not pay a state tax. A few states, however, do charge the LLC a tax based on the amount of
income the LLC makes, in addition to the income tax its owners pay. For instance, California levies a tax on LLCs that
make over $250,000 per year; the tax ranges from about $900 to $11,000.
In addition, some states impose an annual LLC fee that is not income-related. This may be called a "franchise tax," an
"annual registration fee" or a "renewal fee." In most states, the fee is about $100, but California exacts a hefty $800
"minimum franchise tax" per year from LLCs. Before forming an LLC, find out whether your state charges a separate LLC
tax or fee. For more information, check the website of your state's secretary of state, department of corporations, or
department of revenue or tax.
If you're interested in forming an LLC, see Form Your Own Limited Liability Company, by attorney Anthony Mancuso
(Nolo).

Can Corporate Taxation Cut Your LLC Tax Bill?

If you will regularly need to keep a substantial amount of profits in your LLC (called "retained
earnings"), you might benefit from electing corporate taxation (which you can do as an LLC). Any LLC
can choose to be treated like a corporation for tax purposes by filing IRS Form 8832 and checking the
corporate tax treatment box on the form.
Because the corporate income tax rates for the first $75,000 of corporate taxable income are lower
than the individual income tax rates that apply to most LLC owners, this can save you and your co-
owners money in overall taxes.

Click here for related information and products from Nolo


Copyright 2006 Nolo

Cut Taxes With Corporate Income Splitting


From the Nolo Business & Human Resources Center
You can reduce overall income taxes by taking advantage of lower corporate tax rates.
The owners of a profitable small corporation can often save thousands of dollars in overall income taxes by keeping a
modest amount of profits in the corporation and paying out the rest to themselves as employee salaries and bonuses.
Called "income splitting," this works because corporate tax rates on the first $75,000 of corporate income are typically
lower than the owners' personal income tax rates.
How Income Splitting Works
As you already know, a corporation is a separate legal entity from its owners, and it pays its own income taxes. This
means that if the owners keep some income in the corporation (profits that are not paid out to the owners in the form of
salaries and bonuses), it will be taxed at corporate income tax rates, not at the individual income tax rates of its owners.
Income that is kept in the corporation is shown as "retained earnings" on a corporation's balance sheet, and is reported on
IRS Form 1120 each year.
Federal corporate income tax rates on the first $75,000 of corporate income are often lower than the federal individual
income tax rates on that same amount of personal income -- particularly if the person has additional income from other
sources (see the chart below). This means that the corporation's owners might face a lower overall tax bill if they leave
some income in the corporation as retained earnings. (These rates do not apply to professional corporations, which are
taxed at a flat rate of 35%.)

Corporate vs. Individual Tax Rates

2006 Corporate Rates

1
$0 to $50,000 5
%

2
$50,001 to $75,000 5
%

3
$75,001 to $100,000 4
%

2006 Individual Rates - Single

1
$0 to $7,550 0
%

1
$7,551 to $30,650 5
%

2
$30,651 to $74,200 5
%

2
$74,201 to $154,800 8
%

3
$154,801 to $336,550 3
%

2006 Individual Rates - Married Filing


Jointly

1
$0 to $15,100 0
%
1
$15,101 to $61,300 5
%

2
$61,301 to $123,700 5
%

2
$123,701 to $188,450 8
%

3
$188,451 to $336,550 3
%

Using Salaries to Control Income Splitting


You can use owner salaries and bonuses to control how much income is taxed at the corporate rate and how much is taxed
at individual rates. Every dollar you pay yourself increases your personal taxable income and reduces the corporation's
taxable income -- that is, the amount of business income taxed at corporate tax rates. (Because the corporation can
deduct 100% of salaries and bonuses, every dollar you pay yourself is a dollar on which the corporation won't have to pay
tax.)
On the flip side, if you lower your salary and bonuses and leave this money in the corporation, your personal taxable
income will decrease, and the corporation's taxable income will rise.
Using salaries in this way allows for great flexibility when you're searching for ways to save tax dollars.

Example

Ken owns and operates Balanced Interiors, Inc., a newly incorporated interior decorating business.
Ken keeps the first year’s net income of $75,000 in the business, living on savings that he
accumulated (on which he has already paid taxes) prior to incorporating. Balanced Interiors pays
$13,750 in corporate income taxes on this retained corporate income. This is almost $1,600 less than
the $15,331.50 individual income taxes Ken would have paid on the same net income if he took all of
the income out of the business as salary.

Practical Management of Earnings


Reducing taxes is just one of several things you should consider when deciding how to split your corporation's income.
Many other practical and economic needs determine the amount of money that should stay in a corporation. Owners need
salaries on which they can live comfortably, and the corporation needs money to cover its expenses. In addition, the IRS
places limits on the amount of money your corporation can retain. Here are some of the non-tax reasons you may need
to retain or pay out earnings in a corporation.

Start-Up Costs
Especially in the early days of a business, owners typically find that they must retain some profits in the corporation to buy
inventory and equipment, meet payroll costs, develop new products, and cover other expenses of a growing business.
Fortunately, up to $75,000 of these profits will be taxed at the lower corporate tax rates.

Increased Profitability
As a business matures and begins earning more than it needs to fund growth, the owners will no doubt want to pay out
more corporate profits to themselves in the form of salaries and bonuses. Regardless of the possible continued savings
from income splitting, owners are likely to increase their salaries or declare bonuses if the corporation's cash reserves are
adequate to meet foreseeable needs. Plus, the possibility of savings from income splitting decreases as more profits are
kept in the corporation -- rarely will a corporation save money by retaining more than $100,000 of profits in the
corporation each year.

IRS Limits on "Accumulated Earnings"


The IRS may limit the amount of money your corporation can retain. Usually, you can keep a total of $250,000 of
"accumulated earnings" in the business at any one time, no questions asked (for professional corporations, this amount is
limited to $150,000).
You can retain more earnings if you have a valid business reason, but if the IRS decides you are simply trying to lower
your taxes by keeping profits in the corporation, you can be hit with a penalty tax. This penalty can easily wipe out any
benefit you received by keeping excess money in the corporation.
More Information About Income Splitting

To learn more about saving taxes by splitting income between you and your corporation, including
examples of how you can accomplish tax savings, see Save Taxes With Corporate Income Splitting,
by attorney Anthony Mancuso (Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo

LLC Basics
From the Nolo Business & Human Resources Center
Limited liability companies combine the best aspects of partnerships and corporations.
A limited liability company (LLC) combines the corporation's protection from personal liability for business debts and the
pass-through tax structure of a partnership or sole proprietorship. And, while setting up an LLC is more difficult than
creating a partnership or sole proprietorship, running one is significantly easier than running a corporation.
Here are the main features of an LLC:
Limited Personal Liability
Like shareholders of a corporation, all LLC owners are protected from personal liability for business debts and claims. This
means that if the business itself can't pay a creditor -- such as a supplier, a lender, or a landlord -- the creditor cannot
legally come after any LLC member's house, car, or other personal possessions. Because only LLC assets are used to pay
off business debts, LLC owners stand to lose only the money that they've invested in the LLC. This feature is often called
"limited liability."

Exceptions to Limited Liability


While LLC owners enjoy limited personal liability for many of their business transactions, this protection is not absolute.
This drawback is not unique to LLCs, however -- the same exceptions apply to corporations. An LLC owner can be held
personally liable if he or she:
1. personally and directly injures someone
2. personally guarantees a bank loan or a business debt on which the LLC defaults
3. fails to deposit taxes withheld from employees' wages
4. intentionally does something fraudulent, illegal, or reckless that causes harm to the company or to someone else,
or

5. treats the LLC as an extension of his or her personal affairs, rather than as a separate legal entity.

This last exception is the most important. If owners don't treat the LLC as a separate business, a court might say that the
LLC doesn't really exist and find that its owners are really doing business as individuals, who are personally liable for their
acts. To keep this from happening, make sure you and your co-owners:

1. Act fairly and legally. Do not conceal or misrepresent material facts or the state of your finances to vendors,
creditors, or other outsiders.

2. Fund your LLC adequately. Invest enough cash into the business so that your LLC can meet foreseeable
expenses and liabilities.

3. Keep LLC and personal business separate. Get a federal employer identification number, open up a business-
only checking account, and keep your personal finances out of your LLC accounting books.

4. Create an operating agreement. Having a formal written operating agreement lends credibility to your LLC's
separate existence.

Business Insurance
A good liability insurance policy can shield your personal assets when limited liability protection does not. For instance, if
you are a massage therapist and you accidentally injure a client's back, your liability insurance policy should cover you.
Insurance can also protect your personal assets in the event that your limited liability status is ignored by a court.
In addition to protecting your personal assets in such situations, insurance can protect your corporate assets from lawsuits
and claims. But your LLC won't be protected if it doesn't pay its bills: commercial insurance usually does not protect
personal or corporate assets from unpaid business debts, whether or not they're personally guaranteed.
LLC Taxes
Unlike a corporation, an LLC is not considered separate from its owners for tax purposes. Instead, it is what the IRS calls a
"pass-through entity," like a partnership or sole proprietorship. This means that business income passes through the
business to the LLC members, who report their share of profits -- or losses -- on their individual income tax returns. Each
LLC member must make quarterly estimated tax payments to the IRS.
While an LLC itself doesn't pay taxes, co-owned LLCs must file Form 1065, an informational return, with the IRS each year.
This form, the same one that a partnership files, sets out each LLC member's share of the LLC's profits (or losses), which
the IRS reviews to make sure LLC members are correctly reporting their income.
LLC Management
The owners of most small LLCs participate equally in the management of their business. This arrangement is called
"member management."
There is an alternative management structure -- somewhat awkwardly called "manager management" -- in which you
designate one or more owners (or even an outsider) to take responsibility for managing the LLC. The nonmanaging owners
(sometimes family members who have invested in the company) simply sit back and share in LLC profits. In a manager-
managed LLC, only the named managers get to vote on management decisions and act as agents of the LLC. Choosing
manager management sometimes makes sense, but it might require you to deal with state and federal laws regulating the
sale of securities.
Forming an LLC
To create an LLC, you file "articles of organization" (in some states called a "certificate of organization" or "certificate of
formation") with the LLC division of your state government. This office is often in the same department as the corporations
division, which is usually part of the secretary of state's office. Filing fees range from about $100 to $800. You can now
form an LLC with just one person in every state.
Many states supply a blank one-page form for the articles of organization, on which you need only specify a few basic
details about your LLC, such as its name and address, and contact information for a person involved with the LLC (usually
called a "registered agent") who will receive legal papers on its behalf. Some states also require you to list the names and
addresses of the LLC members.
In addition to filing articles of organization, you must create a written LLC operating agreement. While you don't have to
file your operating agreement with the state, it's a crucial document because it sets out the LLC members' rights and
responsibilities, their percentage interests in the business, and their share of the profits.
Ending an LLC
Under the laws of many states, unless your operating agreement says otherwise, when one member wants to leave the
LLC, the company dissolves. In that case, the LLC members must fulfill any remaining business obligations, pay off all
debts, divide any assets and profits among themselves, and then decide whether they want to start a new LLC to continue
the business with the remaining members.
Your LLC operating agreement can prevent this kind of abrupt ending to your business by including "buy-sell," or
buyout, provisions, which set up guidelines for what will happen when one member retires, dies, becomes disabled, or
leaves the LLC to pursue other interests.

Next Steps

If you're ready to create an LLC for your business, Form Your Own Limited Liability Company, by
attorney Anthony Mancuso (Nolo), provides you with guidance and forms on disc. Nolo also publishes
LLC Maker, software that will create articles of organization and an LLC operating agreement for you.

Click here for related information and products from Nolo


Copyright 2006 Nolo
Creating an LLC Operating Agreement
From the Nolo Business & Human Resources Center
Like corporate bylaws, an operating agreement governs the workings of your LLC.
An LLC operating agreement allows you to structure your financial and working relationships with your co-owners in a way
that suits your business. In your operating agreement, you and your co-owners establish each owner's percentage of
ownership in the LLC, his or her share of profits (or losses), his or her rights and responsibilities, and what will happen to
the business if one of you leaves.
Why an Operating Agreement Is Necessary
While many states do not legally require your LLC to have an operating agreement, it's foolish to run an LLC without one
(even if you're the sole owner of your company).
An operating agreement helps your LLC by guarding your limited liability status, heading off financial and management
misunderstandings, and making sure your business is governed by your own rules -- not default rules created by your
state.

Protecting Your Limited Liability Status


The main reason to make an operating agreement is as simple as it is important: It helps ensure that courts will respect
your limited personal liability. This is particularly key in a one-person LLC where, without the formality of an agreement,
the LLC will look a lot like a sole proprietorship. Having a formal written operating agreement will lend credibility to your
LLC's separate existence. For an operating agreement for a single-owner LLC, see Nolo's Legal Forms for Starting &
Running a Small Business, by Fred Steingold, or Quicken Legal Business Pro.

Defining Financial and Management Structure


Co-owned LLCs need to document their profit-sharing and decision-making protocols as well as their procedures for
handling the departure and addition of members. Without an operating agreement, you and your co-owners be ill-equipped
to settle misunderstandings over finances and management. What's more, your LLC will be subject to the default operating
rules created by your state law.

Overriding State Default Rules


Each state has laws that set out basic operating rules for LLCs, some of which will govern your business unless your
operating agreement says otherwise. (These are called "default rules.")
Many states, for example, have a default rule that requires owners to divide up LLC profits and losses equally, regardless
of each member's investment in the business. If you and your co-owners did not invest equal amounts in the LLC, it's
doubtful you'll want to allocate profits equally. To avoid this, your operating agreement must spell out how you and your
co-owners want to split profits and losses.
By writing an operating agreement, you can choose the rules that will govern your LLC's inner workings, rather than
having to follow default rules that may or may not be right for your LLC.
What to Include in Your Operating Agreement
There's a host of issues you must cover in your LLC operating agreement, some of which will depend on your business's
particular situation and needs. Most operating agreements include the following:
1. the members' percentage interests in the LLC
2. the members' rights and responsibilities
3. the members' voting powers
4. how profits and losses will be allocated
5. how the LLC will be managed
6. rules for holding meetings and taking votes, and

7. buyout, or buy-sell, provisions, which establish a framework for what happens when a member wants to sell
his or her interest, dies, or becomes disabled.
While these items may seem fairly straightforward, each requires important details. Make sure you fill out the particulars in
the following key areas.

Percentages of Ownership
The owners of an LLC ordinarily make financial contributions of cash, property, or services to the business to get it started.
In return, each LLC member gets a percentage of ownership in the assets of the LLC. Members usually receive ownership
percentages in proportion to their contributions of capital, but LLC members are free to divide up ownership in any way
they wish. These contributions and percentage interests are an important part of your operating agreement.

Distributive Shares
In addition to receiving ownership interests in exchange for their contributions of capital, LLC owners also receive shares of
the LLC's profits and losses, called "distributive shares." Most often, operating agreements provide that each owner's
distributive share corresponds to his or her percentage of ownership in the LLC. For example, because Tony owns only
35% of his LLC, he receives just 35% of its profits and losses. Najate, on the other hand, is entitled to 65% of the LLC's
profits and losses because she owns 65% of the business. (If your LLC wants to assign distributive shares that aren't in
proportion to the owners' percentage interests in the LLC, you'll have to follow rules for "special allocations." For more
information, see Making Special Allocations.)

Distributions of Profits and Losses


In addition to defining each owner's distributive share, your operating agreement should answer these questions:
1. How much -- if any -- of the LLC's allocated profits (the members' distributive shares) must be distributed to LLC
members each year?
2. Can members expect the LLC to pay them at least enough to cover the income taxes they'll owe on each year's
allocation of LLC profits? (An LLC owner, like a partner in a partnership, has to pay income taxes on the full amount of
profits that are "allocated" to him or her, not just on profits that are actually paid out. When profits are plowed back into
the business instead of being paid out, they are still treated as income to the owners, in the proportions allocated.)
3. Will distributions of profits be made regularly or are the owners entitled to draw at will from the profits of the
business?
Because you and your co-owners may have different financial needs and marginal tax rates (tax brackets), the allocation
of profits and losses is an area to which you should pay particular attention.
You may want to run the allocation part of your operating agreement by a tax professional, to make sure it achieves

the overall results you had in mind.

Voting Rights
While most LLC management decisions are made informally, sometimes a decision is so important or controversial that a
formal vote is necessary. There are two ways to split voting power among LLC members: Either each member's voting
power corresponds to his or her percentage interest in the business, or each member gets one vote -- called "per capita"
voting. Most LLCs mete out votes in proportion to the members' ownership interests. Whichever method you choose, make
sure your operating agreement specifies how much voting power each member has, as well as whether a majority of the
votes or a unanimous decision will be required to resolve an issue.

Ownership Transitions
Many new business owners neglect to think about what will happen if one owner retires, dies, or decides to sell the owner's
interest in the company. These concerns may not be on your mind now, but such situations crop up frequently for small
business owners, and it pays to be prepared. Operating agreements should include a buyout scheme -- rules for what will
happen when a member leaves the LLC for any reason.
How to Create an Operating Agreement
Obviously, you'll need help beyond this article to make your own operating agreement. There are many sources for blank
or sample LLC operating agreements, but you must be sure that your operating agreement is drafted to suit the needs of
your business and the laws of your state.
Software that helps you create your own LLC may be your best alternative. For example, LLC Maker (from Nolo) will use
your input to customize an operating agreement that suits the needs of you and your co-owners and meets the
requirements of your state's laws.
You can also pay a business lawyer for assistance -- in fact, we recommend this for LLCs with more than five owners, and
also for those that opt to have a special manager or management group run the LLC. Lawyers typically have several types
of standard agreements on hand that can be customized for your LLC. Although using a lawyer can get pricey, the peace of
mind you'll gain from knowing that your LLC is protected -- and has adopted operating rules that will best serve its
interests -- may well be worth the cost.
Click here for related information and products from Nolo
Copyright 2006 Nolo
How to Form an LLC
From the Nolo Business & Human Resources Center
Limited liability companies (LLCs) are easier to create than corporations -- and forming one may be the best
thing you can do for your business.
Forming an LLC (limited liability company) is not as hard as most people think. Here are the steps you need to take to
make your LLC a legal reality.
1. Choose an available business name that complies with your state's LLC rules.
2. File formal paperwork, usually called articles of organization, and pay the filing fee (ranging from about $100 to
$800, depending on your state's rules).
3. Create an LLC operating agreement, which sets out the rights and responsibilities of the LLC members.
4. Publish a notice of your intent to form an LLC (required in only a few states).
5. Obtain licenses and permits that may be required for your business.
Choosing a Name for Your LLC
The name of your LLC must comply with the rules of your state's LLC division. (Typically, this office is combined with the
corporations division, and is part of the secretary of state's office.) While requirements differ from state to state, generally:
1. the name cannot be the same as the name of another LLC on file with the LLC office
2. the name must end with an LLC designator, such as "Limited Liability Company" or "Limited Company," or an
abbreviation of one of these phrases (such as "LLC," "L.L.C.," or "Ltd. Liability Co."), and

3. the name cannot include certain words prohibited by the state, such as Bank, Insurance, Corporation or City
(state rules differ on which words are prohibited).
Your state's LLC office can tell you how to find out whether your proposed name is available for your use. Often, for a small
fee, you can reserve your LLC name for a short period of time until you file your articles of organization.
Besides following your state's LLC naming rules, you must make sure your name won't violate another company's
trademark.
Once you've found a legal and available name, you don't usually need to register it with your state. When you file your
articles of organization, your business name will be automatically registered.
Filing Articles of Organization
After settling on a name, you must prepare and file "articles of organization" with your state's LLC filing office. While most
states use the term "articles of organization" to refer to the basic document required to create an LLC, some states use the
term "certificate of formation" or "certificate of organization."

Filing Fees
One disadvantage of forming an LLC instead of a partnership or a sole proprietorship is that you'll have to pay a filing fee
when you submit your articles of organization. In most states, the fees are modest -- typically around $100. In a few
others, they take a bigger bite: this includes California, which charges an $800 annual tax on top of its filing fee.

Required Information
Articles of organization are short, simple documents. In fact, you can usually prepare your own in just a few minutes by
filling in the blanks and checking the boxes on a form provided by your state's filing office. Typically, you must provide
only your LLC's name, its address, and sometimes the names of all of the owners -- called members. Generally, all of the
LLC owners may prepare and sign the articles, or they can appoint just one person to do so.

Registered Agent
You will probably also be required to list the name and address of a person -- usually one of the LLC members -- who will
act as your LLC's "registered agent," or "agent for service of process." Your agent is the person who will receive legal
papers in any future lawsuit involving your LLC.
Creating an LLC Operating Agreement
Even though operating agreements need not be filed with the LLC filing office and are rarely required by state law, it is
essential that you create one. In an LLC operating agreement, you set out rules for the ownership and operation of the
business (much like a partnership agreement or corporate bylaws). A typical operating agreement includes:
1. the members' percentage interests in the business
2. the members' rights and responsibilities
3. the members' voting power
4. how profits and losses will be allocated
5. how the LLC will be managed
6. rules for holding meetings and taking votes, and
7. "buy-sell" provisions, which establish rules for what happens if a member wants to sell his or her interest, dies,
or becomes disabled.

Publication Requirements

In a few states, you must take an additional step to make your company official: You must
publish in a local newspaper a simple notice stating that you intend to form an LLC. You are required
to publish the notice several times over a period of weeks and then submit an "affidavit of
publication" to the LLC filing office. Your local newspaper should be able to help you with this filing.

Licenses and Permits


After you've completed the steps described above, your LLC is official. But before you open your doors for business, you
need to obtain the licenses and permits that all new businesses must have to operate. These may include a business
license (sometimes also referred to as a "tax registration certificate"), a federal employer identification number, a sellers'
permit, or a zoning permit.

Do It Yourself Materials

You can use LLC Maker software (from Nolo) to create articles of organization and a customized
operating agreement that suits the needs of you and your co-owners and meets the requirements of
your state's laws. If you'd rather use a book (with forms on CD), take a look at Form Your Own
Limited Liability Company, by Tony Mancuso (Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo

Top Ten Tax Deductions for Landlords


by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
You are probably paying too much in taxes on your rental income.
No landlord would pay more than necessary for utilities or other operating expenses for a rental property. But, every year,
millions of landlords pay more taxes on their rental income than they have to. Why? Because they fail to take advantage of
all the tax deductions available for owners of rental property.
Rental real estate provides more tax benefits than almost any other investment. Often, these benefits make the difference
between losing money and earning a profit on a rental property. But tax deductions are worthless if you don’t take
advantage of them. Here are the top ten tax deductions for owners of small residential rental property.
1. Interest. Interest is often a landlord’s single biggest deductible expense. Common examples of interest that landlords
can deduct include mortgage interest payments on loans used to acquire or improve rental property and interest on credit
cards for goods or services used in a rental activity.
2. Depreciation. The actual cost of a house, apartment building, or other rental property is not fully deductible in the year
in which you pay for it. Instead, landlords get back the cost of real estate through depreciation. This involves deducting a
portion of the cost of the property over several years. Residential rental property must be depreciated over 27.5 years.
3. Repairs. The cost of repairs to rental property (provided the repairs are ordinary, necessary, and reasonable in
amount) are fully deductible in the year in which they are incurred. Good examples of deductible repairs include repainting,
fixing gutters or floors, fixing leaks, plastering, and replacing broken windows.
4. Local travel. Landlords are entitled to a tax deduction whenever they drive anywhere for their rental activity. For
example, when you drive to your rental building to deal with a tenant complaint or go to the hardware store to purchase a
part for a repair, you can deduct your travel expenses.
If you drive a car, SUV, van, pickup, or panel truck for your rental activity (as most landlords do), you have two options for
deducting your vehicle expenses: You can deduct your actual expenses (gasoline, upkeep, repairs) or you can use the
standard mileage rate (44.5 cents per mile in 2006; 48.5 cents per mile from 9/1/05 to 12/31/05; and 40.5 cents per mile
from 1/1/05 to 8/31/05).
5. Long distance travel. If you travel overnight for your rental activity, you can deduct your airfare, hotel bills, meals,
and other expenses. If you plan your trip carefully, you can even mix landlord business with pleasure and still take a
deduction. However, IRS auditors closely scrutinize deductions for overnight travel -- and many taxpayers get caught
claiming these deductions without proper records to back them up. To stay within the law (and avoid unwanted attention
from the IRS), you need to properly document your long distance travel expenses.
6. Home office. Provided they meet certain minimal requirements, landlords may deduct their home office expenses from
their taxable income. This deduction applies not only to space devoted to office work, but also to a workshop or any other
home workspace you use for your rental business. This is true whether you own your home or apartment or are a renter.
For the ins and outs on taking the home office deduction, see Home Business Tax Deductions, by attorney Stephen
Fishman (Nolo), or Every Landlord's Tax Deduction Guide, also by attorney Stephen Fishman (Nolo).
7. Employees and independent contractors. Whenever you hire anyone to perform services for your rental activity,
you can deduct their wages as a rental business expense. This is so whether the worker is an employee (for example, a
resident manager) or an independent contractor (for example, a repair person).
8. Casualty and theft losses. If your rental property is damaged or destroyed from a sudden event like a fire or flood,
you may be able to obtain a tax deduction for all or part of your loss. These types of losses are called “casualty” losses.
You usually won’t be able to deduct the entire cost of property damaged or destroyed by a casualty. How much you may
deduct depends on how much of your property was destroyed and whether the loss was covered by insurance.
9. Insurance. You can deduct the premiums you pay for almost any insurance for your rental activity. This includes fire,
theft, and flood insurance for rental property, as well as landlord liability insurance. And if you have employees, you can
deduct the cost of their health and workers’ compensation insurance.
10. Legal and professional services. Finally, you can deduct fees that you pay to attorneys, accountants, property
management companies, real estate investment advisors, and other professionals. You can deduct these fees as operating
expenses as long as the fees are paid for work related to your rental activity.

Did You Know?

Did you know that:


1. Landlords can greatly increase the depreciation deductions they receive the first few years
they own rental property by using "segmented" depreciation.
2. Careful planning can permit you to deduct, in a single year, the cost of improvements to
rental property that you would otherwise have to deduct over 27.5 years.
3. You can rent out a vacation home tax-free, in some cases.
4. Most small landlords can deduct up to $25,000 in rental property losses each year.
5. A special tax rule permits some landlords to deduct 100% of their rental property losses
every year, no matter how much.
6. People who rent property to their family or friends can lose virtually all of their tax
deductions.
If you didn’t know one or more of these facts, you could be paying far more tax than you need to.
For more information, see Every Landlord's Tax Deduction Guide, by attorney Stephen Fishman
(Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo
Why the Self-Employed Are Audit Targets
From the Nolo Business & Human Resources Center
The IRS keeps a close eye on self-employed individuals. Here's what it looks for.
The IRS claims that most tax cheats are in the ranks of the self-employed, so it is not surprising that the IRS scrutinizes
this group closely. As a result, the self-employed are more likely to get audited than regular employees. If you are self-
employed, stick to these two rules, at a minimum, to avoid trouble in case you are audited: Claim all of your income, and
don't take deductions for items you didn't have to pay for.
If you are self-employed and the IRS chooses to come after you by way of a tax audit -- or, worse, a criminal investigation
-- be aware that the agency can obtain your bank records and other financial records. If you've been foolish enough to
deposit unreported income in your bank accounts, an IRS auditor may find out.
What the IRS Will Want to Know
If you are investigated, expect the IRS to ask the following questions or look into the following issues:
1. Did you report all of your business sales and receipts?
2. Does your lifestyle appear to exceed the amount of self-employment income you reported?
3. Did you report all cash transactions -- especially large cash transactions?
4. Did you deduct any personal living expenses as business or home office expenses?
5. Did you write off automobile expenses for travel that was not business-related?
6. Did you claim large business entertainment expenses?
7. Did you make the proper payroll tax deposits?
8. Are your workers wrongly classified as independent contractors when they are really employees?
Payroll Taxes
If you have employees, always make the required federal payroll tax deposits when they are due. Never borrow from your
employees' tax funds. If you make a late payroll tax payment to the IRS, the penalties and interest can be substantial. If
you can't pay, then you probably shouldn't be in business.
One good way to see that payroll taxes get paid on time is to use a bonded payroll tax service to both file your payroll tax
returns and make all payroll tax deposits. Many banks, as well as businesses called payroll services companies, offer this
at reasonable prices. If they goof up and don't get a form or payment in on time, they will pay the late payment penalty.
Cash Transactions
As part of a government campaign against the underground economy in general, and drug-related money laundering in
particular, the law requires that cash and cash equivalent business transactions over $10,000 be reported to the IRS on
Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business. These report forms are also called
Currency Transaction Reports, or CTRs. (For a detailed pamphlet explaining this law, see IRS Publication 1544, Reporting
Cash Payments of Over $10,000.) Some state tax agencies have similar reporting laws and forms.
If you don't file a Form 8300 when you should, and the IRS finds out, you can be fined, audited, or both. You can also get
in trouble criminally -- CTR violations are investigated by the IRS Criminal Investigation Division.
Cash Businesses
If your business deals in a lot of cash -- for example, you run a bar, a restaurant, vending machines, or a laundromat --
the IRS may suspect you of skimming cash off your receipts. This is true whether you file Form 8300 or not. The audit
potential of cash businesses is much higher than average.

Resources

For guidance in taking legitimate deductions, more information on how to avoid audit triggers, and
how to keep proper records for the IRS, see the following Nolo products:

1. Tax Savvy for Small Business, by attorney Frederick W. Daily

2. Working for Yourself: Law & Taxes for Independent Contractors, Freelancers, & Consultants,
by attorney Stephen Fishman
3. Deduct It! Lower Your Small Business Taxes, by attorney Stephen Fishman.

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Copyright 2006 Nolo

Business Income Defined


From the Nolo Business & Human Resources Center
There are many different kinds of business income, and almost all of them are taxable.
Just as the IRS taxes individuals' income, such as income from a job, the IRS also taxes the income a business brings in. A
small business can lower its taxable income through deductions and credits, just like an individual.
Before learning about business deductions, it's necessary to understand what the tax code means by the term "income"
and "gross income."
What Is Income?
The tax code (IRC § 61) reads: "Except as otherwise provided … gross income means all income from whatever source
derived." This includes all of the following:
Goods and services. Taxable "income" doesn't mean just cash; it can take many forms. Goods, property or services
received have all been held to be within the definition of income.
If you barter (exchange goods or services for the same), the fair market value of the item or service you received should
be included in your tax reported income. Of course, a lot of bartering goes on, and the IRS isn't any the wiser, but getting
away with it doesn't make it right. Anything of value that you or your business receives is income, unless it specifically falls
within the exclusions discussed below.
Constructive income. Income also includes anything you have the right to put your hands on but don't for some reason.
The legal doctrine of "constructive receipt" says that as soon as money or property is available to you, or is credited to
your account, it becomes income -- whether you grab it or not. For instance, you can't get a check for services in
November 2003 and hold it for deposit until 2004 without being taxed on it in 2003, the year received.
Illegal income. Note that IRC § 61 is morally neutral; it doesn't distinguish between illegal and legal income. If you earn
a living as a hit man for the mob, you still are earning income as far as the IRS is concerned, and you'd better declare it on
your tax return. Al Capone wasn't sent to prison for murder, bootlegging or racketeering. He was convicted of tax evasion
for not declaring his income from bootlegging and racketeering.
Worldwide income. Americans are taxed on their worldwide income; no matter where it's earned, it's still income taxable
in the United States. There is one exception: A person who resides outside the United States for most of the year can
exclude some or all of his foreign income. For more information, see IRS Publication 54, Tax Guide for U.S. Citizens and
Resident Aliens Abroad.
What Is Not Income?
Some kinds of income fall into the "except as otherwise provided" exception of IRC § 61 and are not taxable to a business.
For instance, the tax code specifically excludes gifts and inheritances from taxable income. (Sorry, the $10 million that is
being dropped off by the Prize Patrol from Publisher's Clearinghouse is not legally a gift and is taxable.)
Fringe benefits. Thankfully, many so-called fringe benefits provided by businesses to owners and employees are
specifically excluded from income. Most of the statutory exclusions from income granted by Congress are found in
IRC §§ 101 to 150.
Return of capital. Owners and investors in businesses are very glad to know that the return of a capital investment is not
taxable income. In other words, to the extent that you sell a business or an asset and get back your money exchanged for
the asset, you haven't earned any taxable income. Only the profit, if any, is taxed. And it is taxed at capital gains tax
rates.

Example

Toni invests $1,000 in the stock of Ronaldo's Rubber Fashions, a small business corporation, and
later sells her stock for $1,500. Only $500 is considered income for tax purposes; the other $1,000 is
a return of capital to Toni.

Tax-free withdrawals. If you borrow against an asset, whether it belongs to your business or to you personally, the loan
proceeds are not income. Borrowing is a valuable tool for taking money tax-free out of an unincorporated business that
holds an appreciated asset, such as real estate.
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Copyright 2006 Nolo

Top Ten Tax Deductions for Professionals


by Attorney Stephen Fishman
From the Nolo Business & Human Resources Center
Don’t pay more in taxes than you need to.
If you’re a professional, no one needs to tell you that taxes are one of your largest expenses. The IRS doesn’t make a
point of advertising ways to lower your taxes and it certainly won’t complain if you don’t take all the deductions you’re
entitled to. In fact, many professionals miss out on all kinds of deductions every year simply because they aren’t aware of
them -- or because they neglect to keep the records necessary to back them up.
Here are the top ten tax deductions that every professional business owner should know about.
1. Business operating expenses. This includes all your ordinary and necessary business expenses -- the bread-and-
butter costs virtually every professional incurs for things like rent, supplies, and salaries. If you don’t maintain an
inventory or buy expensive equipment, these day-to-day costs will probably be your largest category of business expenses
-- and your largest source of deductions.
2. Business entertainment. Oftentimes important business meetings, client contacts, and marketing efforts take place at
restaurants, golf courses, or sporting events. The tax law recognizes this and allows professionals to deduct half of the cost
of their business-related entertainment. However, taxpayers have abused this deduction in the past, so the IRS imposes
strict rules limiting the types and amount of entertainment costs you can deduct.
3. Local travel. Professionals can deduct the costs of their local transportation expenses if they are ordinary and
necessary for their business. It makes no difference how you travel -- by car, van, SUV, limousine, motorcycle, taxi, bus,
or train -- or whether the vehicle you use is owned or leased. But, beware: transportation expenses are a red flag for the
IRS. They are the number one item that IRS auditors look at when they examine small businesses.
4. Long distance travel. Professionals who travel overnight for business can deduct their airfare, hotel bills, and other
expenses. And, if you plan your trip right, you can even mix business with pleasure and still get a deduction. However, IRS
auditors closely scrutinize this deduction. To avoid unwanted attention, you need to keep proper records and understand
the limitations on this deduction.
5. Long-term assets. A long-term asset is business property that you reasonably expect to last for more than one year.
For professionals, this typically includes items such as office furniture, computer equipment, medical, dental, or other
specialized equipment, buildings, automobiles, and books. There are two basic ways you can deduct long-term assets: by
depreciating them (deducting some of the cost each year over the asset’s useful life) or by using Section 179 of the
Internal Revenue Code to deduct all of the cost in one year.
6. Home office deduction. If, like many professionals, you regularly work at home, you may able to claim the home
office deduction. (Sometimes you can use this deduction even if you have an outside office where you do the bulk of your
work.) However, if you want to use this deduction, you must learn to do it properly. There are strict requirements you
must follow. How you claim the deduction will depend in part on what type of business entity you have.
7. Outside office. The great majority of professionals have outside offices where they do their work. An outside office --
that you rent or own -- presents many opportunities for tax deductions. Virtually all your outside office expenses are
deductible, including rent, utilities, insurance, repairs, improvements, and maintenance.
8. Health insurance. As business owners, professionals have an advantage that most others don’t have with regard to
health care costs -- they can deduct many of their health insurance costs from their taxes. In addition, professionals can
deduct a wide variety of uninsured medical expenses, including nonprescription medications, acupuncture, and eyeglasses.
9. Retirement plans. When it comes to saving for retirement, professional small business owners are better off than
employees of most companies. This is because the federal government allows small businesses to set up retirement
accounts specifically designed for small business owners. These accounts provide enormous tax benefits that are intended
to maximize the amount of money you can put away in tax-deferred accounts during your working years.
10. Hiring workers. You may deduct most or all of what you pay someone you hire as a business expense. Thus, for
example, if you pay an employee $50,000 per year in salary and benefits, you’ll ordinarily get a $50,000 tax deduction. If
you hire an independent contractor to perform services for your practice, you can deduct the amount you pay as a
business operating expense.

Want to Learn More?

For more information on deducting health insurance, vehicles, travel, and home office expenses, see
Tax Deductions for Professionals, by attorney Stephen Fishman (Nolo). This book can also help you:
1. choose the best legal structure for your practice
2. decide whether to buy or lease the building you work in, and

3. maximize your retirement funding.

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Copyright 2006 Nolo

What Auditors Look for When Examining a Business


From the Nolo Business & Human Resources Center
Know what an IRS auditor looks for when examining your business and its records.
First and foremost, the IRS training manual tells its auditors that they are examining you, not just your tax return.
The auditor wants to see how you match up with the income reported on your return -- "economic reality" in IRS-speak. If
your business is audited, the IRS is likely to investigate these issues:

1. Does your lifestyle square with your reported income? An auditor sizes you up for dress style, jewelry, car,
and furnishings in your home or office, if given a chance to make these observations. Someone who looks like a Vegas
high roller, with the tax return of a missionary, will cause any auditor to dig deeper.

2. Does your business handle a lot of cash? If your business handles a lot of cash, expect the auditor to suspect
skimming, or diverting income into your own pocket without declaring it.

3. Did you write off auto expenses for your only car? Personal use of your business-deducted set of wheels is
so common that auditors expect to find it. That doesn't mean they will accept it, however. Auditors don't believe you use
your one-and-only auto 100% for business and never to run to the grocery store or the dentist. If you operate your car for
both business and pleasure and claim a high percentage of business usage, keep good records (preferably a mileage log).

4. Did you claim personal entertainment, meals, or vacation costs as business expenses? Travel and
entertainment business expenses are another area where the IRS knows it can strike gold. Document all travel and
entertainment deductions. Taking buddies to the ball game and calling it business won't fly if you can't explain the
business relationship in a credible fashion.

1. Did you "forget" to report all of your business sales or receipts? If you failed to report significant business
income -- $10,000 or more -- strongly consider hiring a tax pro to handle the audit. Remove yourself from the process
altogether. If the auditor finds evidence of large amounts of unreported income, and it looks intentional, he may call in the
IRS criminal investigation team. However, if there is any kind of halfway plausible explanation ("Someone must have
forgotten to record September's sales"), then don't worry about jail. The auditor will probably just assess the additional tax
you should have paid in the first place, plus interest and a 20% penalty.

2. Did you write off personal living costs as business expenses? Let's face it, every small-time operator has
claimed a personal expense as a business one. For little things, such as a few personal long-distance calls on the business
telephone line, the IRS won't get too excited. But if you deducted $2,000 in repairs on your motor home during a trip to
Yellowstone, an auditor may figure this out by looking at your receipts and disallow it, with penalty added.

3. If you have employees, are you filing payroll tax returns and making tax payments? Employment taxes
are a routine part of every audit of a small enterprise.
4. And last but not least, if you hire people you call "independent contractors," are they really
employees? The IRS routinely conducts audits of businesses that hire independent contractors, because of the tax
savings associated with hiring contractors instead of employees.
This list is by no means complete. These are just the most likely things an IRS auditor will look for. For more information
on business taxes and audits, see Tax Savvy for Small Business, by attorney Frederick W. Daily (Nolo).
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Copyright 2006 Nolo

Understanding Small Business Tax Deductions


From the Nolo Business & Human Resources Center
Thankfully, you can reduce your tax burden by deducting most of what you spend in the course of business.
How tax savvy a businessperson you are has a great effect on how much money is in your pocket at the end of the year.
You probably know that the tax code allows you to deduct costs of doing business from your gross income. What you are
left with is your net business profit. This is the amount that gets taxed.
So knowing how to maximize your deductible business expenses lowers your taxable profit. To boot, you may enjoy a
personal benefit from a business expenditure -- a nice car to drive, a combination business trip/vacation, a retirement
savings plan -- if you follow the myriad tax rules. The balance of this article deals with how the IRS decides when an
expense is deductible.
Ordinary and Necessary Expenses
We won't burden you with a lot of tax code sections, but hear us out on this one. Section 162 is the cornerstone for
determining the tax deductibility of every business expenditure. Here are the first 35 or so words:
Internal Revenue Code § 162. Trade or business expenses. (a) In general. There shall be allowed as a deduction all the
ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business...
Section 162 goes on -- and on -- but the important part is that expenses must be "ordinary and necessary" or they can't
be deducted. However, the tax code doesn't define either "ordinary" or "necessary." Luckily, in many cases a legitimate
business expense under Section 162 is obvious (for instance, office equipment and supplies are clearly deductible).
Pubs and regs. In some cases, such as outlays for travel, the IRS provides specific instructions for determining whether
or not an expense is "ordinary and necessary." This is often done through various IRS publications ("pubs") and
regulations ("regs").
Court decisions. When a specific expense hasn't been mentioned in Section 162 or in publications or regulations, federal
courts have tried to figure out what Congress intended and apply it to a particular set of facts. The legal consensus is that
"ordinary and necessary" refers to the purpose for which an expense is made. For instance, renting office space is ordinary
and necessary for many business folks, but it is neither unless it is actually used in running a business. "Ordinary" has
been held by courts to mean "normal, common, and accepted under the circumstances by the business community."
"Necessary" has been taken to mean "appropriate and helpful."
Given these broad legal guidelines, it is not surprising that some folks have tried to push the envelope on "ordinary and
necessary" business expenses, and the IRS has pushed back. Sometimes a compromise is reached, and sometimes the
issue is thrown into a court's lap.

Example

Mr. Henry, an accountant, deducted his yacht expenses, contending that because the boat flew a
pennant with the numbers "1040," it brought him professional recognition and clients. The matter
ended up before the tax court. The court ruled that the yacht wasn't a normal business expense for a
tax professional, and so it wasn't "ordinary" or "necessary." In short, the yacht expense was personal
and thus nondeductible. (Henry v. CIR, 36 TC 879 (1961).)

The laugh test. Tax professionals frequently rely on the "laugh test": Can you put down an expense for business without
laughing about putting one over on the IRS? In the example above, the tax court laughed the accountant and his yacht out
of court.
Large Expenses
Because the IRS knows that people don't intentionally overpay for anything, amounts paid aren't usually questioned.
However, IRS auditors sometimes object to expenditures deemed unreasonably large under the circumstances.
While the tax code itself contains no "too big" limitation, courts have ruled that it is inherent in Section 162. For example,
it might be reasonable for a multi-state apparel company to lease a jet for travel between manufacturing plants, but not
for a corner deli owner to fly to New York to meet with her pickle supplier.
Personal Expenses
The number one concern of the IRS when auditing business deductions is whether purely personal expenditures are being
claimed as business expenses. For instance, you can't deduct the cost of commuting to work, because the tax code
specifically says this is a personal, not a business, expense. Ditto with using the business credit card for a vacation or
cruising the beach in the company car. Because such shenanigans are common, IRS auditors are ever watchful.
Fortunately, you can often arrange your affairs -- legally -- in a way that lets you derive considerable personal benefit and
enjoyment from business expenditures.

Be careful if you deal with relatives. An IRS auditor will look askance at payments to a family member or to
another business in which your relatives have an ownership interest (in tax code parlance, these are termed "related
parties"). An auditor may suspect that taxable profits are being taken out of your business for direct or indirect personal
benefit in the guise of deductible expenses. For example, paying your spouse's father, who is in prison, $5,000 as a
consultant's fee for your restaurant business would smell bad to an auditor.

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Preparing for a Business Audit


From the Nolo Business & Human Resources Center
A tax audit will be much less worrisome if you prepare your business for it.
Who's afraid of the IRS? Almost everyone. The key to surviving a tax audit -- and even coming out on top -- is not to
panic, but to prepare.
What to Do Before Your Audit
If you go it alone, before meeting the auditor, you should thoroughly review the tax returns being audited. Be ready to
explain how you, or your tax return preparer, came up with the figures. If you can't, then contact your tax preparer or
another tax pro.
Find all records that substantiate your tax return. As discussed, the IRS has a right to look at any records used to
prepare your tax return. Organize your records for the auditor in a logical fashion. Your pre-audit organization of receipts,
checks, and other items will refresh your recollection for the audit meeting.
Neatness counts. Forget about dumping a pile of receipts before an auditor and telling him or her to go at it. Messy
records mean more digging -- and more digging, to the IRS, means more gold for them. Conversely, auditors frequently
reward good recordkeepers by giving these folks the benefit of the doubt if any problems arise. Neatness builds your
credibility with the auditor. Tidiness and order appeal to an accountant's mentality, and most auditors are accountants.
Pinpoint problems backing up income sources or expense deductions. You'll need to legally show your right to take
tax deductions or other tax benefits claimed on your return. Research tax law, if necessary.
What to Bring to an Audit of Your Small Business
Audit success means documenting your expenses. Proof should be in writing, though auditors are allowed to accept oral
explanations. A list of items the auditor wants to see usually accompanies your audit notice.
At a minimum, the IRS will expect you to produce the following documents:

1. Bank Statements, canceled checks, and receipts. The auditor will want to see bank records from all of your
accounts, both personal and business. As a rule, don't discard any business-related canceled checks, invoices, or sales
slips. If you paid some expenses with cash, keep the paperwork (handwritten notes, notebooks, receipts, or petty cash
vouchers) showing the payments.

2. Electronic records. Most banks don't return canceled checks anymore, and many business expenses are
charged on credit or debit cards. Bank and charge card (Visa, MasterCard, American Express) statements are now
accepted by the IRS as proof of payment. They must show the name, the date, the amount, and the address of the payee.
Since charges and statements don't always show the business nature of the expense, you can't rely on them as
your only records.

3. Books and records. The auditor will ask to see your "books." The tax code doesn't require small businesses to
keep a formal set of books; don't let an auditor tell you otherwise. If you keep records with only a checkbook and cash
register tapes, so be it. If you maintain more formal records such as ledgers and journals, the auditor is entitled to see
them. If your data is on a computer, the auditor will want to see a printout.

Don't make the IRS guess. If you don't produce adequate records, the auditor is legally permitted to estimate your
income and/or expenses and to impose a separate penalty for your failure to keep records.

1. Appointment books, logs, and diaries. Businesses that offer services typically track activities and expenses
using calendars, business diaries, appointment books, and logs. An entry in a business diary helps justify an expense to an
auditor as long as it appears to be reasonable.
Additionally, you must keep special records for certain equipment, called "listed property," that is often used for
both business and personal purposes. (IRC § 280F.) Cell phones, computers kept at home but used for business,
and vehicles used for both business and pleasure are designated as listed property.
Purely business equipment is not in this category. For example, mechanic's tools, a lathe, or a carpet loom are
purely business tools, and no records of usage are required. But when assets are put to both business and
personal use, the auditor can demand records of usage. For example, if you use a computer for business email
and to play solitaire, keep track of the business portion. One way is to make notes in a note pad next to the
computer.
If you haven't kept usage records of listed property, reconstruct them by memory or reference to projects that
you worked on during the year.

2. Auto records. A vehicle can be "listed property" if it's used for personal purposes as well as business. So
business use of your personal auto requires detailed records showing the work use portion. A log is the best way to keep
track (and it's easy to keep a little notebook in the glove compartment), although it's not required by the tax code.
Alternatively, you can keep all gas and repair receipts in an orderly fashion, with notations of trips showing how the car
was used for business. A less accurate way to keep records is to add up the gas bills and divide by the number of miles per
gallon that your car averages. Show the auditor your auto trip receipts and explain how they link up to sales trips by your
business diary or calendar notations.

1. Travel and entertainment records. By law, out-of-town business travel and entertainment expenses (T & E, in
auditor lingo) require greater recordkeeping than most other expenses. You must have a written record of the specific
business purpose of the travel or entertainment expense, as well as a receipt for it. (IRC § 267.)
A good way to document T & E expenses is with an appointment book or log, noting each time you incur a
business expense, and the reason. Most folks aren't disciplined enough to write down every expense as it is
incurred. It is okay to put together a log or diary after you have received an audit notice. But be up-front about it
-- don't insult the auditor's intelligence by trying to pass off wet-inked paper as an old record. Remember, it's key
to develop and maintain credibility with the auditor.

Example 1:

Bianca, a self-employed designer, reconstructs a calendar book with a notation for June 18, 2006, as
follows: "Round-trip cab fare to office of John Johnson, prospective client, $14 (no receipt). Lunch at
Circle Restaurant: Discuss proposal to decorate new offices at 333 Pine Street, $32 (Visa charge)
plus cash tip of $6 (no receipt)." Bianca can also give the auditor details, if asked. The auditor will
probably be satisfied if it appears reasonable.

Example 2:

Sam, the owner of a computer store went to an out-of-town computer retailers' convention. He spent
$1,800 and claimed it as business travel expenses on his tax return. On audit, Sam produces charge
card statements to prove the $1,800 was spent for hotels, meals, and convention registration. The
auditor wants more and asks Sam to justify the business purpose of this trip. Sam produces an ad for
the convention, an agenda of events, and notes he took at programs. If it looks legitimate, and
Sam's explanation of why it was important for him to be there is convincing, the auditor should allow
the deduction in full.

1. Expenses for renting or buying property. To prove business rental expenses, bring in a copy of your lease. If
you purchased the property or equipment, have the purchase contract. This establishes grounds for claiming these
expenses as well as a beginning tax basis of the property, if you claim depreciation expenses.
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Copyright 2006 Nolo

Deductions Your Small Business Shouldn't Miss


From the Nolo Business & Human Resources Center
Keep an eye out for these often-overlooked ways to cut your tax bill.
It's simple: The more tax deductions your business can legitimately take, the lower its taxable profit will be. And in
addition to putting more money into your pocket at the end of the year, the tax code provisions that govern deductions
can also yield a personal benefit: a nice car to drive at a small cost, or a combination business trip and vacation. It all
depends on paying careful attention to IRS rules on just what is, and isn't, deductible.
When you're toting up your business's expenses at the end of the year, don't overlook these 14 common business
deductions.
1. Auto Expenses
Operating a car is expensive. The good news is that if you use your car for business, or your business owns its own
vehicle, you can deduct some of the costs of keeping it on the road. Mastering the rules of car expense deductions can be
tricky, but well worth your while.
There are two methods of claiming expenses: You can either keep track of and deduct all of your actual business-related
expenses, or you can deduct a certain amount for each mile driven (the "standard mileage amount," which is 44.5 cents
per mile in 2006) plus all business-related tolls and parking fees.
As a rule, if you use a newer car primarily for business, the actual expense method provides a larger deduction at tax time.
If you use the actual expense method, you can also deduct depreciation on the vehicle. However, you must use the
standard mileage rate if you have claimed accelerated depreciation deductions in previous years, such as Section 179
depreciation. (For more on Section 179, see "New Equipment," below.)
If your auto is used for both business and pleasure, only the business portion produces a tax deduction. That means you
must keep track of how often you use the vehicle for business, and add it all up at the end of the year. Certainly, if you
own just one car or truck, no IRS auditor will let you get away with claiming that 100% of its use is related to your
business.
2. Expenses of Going Into Business
Once you're running a business, expenses such as advertising, utilities, office supplies, and repairs can be deducted as
current business expenses. But not before you open your doors for business. The costs of getting a business started are
capital expenses -- $5,000 of which you may deduct the first year you're in business. Any remainder must be deducted in
equal amounts over the next 15 years.

If you expect your business to make a profit immediately, you may be able to work around this rule by a delay
in paying some bills until after you're in business, or by doing a small amount of business just to officially start. But if, like
many businesses, you will suffer losses during the first few years of operation, you might be better off taking the deduction
over five years, so you'll have some profits to offset.
3. Education Expenses
You can deduct education expenses if they are related to your current business, trade, or occupation. The expense must be
to maintain or improve skills required in your present employment, or be required by your employer or as a legal
requirement of your job. The cost of education that qualifies you for a new job isn't deductible.
4. Legal and Professional Fees
Fees that you pay lawyers, tax professionals, or consultants generally can be deducted in the year incurred. But if the work
clearly relates to future years, they must be deducted over the life of the benefit you get from the lawyer or other
professional.
Business books, including those that help you do without legal and tax professionals, are fully deductible as a cost of doing
business.
5. Bad Debts
If someone stiffs your business, the bad debt may or may not be deductible -- it depends on the kind of product your
business sells.
If your business sells goods, you can deduct the cost of goods that you sell but aren't paid for. If, however, your business
provides services, no deduction is allowed for time you devoted to a client or customer who doesn't pay. The rationale
behind this rule is that it would be too easy for businesses to inflate bills and claim large deductions for bad debts.
6. Business Entertaining
If you pick up the tab for entertaining present or prospective customers, you may deduct 50% of the cost if it is either:
1. "directly related" to the business and business is discussed at the event -- for example, a catered meeting at
your office, or

2. "associated with" the business, and the entertainment takes place immediately before or after a business
discussion.

Make notes. On the receipt or bill, always make a note of the specific business purpose -- for example, "Lunch with
Joyce Slater of Ace Manufacturing Co. to discuss widget contract."
7. Travel
When you travel for business, you can deduct many expenses, including the cost of plane fare, costs of operating your car,
taxis, lodging, meals, shipping business materials, clothes cleaning, telephone calls, faxes, and tips.
What about combining business and pleasure? It's okay, as long as business is the primary purpose of the trip. But if you
take your family along, you can deduct only your own expenses, just as if you had traveled alone.
8. New Equipment
Some small businesses can write off the full cost of some assets in the year they buy them, rather than "capitalizing" them
-- deducting their cost over a number of years. Section 179 of the Internal Revenue Code allows you to deduct up to
$105,000 form the cost of new equipment or other assets in 2005 through 2007 (subject to a phase-out if you placed more
than $420,000 of equipment in service in any one year). Some assets don't qualify for this Section 179 deduction,
including real estate, inventory bought for resale, and property bought from a close relative.
9. Interest
If, like many folks, you use credit to finance business purchases, the interest and carrying charges are fully tax-deductible.
The same is true if you take out a personal loan and use the proceeds for your business. But be sure to keep good records
showing that the money was really put into your business. Otherwise, if you're audited later, the interest expense
deduction could be disallowed because it's considered a personal expense.
10. Moving Expenses
If you move because of your business or job, you may be able to deduct certain moving costs that would otherwise be
nondeductible personal living expenses. To qualify, you must have moved in connection with your business (or job, if
you're an employee of your own corporation or someone else's business). The new workplace must be at least 50 miles
farther from your old home than your old workplace was. (Technically, moving expenses aren't business expenses; there's
a special place to list them on your Form 1040 tax return.)
11. Software
As a general rule, software bought for business use must be depreciated over a 36-month period. But there are some
important exceptions:
1. Computer software placed in service from 1/1/2003 to 12/31/2007 is eligible for a Section 179 deduction, which
means that 100% of the cost of software can be deducted in the year purchased. Starting in 2008, you will no longer be
able to use Section 179 to deduct off-the-shelf software.

2. When software comes with a computer, and its cost is not separately stated, it's treated as part of the hardware
and is depreciated over five years. However, you can write off a whole computer system, including bundled software, in
the first year (under Section 179) if the total cost is less than a certain amount ($105,000 in 2005 through 2007). See IRS
Publication 946, How to Depreciate Property.
12. Charitable Contributions
If your business is a partnership, a limited liability company, or an S corporation (a corporation that has chosen to be
taxed like a partnership), your business can make a charitable contribution and pass the deduction through to you, to
claim on your individual tax return. If you own a regular (C) corporation, the corporation can deduct the charitable
contributions.

If you've got some old computers or office furniture, giving it to a school or nonprofit organization can yield
goodwill plus a tax benefit. But if the equipment has been fully depreciated (written off), you can't claim a deduction.
13. Taxes
Taxes incurred in operating your business are generally deductible. How and when they are deducted depends on the type
of tax.
1. Sales tax on items you buy for your business's day-to-day operations is deductible as part of the cost of the
items; it's not deducted separately. But tax on a big business asset, such as a car, must be added to the car's cost basis; it
isn't deductible entirely in the year the car was bought.
2. Excise and fuel taxes are separately deductible expenses.
3. If your business pays employment taxes, the employer's share is deductible as a business expense. Self-
employment tax is paid by individuals, not their businesses, and so isn't a business expense.
4. Federal income tax paid on business income is never deductible. State income tax can be deducted on your
federal return as an itemized deduction, not as a business expense.
5. Real estate tax on property used for business is deductible, along with any special local assessments for repairs
or maintenance. If the assessment is for an improvement -- for example, to build a sidewalk -- it isn't immediately
deductible; instead, it is deducted over a period of years.
14. Advertising and Promotion
The cost of ordinary advertising of your goods or services -- business cards, yellow page ads, and so on -- is deductible as
a current expense. Promotional costs that create business goodwill -- for example, sponsoring a peewee football team --
are also deductible as long as there is a clear connection between the sponsorship and your business. For example, naming
the team the "Southwest Auto Parts Blues" or listing the business name in the program is evidence of the promotion effort.

Easily Overlooked Business Expenses

Here are some additional routine deductions that many business owners miss. Keep your eye out for
them.
1. audiotapes and videotapes related to 1. credit bureau fees
business skills
2. office supplies
2. bank service charges
3. online computer services related to
3. business association dues business
4. business gifts 4. parking and meters
5. business-related magazines and books 5. petty cash funds
6. casual labor and tips 6. postage
7. casualty and theft losses 7. promotion and publicity
8. coffee and beverage service 8. seminars and trade shows
9. commissions 9. taxi and bus fare
10. consultant fees 10. telephone calls away from the
business

Note: Just because you didn't get a receipt doesn't mean you can't deduct the expense, so keep
track of those small items and get big tax savings.

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Current vs. Capital Expenses
From the Nolo Business & Human Resources Center
When you may deduct a given expense depends in part on whether it is considered a current or capital
expense.
Tax rules cover not only what expenses can be deducted but also when -- in what year -- they can be deducted. Some
types of expenditures are deductible in the year they are incurred but others must be taken over a number of future years.
The first category is called "current" expenses, and the second "capital" or "capitalized" expenditures. You need to know
the difference between the two, and the tax rules for each type of expenditure. We'll try to make it easy on you, but there
are some gray areas.
Generally, "current expenses" are everyday costs of keeping your business going, such as the rent and electricity bills.
Rules for deducting current expenses are fairly straightforward; you subtract the amounts spent from your business's
gross income in the year the expenses were incurred.
Other business expenditures, such as the cost of equipment, land, and vehicles to name a few, cannot be deducted in the
same way as current expenses. Asset purchases, since they are expected to generate revenue in future years, are treated
as investments in your business. They must be deducted over a number of years, or "capitalized," as specified in the tax
code (with one important exception -- Section 179 -- discussed below). This, theoretically, allows the business to more
clearly account for its profitability from year to year. The general rule is that if an item has a "useful life" of one year or
longer, it must be capitalized.
Capitalizing Expenses
The deduction taken over a number of years is usually called "depreciation," but in some cases it is called a "depreciation"
or "amortization" expense. All of these words describe the same thing: writing off or depreciating asset costs through
annually claimed tax deductions.
There are many rules for how different types of assets must be written off. The tax code dictates both absolute limits on
some depreciation deductions, and over how many future years a business must spread its depreciation deductions for all
asset purchases. Businesses, large and small, are affected by these provisions (IRC §§ 167, 168, and 179).

Take advantage of the immediate Section 179 deduction.

A valuable tax break creating an exception to the long-term write-off rules is found in IRC Section
179. A small business can write off in one year most types of its capital expenditures, up to a grand
total of $105,000 in 2005 through 2007. The annual deduction limit is scheduled to go down to
$25,000 in 2008. Some assets don't qualify for this deduction: real estate, inventory bought for
resale, and property bought from a close relative.
All small businesses should take full advantage of this provision, unless they don't have enough
business income to offset the Section 179 deduction (the Section 179 deduction can't exceed your
total taxable earnings).

Repairs and Improvements


Normal repair costs, such as fixing a broken copy machine or a door, are current expenses and so can be deducted in the
year incurred. On the other hand, the tax code says that the cost of making improvements to a business asset must be
capitalized if the enhancement:
1. adds to the asset's value, or
2. appreciably lengthens the time you can use it, or

3. adapts it to a different use.

"Improvements" usually refers to real estate -- for example, putting in new electrical wiring, plumbing, and lighting -- but
the rule also applies to rebuilding business equipment.

Example:
Gunther uses a specialized die-stamping machine in his metal fabrication shop. After 15 years of
constant use, the machine is on its last legs. His average yearly maintenance expenses on the
machine have been $10,000, which Gunther has properly deducted as a repair expense. In 2006,
Gunther is faced with either thoroughly rehabilitating the machine at a cost of $80,000, or buying a
new one for $175,000. He goes for the rebuilding. The $80,000 expense must be capitalized -- that
is, it can't be deducted using Section 179 because it is an improvement -- not a normal repair. Under
the tax code, metal-fabricating machinery must be deducted over five years.

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Cash vs. Accrual Accounting


From the Nolo Business & Human Resources Center
Cash or accrual? All small businesses need to choose one of these methods of accounting.
It's important to understand the basics of the two principal methods of keeping track of a business's income and expenses:
cash method and accrual method (sometimes called cash basis and accrual basis). In a nutshell, these methods differ only
in the timing of when transactions, including sales and purchases, are credited or debited to your accounts. The accrual
method is the more commonly used method of accounting.
Under the accrual method, transactions are counted when the order is made, the item is delivered, or the services occur,
regardless of when the money for them (receivables) is actually received or paid. In other words, income is counted when
the sale occurs, and expenses are counted when you receive the goods or services. You don't have to wait until you see
the money, or actually pay money out of your checking account, to record a transaction.
Under the cash method, income is not counted until cash (or a check) is actually received, and expenses are not counted
until they are actually paid.

Example

Your computer installation business finishes a job in November, and doesn't get paid until three
months later in January. Under the cash method, you would record the payment in January. Under
the accrual method, you would record the income in your books in November.

Example

You purchase a new laser printer on credit in May and pay $1,000 for it in July, two months later.
Using the cash method accounting, you would record a $1,000 payment for the month of July, the
month when the money is actually paid. Under the accrual method, you would record the $1,000
payment in May, when you take the laser printer and become obligated to pay for it.

Determining the Transaction Date


With the accrual method, sometimes it's not so easy to know when the sale or purchase has occurred. The key date here is
the job completion date. Not until you finish a service, or deliver all the goods a contract calls for, do you put the income
down in your books. Likewise, you don't record an item as an expense until the service is completed or all goods have
been received and installed, if necessary. (If a job is mostly completed but will take another 30 days to add the finishing
touches, technically it doesn't go on your books until the 30 days pass.)
Choosing an Accounting Method
Most small businesses (with sales of less than $5 million per year) are free to choose which accounting method to adopt.
But if your business stocks an inventory of items that you will sell to the public, the IRS requires that you use the accrual
method of accounting. Inventory includes any merchandise you sell, as well as supplies that will physically become part of
an item intended for sale.
Whichever method you use, it's important to realize that either one gives you only a partial picture of the financial status
of your business. While the accrual method shows the ebb and flow of business income and debts more accurately, it may
leave you in the dark as to what cash reserves are available, which could result in a serious cash flow problem. For
instance, your income ledger may show thousands of dollars in sales, while in reality your bank account is empty because
your customers haven't paid you yet.
And though the cash method will give you a truer idea of how much actual cash your business has, it may offer a
misleading picture of longer-term profitability. Under the cash method, for instance, your books may show one month to
be spectacularly profitable, when actually sales have been slow and, by coincidence, a lot of credit customers paid their
bills in that month. To have a firm and true understanding of your business's finances, you need more than just a
collection of monthly totals; you need to understand what your numbers mean and how to use them to answer specific
financial questions.
Claiming Tax Deductions
The most significant way your business is affected by the accounting method you choose involves the tax year in which
income and particular expense items will be counted.
For instance, if you incur expenses in the 2006 tax year but don't pay them until the 2007 tax year, you won't be able to
claim them in 2006 if you use the cash method. But you would be able to claim them if you use the accrual method, since
under that system you record transactions when they occur, not when money actually changes hands.

Example

Zara runs a small flower shop called ZuZu's Petals. On December 22, 2006, Zara buys a set of new
lighting equipment for her shop, for which she will be billed $400. She installs the lighting equipment
that day but, according to the terms of the purchase, doesn't pay for it for 30 days. Under her
accrual system of accounting, she counts the $400 expense in the December 2006 accounting period,
even though she didn't actually write the check until January of the next year. This means that Zara
can deduct the $400 as a business expense from her taxable income of 2006.

Example

Scott and Lisa operate A Stitch in Hide, a leather repair shop. They're hired to repair an antique
leather couch, and they finish their job on December 15, 2006. They bill the customer for $750,
which they receive on January 20, 2007. Because they use the accrual method of accounting, Scott
and Lisa count the $750 income in December 2006, the date they earned the money by finishing the
job. This income must be reported in their 2006 tax return even though they don't receive the
money.

Again, you can usually choose the method of accounting that is most advantageous for your business, unless your business
stocks an inventory of items that you will sell to the public, or your business has sales of more than $5 million per year.
Tax Years and Accounting Periods
Income and expenses must be reported to the IRS for a specific period of time, called your tax year, your accounting
period, or your fiscal year.
Unless there is a valid business reason to use a different period, or your business is a corporation, you'll have to use the
calendar year, beginning on January 1 and ending on December 31. Most business owners use the calendar year for their
tax year, simply because they find it easy and natural to use. If you want to use a different period, you must request
permission from the IRS by filing Form 8716, Election to Have a Tax Year Other Than a Required Tax Year.
Also, your fiscal year can't begin and end on just any day of the month: It must begin on the first day of a month and end
on the last day of the previous month one year later.
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When Your Business Ships Goods


by Attorney Richard Stim
From the Nolo Business & Human Resources Center
If your products are late getting to customers, not only will it cause you a loss of goodwill, it may also violate
federal law. Here are the basics.
When taking orders, whether by phone or online, you must follow the shipping and refund rules of the Federal Trade
Commission’s (FTC's) Mail or Telephone Order Merchandise Rule, also known as the "30-Day Rule.” In a nutshell, the rule
mandates that when you advertise merchandise and state the shipping times, you must have a reasonable basis for
believing you can meet these shipping deadlines.
The 30-Day Rule
If you don’t say anything about shipment times, you’re expected to ship within 30 days from the date you received a
properly completed order -- that is, when you receive the payment and all the information needed to fill the order. The rule
does not apply to collect-on-delivery (C.O.D.) orders or sales of seeds and growing plants or to magazine subscriptions
(except for the delivery of the first issue).
If you notify the customer of a delay, you’ll need to get the customer’s consent. This is also true for online orders, which
are considered complete when the customer clicks it along to you. If you can’t get the customer's consent to the delay,
you must, without being asked, refund the money the customer paid you for the unshipped merchandise. If there’s a
shipping delay and you don’t want to seek the customer’s consent, you can simply cancel the order, notify the customer,
and refund the payment. Keep a record of how you gave the notice (whether by email, phone, fax, or regular mail), when
you gave it, and how the customer responded. Again, if you don’t say anything about shipment times at the time of the
order, you’re expected to ship within 30 days.

Is Your Customer Applying for Credit?

If your customer is applying to you to establish a new credit account or increase an existing credit
line to pay for the merchandise being ordered and if you don’t give a shipment date, you are allowed
50 (instead of 30) days to ship. The extra 20 days is to give you time to process the credit
application. Of course, if you want to use this provision of the FTC rule, you must have a reasonable
basis to believe you can ship in 50 days. For more information about these rules, check out the FTC's
website at www.ftc.gov.

Drop Shipping
Drop shipping is a process in which you sell items you don’t keep in stock. Instead, you collect the money and forward the
order to a distributor, who ships to the customer using your packaging. Amazon and other online stores perfected this art,
and it has since been adopted by thousands of online retailers. The advantage of drop-shipping is that you can offer a wide
variety of merchandise without maintaining an inventory. The disadvantage is that you may have to pay setup fees, make
a minimum number of orders each month, and deal with refunds if the drop shipper screws up.
In cases of drop-shipped orders, you (the person taking the order), not the shipper, are responsible for complying with the
30-day rule. Find out the distributor’s return policy and post it at your point of sale or in your catalog, or if that’s not
possible, include it with the order.
If the customer complains about the merchandise -- for example, it arrives damaged or has a factory defect -- the
distributor will have to correct the error. But because the customer purchased the product from you, not the distributor,
you’ll have to stay on top of the transaction -- for example, get the RMA (return merchandise authorization) number from
the distributor and email it to the customer. The RMA allows you and the distributor to accurately track and process the
returned merchandise.
To learn about starting and running your own business, see Whoops! I'm in Business: A Crash Course in Business Basics,
by attorneys Richard Stim & Lisa Guerin (Nolo).
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Copyright 2006 Nolo

Invoicing Customers and Extending Credit


by Attorney Richard Stim
From the Nolo Business & Human Resources Center
If you're new to invoicing -- or even if you've been doing it for a while -- here are a few things to keep in
mind.
If you’re a professional service provider (such as a consultant or accountant) or you sell products to a wholesaler (a
company that places your goods in retail accounts), then you probably invoice your customers. An invoice is a bill that sets
the terms for payment. When you invoice a customer, your business is extending credit.
Extending Credit to Your Customers
You may not feel like you’re extending credit -- after all, you’re just waiting for payment -- but from a legal perspective,
you’re making an unsecured loan. (An unsecured loan is one which the borrower does not pledge property as collateral for
the loan.) The problem with unsecured loans is that they’re … unsecured. If the business doesn’t have the money, it won’t
do any good to sue, because there will be nothing to recover. If the business goes bankrupt, you’re out of luck.
If you have doubts about a new customer, you can check on their creditworthiness by having them complete a credit
reference form. A good credit reference form requires information about who is in charge of the business, who to contact if
problems develop, how much credit the applicant is seeking, other firms with which the company has done business on
credit, and any other financial information you need to make your decision. If it’s a big account and you’re investing a lot
of resources (time, money, or supplies) in it, it may be worth it to pay for credit research from a company such as Dun &
Bradstreet (www.dnb.com), BusinessCreditUSA (www.businesscreditusa.com), or Equifax (www.equifax.com).
Evaluating Credit Risk
After a potential customer fills out a credit reference form, how do you tell whether the customer is a credit risk? That will
be a personal call based on the size of the business and its credit history. Collections expert Timothy Paulsen suggests
separating patterns from single events. If a customer has one or two minor credit blemishes -- perhaps the result of an
unexpected growth spurt -- that should not necessarily be the basis of denying credit. That is different from evidence that
indicates the client or customer just doesn’t like to pay bills.
The greatest risk in extending credit is when you throw all of your business to one big account. The obvious problem with
that strategy is that you risk losing a lot of money if the big account has financial problems or goes bankrupt. For that
reason, don’t ditch your smaller accounts because of large orders from one customer. Loyal smaller accounts give a
business a constant, reliable source of income.
Preparing Your Invoice
When you prepare an invoice, it's important to provide an accurate, clear statement of the transaction and a request that
the customer contact you if there are any problems. Most invoices require payment within 30, 60, or 90 days. Be sure to
specify when payment is due. With this information clearly noted on the invoice, it may be more difficult for a slow-paying
account to later excuse its delinquent behavior.

Want to Learn More?

To learn about starting and running your own business, see Whoops! I'm in Business: A Crash
Course in Business Basics, by attorneys Richard Stim & Lisa Guerin (Nolo).

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Copyright 2006 Nolo

Bookkeeping and Accounting Basics


From the Nolo Business & Human Resources Center
While keeping track of your business's finances may seem overwhelming, it's not that hard when you know
the basics of accounting and bookkeeping.
Bookkeeping and accounting share two basic goals:

1. To keep track of your income and expenses, which improves your chances of making a profit.

2. To collect the financial information necessary for filing your various tax returns.
Sounds pretty simple, doesn't it? It can be, especially if you remind yourself of these two goals whenever you feel
overwhelmed by the details of keeping your financial records.
There is no requirement that your records be kept in any particular way. As long as your records accurately reflect your
business's income and expenses, the IRS will find them acceptable. (There is a requirement, however, that some
businesses use a certain method of crediting their accounts: the cash method or accrual method. )
Three Steps to Keeping Your Books
The actual process of keeping your books is easy to understand when broken down into three steps.
1. Keep receipts or other acceptable records of every payment to and every expenditure by your business.
2. Summarize your income and expenditure records on some periodic basis (daily, weekly, or monthly).
3. Use your summaries to create financial reports that will tell you specific information about your business, such as
how much monthly profit you're making or how much your business is worth at a specific point in time.
Whether you do your accounting by hand on ledger sheets or use accounting software, these principles are exactly the
same.
Step One: Keeping Your Receipts
Each of your business's sales and purchases must be backed by some type of record containing the amount, the date, and
other relevant information about that sale. You'll use these to create summaries of your transactions.
From a legal point of view, your method of keeping receipts can range from slips kept in a cigar box to a sophisticated cash
register hooked into a computer system. Practically, you'll want to choose a system that fits your business needs. For
example, a small service business that handles only relatively few jobs may get by with a bare-bones approach. But the
more sales and expenditures your business makes, the better your receipt filing system needs to be.
Step Two: Setting Up and Posting to Ledgers
A completed ledger is really nothing more than a summary of revenues, expenditures, and whatever else you're keeping
track of (entered from your receipts according to category and date). Later, you'll use these summaries to answer specific
financial questions about your business, such as whether you're making a profit and, if so, how much.
On some regular basis -- like every day, once a week, or at least once a month -- you should transfer the amounts from
your receipts for sales and purchases into your ledger. This is called "posting;" how often you do this depends on how
many sales and expenditures your business makes, and how detailed you want your books to be.
Generally speaking, the more sales you do, the more often you should post to your ledger. A retail store, for instance, that
does hundreds of sales amounting to thousands or tens of thousands of dollars every day should post daily. With that
volume of sales, it's important to see what's happening every day and not to fall behind with the paperwork. To do this,
the busy retailer should use a cash register that totals and posts the day's sales to a computerized bookkeeping system at
the push of a button. A slower business, however, or one with just a few large transactions per month, such as a small
website design shop, dog-sitting service, or swimming-pool repair company, would probably be fine if it posted weekly or
even monthly.
You can purchase an accounting software program that will generate its own ledgers as you enter your information (and
then automatically generate the necessary financial reports from the same information). All but the tiniest new business
are well advised to use an accounting software package to help keep their books (and micro-businesses can get by with
personal finance software such as Quicken).
Step Three: Creating Basic Financial Reports
Financial reports are important because they bring together several key pieces of financial information about your business
in one place. Think of it this way: while your income ledger may tell you that your business brought in a lot of money
during the year, you may have no way of knowing whether you turned a profit without measuring your income against
your total expenses. And even comparing your monthly totals of income and expenses won't tell you whether your credit
customers are paying fast enough to keep adequate cash flowing through your business to pay your bills on time.
That's why you need financial reports: to combine data from your ledgers and sculpt it into a shape that shows you the big
picture of your business. The key reports you need to create regularly are a cash flow analysis, a profit and loss forecast,
and a balance sheet. (Both QuickBooks and Quicken Home and Business, as well as other accounting software, can provide
these regular reports.)
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Accounting Terms Every Businessperson Should Know


From the Nolo Business & Human Resources Center
This glossary of accounting terms will get you up to speed if you're new to business.
A big part of understanding the financial side of your business consists of nothing more than learning the language of
accounting. Once you're familiar with basic terms, you'll be better prepared to make sense of basic written reports and
better able to communicate with others about important financial information.
Accounting is a general term that refers to the overall process of tracking your business's income and expenses, and then
using these numbers in various calculations and formulas to answer specific questions about the financial and tax status of
the business.
Bookkeeping refers to the task of recording the amount, date, and source of all business revenues and expenses.
Bookkeeping is essentially the starting point of the accounting process. Only with accurate bookkeeping numbers can
meaningful accounting be done.
An invoice is a written record of a transaction, often submitted to a customer or client when requesting payment. Invoices
are sometimes called bills or statements, though the latter term has a separate meaning, as explained below.
A ledger is a physical collection of related financial information, such as revenues, expenditures, accounts receivable, and
accounts payable. Ledgers used to be kept in books preprinted with lined ledger paper -- which explains why a business's
financial info is often referred to as the "books" -- but are now commonly kept in computer files that can be printed out.
An account is a collection of financial information grouped according to customer or purpose. For example, if you have a
regular customer, the collection of information regarding that customer's purchases, payments, and debts would be called
his or her "account." A written record of an account is called a statement, as explained below.
A statement is a formal written summary of unpaid, and sometimes paid, invoices. Unlike an invoice, a statement is not
generally used as a formal request for payment, but may be more of a reminder to a customer or client that payment is
due or that payment has been made.
A receipt is a written record of a transaction. A buyer receives a receipt to show that he paid for an item. The seller keeps
a copy of the receipt to show she received payment for the item. Receipts are sometimes called sales slips.
A balance sheet is a statement listing a business's assets, liabilities, and net worth, or equity (the difference between the
value of the assets and the liabilities).
Accounts payable are amounts that your business owes. For example, unpaid utility bills and purchases your business
made on credit would be included in your accounts payable.
Accounts receivable are amounts owed to your business that you expect to receive. Accounts receivable include sales
your business made on credit.
Bad debt is money owed for a business debt that cannot be collected; it can be deducted as an operating expense.
Net income is gross income less expenses; it represents a business's profit for a given year.
The accrual method of accounting accounts for income and expenses that are earned or incurred within the 12-month
period, which is not necessarily when it is received or paid.
The cash method of accounting accounts for income and expenses when actually received or paid.
Double-entry accounting is a system of accounting that records each business transaction twice (once as a debit and
once as a credit).
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Copyright 2006 Nolo

When Your Business Ships Goods


by Attorney Richard Stim
From the Nolo Business & Human Resources Center
If your products are late getting to customers, not only will it cause you a loss of goodwill, it may also violate
federal law. Here are the basics.
When taking orders, whether by phone or online, you must follow the shipping and refund rules of the Federal Trade
Commission’s (FTC's) Mail or Telephone Order Merchandise Rule, also known as the "30-Day Rule.” In a nutshell, the rule
mandates that when you advertise merchandise and state the shipping times, you must have a reasonable basis for
believing you can meet these shipping deadlines.
The 30-Day Rule
If you don’t say anything about shipment times, you’re expected to ship within 30 days from the date you received a
properly completed order -- that is, when you receive the payment and all the information needed to fill the order. The rule
does not apply to collect-on-delivery (C.O.D.) orders or sales of seeds and growing plants or to magazine subscriptions
(except for the delivery of the first issue).
If you notify the customer of a delay, you’ll need to get the customer’s consent. This is also true for online orders, which
are considered complete when the customer clicks it along to you. If you can’t get the customer's consent to the delay,
you must, without being asked, refund the money the customer paid you for the unshipped merchandise. If there’s a
shipping delay and you don’t want to seek the customer’s consent, you can simply cancel the order, notify the customer,
and refund the payment. Keep a record of how you gave the notice (whether by email, phone, fax, or regular mail), when
you gave it, and how the customer responded. Again, if you don’t say anything about shipment times at the time of the
order, you’re expected to ship within 30 days.

Is Your Customer Applying for Credit?

If your customer is applying to you to establish a new credit account or increase an existing credit
line to pay for the merchandise being ordered and if you don’t give a shipment date, you are allowed
50 (instead of 30) days to ship. The extra 20 days is to give you time to process the credit
application. Of course, if you want to use this provision of the FTC rule, you must have a reasonable
basis to believe you can ship in 50 days. For more information about these rules, check out the FTC's
website at www.ftc.gov.

Drop Shipping
Drop shipping is a process in which you sell items you don’t keep in stock. Instead, you collect the money and forward the
order to a distributor, who ships to the customer using your packaging. Amazon and other online stores perfected this art,
and it has since been adopted by thousands of online retailers. The advantage of drop-shipping is that you can offer a wide
variety of merchandise without maintaining an inventory. The disadvantage is that you may have to pay setup fees, make
a minimum number of orders each month, and deal with refunds if the drop shipper screws up.
In cases of drop-shipped orders, you (the person taking the order), not the shipper, are responsible for complying with the
30-day rule. Find out the distributor’s return policy and post it at your point of sale or in your catalog, or if that’s not
possible, include it with the order.
If the customer complains about the merchandise -- for example, it arrives damaged or has a factory defect -- the
distributor will have to correct the error. But because the customer purchased the product from you, not the distributor,
you’ll have to stay on top of the transaction -- for example, get the RMA (return merchandise authorization) number from
the distributor and email it to the customer. The RMA allows you and the distributor to accurately track and process the
returned merchandise.
To learn about starting and running your own business, see Whoops! I'm in Business: A Crash Course in Business Basics,
by attorneys Richard Stim & Lisa Guerin (Nolo).
Click here for related information and products from Nolo
Copyright 2006 Nolo

Mediation for Small Businesses


by Attorney Emily Doskow
From the Nolo Business & Human Resources Center
Are you a small business owner with a dispute? Mediation might be for you.
Suppose your small business is affected by noise or smells or parking lot litter from a neighboring business, and your
attempts to talk it out with your neighbor lead to each of you loudly proclaiming your own point of view. You may feel that
your options are limited to calling in the law or living with the situation. But the law may not exactly address your
situation. Or, your legal rights may be too costly to pursue. On the other hand, you may not be willing or able to live with
the situation as it is.
Small business owners are just as likely as major corporations to run into conflict -- with neighboring businesses,
employees, customers, or vendors -- and among business partners. But small businesses are far less likely to have public
relations, human resources, and legal departments to help them deal with these conflicts.
In fact, it may be overwhelming for a small business to come up with the time, money, and expertise to cope with even a
relatively minor dispute through legal means. What’s more, unless the situation is resolved amicably, the leftover hostility
will likely affect the quality of life of a small business proprietor who may be bumping up against the unfriendly party
personally on a day-to-day basis.
The Mediation Alternative
Mediation offers another way to resolve conflict -- in this example, one that could help you and your neighbor come to a
genuine understanding and come up with a resolution that takes both of your needs and interests into account. In
mediation, a neutral third person -- the mediator -- meets with parties who are having a conflict to help them try to work it
out it together. Because you and the other party make the agreement together, you are both more likely to keep it. And
the process of working things out in mediation is an experience you and your neighbor can draw upon if you run into
problems again in the future.
Costs of Mediation
Mediation is usually much less expensive than hiring a lawyer. Community mediation centers offer low-cost services, and
even if you hire a private mediator who charges by the hour, you'll be sharing the cost with the other party instead of
paying a lawyer on your own. And mediation only lasts a few hours, compared to the many hours a lawyer would spend
preparing your case and arguing with the other side.
Finding a Mediator
If you think you might want to mediate a dispute, the first step is to find a mediator or mediation service. Lots of places
have community mediation centers that use volunteer mediators and offer very low-cost mediation services. Look in your
local phone book under “mediation” or “conflict resolution.” That’s also where you’ll find private mediators. Some
mediators are lawyers, so you can also look under “attorneys” if you want to use a lawyer-mediator.
If you belong to a small business association like a chamber of commerce or the Better Business Bureau, check to see
whether they have a mediation program tailored to small businesses -- lots of them do.
The Results of Mediation
The vast majority of mediations result in a settlement. If your mediation is successful, you’ll leave with a signed agreement
or, at the very least, a signed memorandum setting out what you and the other party have agreed to. You have the choice
of making the agreement enforceable in court or not -- many people want to be able to ask a judge to enforce the
settlement in the future if the other party doesn’t live up to the agreement.
If you don’t reach a resolution in mediation, you haven’t lost anything, and you’ve probably learned a lot about how the
other person sees the problem. You still have the option of taking legal action if that’s what you feel you need to do.
In short, mediation is an efficient, effective way to resolve disputes and build community among small business people and
their customers and neighbors. If you have a dispute, we encourage you to give it a try. To learn more detail about the
process of mediation, you can check out Mediate, Don’t Litigate, by Peter Lovenheim and Lisa Guerin (Nolo).
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Copyright 2006 Nolo

Selling: Wholesale, Retail, and Consignments


From the Nolo Business & Human Resources Center
Pay attention to legal details when you sell your goods.
There are several options for selling your goods. These include working through distributors (wholesale), selling retail, and
placing products on consignment. It’s smart to apply standard business procedures to these methods of selling in order to
avoid legal problems and protect your business.
Wholesale Marketing
In a wholesale transaction, you sell quantities of your work to a dealer or retailer, usually at a discount. You get a higher
volume of business and your buyer gets a discount. That person then resells your work to their clients. Wholesale
transactions can take place at craft shows, directly between galleries and artist's or sometimes with the aid of agents.
A wholesale order can be exciting but you need to think through the terms before you accept it. Items to consider:
1. Will you offer credit or other payment terms? If you do, can you “carry” your client until they pay?
2. Is the client creditworthy? What will happen to your business if your client goes bankrupt? Are you putting all
your eggs in one basket? When in doubt, don’t extend credit.
3. Do you have a wholesale order form? Or a signed purchase order or contract? Make sure it includes an agreed
upon cancellation fee. This is very important if you are extending any kind of credit.
4. Do you have a volume discount schedule? This allows the buyer to get a greater discount when they buy more
units
5. Are you selling on a returnable basis or a nonreturnable basis? Nonreturnable sales will help you reduce returns
but clients often expect a greater discount.
Retail Sales
These are sales made directly to the public, whether at a storefront, a crafts fair, open studio, or as the result of a special
order. Such sales are often the bread and butter of small businesses. If you’re selling retail, you need to decide:
1. what payment types you’ll accept
2. your plan for handling and paying sales taxes
3. your returns policy, and

4. what, if any, credit you’ll extend.

Consignment Sales
A consignment occurs when you provide work to a reseller (the “consignee”), who agrees to pay you proceeds from the
sales minus a commission. If your product doesn’t sell, the consignee can return it. Under this arrangement, the consignee
takes very little risk since it does not have to purchase goods. The advantage to you can be that it gives you access to
sales outlets that might not otherwise be open to you.
Consignment sales can be big business. In craft sales alone, consignments account for more than $3 billion annually in
the United States. These numbers can be exciting, but before you jump into consignment sales, you should consider:
1. the credit or references of your consignee
2. having a written consignment agreement that spells out the inventory being consigned and other details
3. the retail price the goods will be sold for
4. the consignee’s fees
5. who pays for shipping and other matters that will affect your ability to realize a profit on your goods
6. insurance that the consignee will carry to protect your goods
7. when the deal will terminate, and

8. how disputes will be resolved.

Collecting Payment
No matter what you sell, you may have problems collecting what you are owed. The best way to avoid problems is to
minimize them up front with good policies and by carefully offering credit on larger orders. If you have a client who does
not pay and you can’t work out a plan, you have several collections options:
1. Turn the account over to a collection agency.
2. Sue in small claims court.
3. Hire a lawyer.
To set the right procedures in plans in place, get help from Your Crafts Business: A Legal Guide, by attorney Richard Stim
(Nolo).
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Copyright 2006 Nolo

Invoicing Customers and Extending Credit


by Attorney Richard Stim
From the Nolo Business & Human Resources Center
If you're new to invoicing -- or even if you've been doing it for a while -- here are a few things to keep in
mind.
If you’re a professional service provider (such as a consultant or accountant) or you sell products to a wholesaler (a
company that places your goods in retail accounts), then you probably invoice your customers. An invoice is a bill that sets
the terms for payment. When you invoice a customer, your business is extending credit.
Extending Credit to Your Customers
You may not feel like you’re extending credit -- after all, you’re just waiting for payment -- but from a legal perspective,
you’re making an unsecured loan. (An unsecured loan is one which the borrower does not pledge property as collateral for
the loan.) The problem with unsecured loans is that they’re … unsecured. If the business doesn’t have the money, it won’t
do any good to sue, because there will be nothing to recover. If the business goes bankrupt, you’re out of luck.
If you have doubts about a new customer, you can check on their creditworthiness by having them complete a credit
reference form. A good credit reference form requires information about who is in charge of the business, who to contact if
problems develop, how much credit the applicant is seeking, other firms with which the company has done business on
credit, and any other financial information you need to make your decision. If it’s a big account and you’re investing a lot
of resources (time, money, or supplies) in it, it may be worth it to pay for credit research from a company such as Dun &
Bradstreet (www.dnb.com), BusinessCreditUSA (www.businesscreditusa.com), or Equifax (www.equifax.com).
Evaluating Credit Risk
After a potential customer fills out a credit reference form, how do you tell whether the customer is a credit risk? That will
be a personal call based on the size of the business and its credit history. Collections expert Timothy Paulsen suggests
separating patterns from single events. If a customer has one or two minor credit blemishes -- perhaps the result of an
unexpected growth spurt -- that should not necessarily be the basis of denying credit. That is different from evidence that
indicates the client or customer just doesn’t like to pay bills.
The greatest risk in extending credit is when you throw all of your business to one big account. The obvious problem with
that strategy is that you risk losing a lot of money if the big account has financial problems or goes bankrupt. For that
reason, don’t ditch your smaller accounts because of large orders from one customer. Loyal smaller accounts give a
business a constant, reliable source of income.
Preparing Your Invoice
When you prepare an invoice, it's important to provide an accurate, clear statement of the transaction and a request that
the customer contact you if there are any problems. Most invoices require payment within 30, 60, or 90 days. Be sure to
specify when payment is due. With this information clearly noted on the invoice, it may be more difficult for a slow-paying
account to later excuse its delinquent behavior.

Want to Learn More?

To learn about starting and running your own business, see Whoops! I'm in Business: A Crash
Course in Business Basics, by attorneys Richard Stim & Lisa Guerin (Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo

Consumer Protection Laws


From the Nolo Business & Human Resources Center
Business owners should familiarize themselves with consumer protection laws, including rules against
deceptive advertising and pricing.
Remember "caveat emptor" -- let the buyer beware? This was the idea that buyers take responsibility for what they
purchase. That used to be the law of the marketplace. Not anymore -- today, consumers have clout.
State consumer protection statutes are meant to protect consumers from unfair or deceptive practices and often go
beyond the traditional legal remedies available for breach of warranty. Laws like these are on the books in nearly every
state, although the details vary. And they can really help the consumers:
Example: In Florida, a Chevrolet dealer promised a "free four-day, three-night vacation to Acapulco" to anyone who
bought a car or van. Relying on this special promotion, Peter bought a van from the dealer. When the vacation voucher
arrived, Peter found that the so-called free vacation was really a time-share sales promotion. The vacation trip was loaded
down with conditions, restrictions and obligations. Believing he'd been cheated, Peter sued the dealer. The jury awarded
Peter $1,768 in compensatory damages (the value of the trip) plus $667,000 in punitive damages.
Example: In New Jersey, Kenneth ordered some furniture from a store. When it arrived, Kenneth noticed numerous
defects. He rejected the order and demanded a return of his $600 deposit. The furniture store refused, and Kenneth sued.
The jury awarded him three times the amount of his deposit and ordered the furniture store to pay his attorney fees.
Both cases were brought under state consumer protection statutes.
Punitive Damages
Consumer protection laws place a potent weapon in the hands of buyers. In an ordinary lawsuit, a plaintiff can recover only
his or her actual losses. For example, without the benefit of a consumer protection law, the man who sued to get back his
furniture deposit would be entitled to no more than his $600 deposit. But under the statute in his state, he received triple
damages plus attorney fees. Similarly, the man who sued the car dealer about the free vacation won punitive damages
amounting to many times the value of his trip. The potential for large verdicts gives buyers and their lawyers an incentive
to sue if it looks like a law has been violated.
"Big deal," you may say. "I'm an honest and ethical business person. None of this affects me." Well, that may not be so.
For one thing, you need to know the details of your state's consumer protection laws so that you can tell your employees
about practices that could get you in trouble. Furthermore, these state laws often allow a customer to sue even if the
violation was not intentional. If you sell a product manufactured by a U.S.-based company (say, a Schwinn bike) and
mistakenly advertise that the product was made in the U.S. when in fact it was made in Taiwan, you may be liable under
consumer protection laws.
Hundreds of cases have been brought under consumer protection laws, including these:
1. A man sued a department store that ran out of an advertised waffle iron and didn't give him a rain check -- a
violation of the consumer protection law in his state.
2. A homeowner sued a roofing contractor that falsely advertised that it could arrange financing for roof repair jobs.
3. A woman sued a health spa that reneged on its promise to return her deposit and cancel her contract if she
changed her mind within three days.
Health spas, incidentally, have been singled out for special regulation; if you're going to start one, get the Federal Trade
Commission (FTC) pamphlet on this subject.
Most consumer protection laws contain a broad prohibition on "unfair or deceptive practices." In addition, many statutes
list specific practices that are forbidden, such as deceptive advertising and pricing, discussed below.
Deceptive Advertising
Under both federal and state law, an ad is unlawful if it tends to mislead or deceive, even if it doesn't actually fool anyone.
If your ad is deceptive, you'll face legal problems whether you intended to mislead the customer or not. What counts is the
overall impression created by the ad -- not the technical truthfulness of the individual parts.
Over the years, the Federal Trade Commission has taken action against many businesses accused of engaging in false and
deceptive advertising. If FTC investigators are convinced that an ad violates the law, they usually try to bring the violator
into voluntary compliance. If that doesn't work, the FTC can issue a cease-and-desist order and bring a civil lawsuit on
behalf of people who have been harmed. They can seek a court order (injunction) to stop a questionable ad while an
investigation is in progress, and they can require an advertiser to run corrective ads, admitting that an earlier ad was
deceptive.
Consumers often have the right to sue advertisers under state consumer protection laws. For example, someone who buys
a product in reliance on a deceptive ad might sue in small claims court for a refund or join others (sometimes tens of
thousands of others) to sue for a huge sum in another court.
Deceptive Pricing
The two pricing practices most likely to get your business into trouble are: making incorrect price comparisons with other
merchants or with your own "regular" prices, or offering something that is supposedly "free" but in fact has a cost.

Price Reductions
Offering a reduction from your usual selling price is a common sales technique. But the price is misleading unless the
former price is the actual, bona fide price at which you offered the article. For example, if you announce a new product for
$129, but sell it to wholesalers as if it were a $79 product, and similarly discount it to direct customers, the $129 price
never really existed -- and you have broken the law. It misleads customers into thinking they are receiving a discount.
It's even more blatant to buy a special batch of merchandise especially for a sale and create a fictional "regular" price or
one you adhered to for only a day or two. Some merchants are tempted to do this when they buy seconds or discontinued
product lines at a deep discount and want to pretend customers are getting a bargain.
If your ad compares your price with what other merchants are charging for the same product, be sure of two things:
1. the other merchants are selling the identical product, and

2. the other merchants had enough sales at the higher price in your area so that you're offering a legitimate
bargain.
In other words, make sure that the higher comparison price isn't an isolated or unrepresentative price.

Less-Than Free Offers


Regarding offers of "free" products or services, you can offer gifts only if there are no strings attached. For example, if you
offer a free paintbrush to anyone who buys a can of paint for $14.95, the brush really isn't free if you:
1. usually charge less than $14.95 for this kind of paint.

2. usually provide a service (such as free delivery) with a paint purchase, but don't when the customer gets a "free"
brush.

More Information About Consumer Protection Laws

You can find out more about consumer protection laws by contacting the Federal Trade Commission
(www.ftc.gov), 600 Pennsylvania Avenue NW, Washington, DC 20850, 877-FTC-HELP (382-4357),
and by contacting your state's consumer protection agency.

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Copyright 2006 Nolo

Buying vs. Leasing Business Equipment


From the Nolo Business & Human Resources Center
Knowing the pros and cons of buying and leasing business equipment will help you decide which option works
best for you.
Leasing equipment can be a better option for business owners who have limited capital or who need equipment that must
be upgraded every few years, while purchasing equipment can be a better option for established businesses or for
equipment that has a long usable life. Each business owner’s situation is unique, however, and the decision to buy or lease
business equipment must be made on a case-by-case basis. Here's a look at both options.
Leasing Equipment
Leasing business equipment and tools preserves capital and provides flexibility but may cost you more in the long run.

Advantages of Leasing Equipment


The primary advantage of leasing business equipment is that it allows you to acquire assets with minimal initial
expenditures. Because equipment leases rarely require a down payment, you can obtain the goods you need without
significantly affecting your cash flow.
Another financial benefit of leasing equipment is that your lease payments can usually be deducted as business expenses
on your tax return, reducing the net cost of your lease. In addition, leases are usually easier to obtain and have more
flexible terms than loans for buying equipment. This can be a significant advantage if you have bad credit or need to
negotiate a longer payment plan to lower your costs.
Leasing also allows businesses to address the problem of obsolescence. If you use your lease to attain items that are
subject to becoming technologically outdated in a short period of time, such as computers or other high-tech equipment, a
lease passes the burden of obsolescence onto the lessor, as you are free to lease new, higher-end equipment after your
lease expires.

Disadvantages of Leasing Equipment


Leasing business equipment has two main disadvantages: overall cost and lack of ownership. With regard to cost, leasing
an item is almost always more expensive than purchasing it. For example, a 3-year lease on a computer worth $4,000, at
a standard rate of $40/month per $1,000, will cost you a total of $5,760. If you had bought it outright, you would have
paid only $4,000. In addition to the higher cost, you will have built up no equity in the computer. Unless the computer has
become obsolete by the end of the lease, this lack of ownership is a significant disadvantage.
Another downside to leasing is that you are obligated to make payments for the entire lease period even if you stop using
the equipment. Some leases give you the option to cancel the lease if your business changes directions and the equipment
you leased is no longer necessary, but large early termination fees always apply.
Buying Equipment
Ownership and tax breaks make buying business equipment appealing, but high initial costs mean this option isn’t for
everyone.

Advantages of Buying Equipment


The most obvious advantage of buying business equipment is that, after you purchase the equipment, you gain ownership
of it. This is especially true when the property has a long useful life and is not likely to become technologically outdated in
the near future, such as office furniture or farm machinery.
Tax incentives are another good reason to consider purchasing business equipment. Section 179 of the Internal Revenue
Code allows you to fully deduct the cost of some newly purchased assets in the first year. In 2006, you can deduct up to
$108,000 of equipment (subject to a phase-out if you placed more than $430,000 of equipment in service in any one
year). For example, if you are in the 25% tax bracket and you purchase $100,000 in business equipment this year, the net
cost to you is only $75,000.
Although not all equipment purchases are eligible for Section 179 treatment, you can still receive tax savings for almost
any business equipment through depreciation deductions. (Some assets that don't qualify for the Section 179 deduction
are real estate, inventory bought for resale, and property bought from a close relative.)

Disadvantages of Buying Equipment


For some people, purchasing business equipment may not be an option, because the initial cash outlay is too high. Even if
you plan on borrowing the money and making monthly payments, most banks require a down payment of around 20%.
Borrowing money may also tie up lines of credit, and lenders may place restrictions on your future financial operations to
ensure that you are able to repay your loan.
Although ownership is perhaps the biggest advantage to buying business equipment, it can also be a disadvantage. If you
purchase high-tech equipment, you run the risk that the equipment may become technologically obsolete, and you may be
forced to reinvest in new equipment long before you had planned to. Certain business equipment has very little resale
value. A computer system that costs $5,000 today, for instance, may be worth only $1,000 or less three years from now.
Should You Buy or Lease?
When deciding whether to buy or lease a particular piece of business equipment, you should try to figure out the
approximate net cost of that asset. Be sure to factor in tax breaks and resale value when making this calculation. After
determining which option is more cost-effective, consider other intangibles such as the possibility that the product will
become obsolete (if you are considering purchasing) or that your need for the product will expire before the lease does (if
you are considering leasing).
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Copyright 2006 Nolo

Consumer Credit Laws


From the Nolo Business & Human Resources Center
If your business extends credit to its customers, you'll need to comply with federal consumer credit laws.
If your business grants credit to customers (allows customers to pay at a later date), you must comply with laws affecting
credit sales to consumers.
1. The Truth in Lending Act
This federal law helps customers know what they're getting into. It requires you to disclose your exact credit terms to
credit applicants and regulates how you advertise consumer credit. Among the items you must disclose to a consumer who
buys on credit are the following:
1. the monthly finance charge
2. the annual interest rate
3. when payments are due
4. the total sale price (the cash price of the item or service, plus all other charges), and

5. the amount of any late payment charges and when they'll be imposed.

2. The Fair Credit Billing Act


This federal law tells you what to do if a customer claims you made a mistake in your billing. The customer must notify you
within 60 days after you mailed the first bill containing the claimed error. You must respond within 30 days unless the
dispute has already been resolved. You must also conduct a reasonable investigation and, within 90 days of getting the
customer's letter, explain why your bill is correct or else correct the error.
If you don't follow this procedure, you must give the customer a $50 credit toward the disputed amount -- even if your bill
was correct. Until the dispute is resolved, you can't report to a credit bureau that the customer is delinquent.

Example:

Ron notifies CompuCo that he wasn't properly credited for a payment he sent in on his computer
purchase. Under the Fair Credit Billing Act, CompuCo must acknowledge Ron's notice within 30 days.
And within 90 days, CompuCo must either agree with Ron and correct his account or, after
conducting a reasonable investigation, send Ron a letter explaining why the company feels his bill
was correct. While this is happening, Ron doesn't have to pay the disputed amount. And he can't be
penalized for withholding payment. During this period, CompuCo can't tell a credit reporting agency
that this is a delinquent bill. CompuCo can charge interest on the disputed amount, but if Ron turns
out to be right, the interest must be dropped.

State laws may also deal with billing disputes. Generally, if a state law on this subject conflicts with the federal statute, the
federal statute will control -- but there's one exception: a state law will prevail if it gives a consumer more time to notify a
creditor about a billing error. For example, as explained above, the federal law gives a consumer 60 days after receiving a
bill to notify you of a billing error. If a state law gives a consumer 90 days to notify you, the consumer will be entitled to
the extra 30 days.
In addition to telling you how to handle billing disputes, the Fair Credit Billing Act requires you, in periodic mailings, to tell
consumers what their rights are.
3. The Equal Credit Opportunity Act
You may not discriminate against a credit applicant on the basis of race, color, religion, national origin, age, sex or marital
status. The Act does leave you free to consider legitimate factors in granting credit, such as the applicant's financial status
(earnings and savings) and credit record. Despite the prohibition on age discrimination, you can reject a consumer who
hasn't reached the legal age for entering into contracts.
4. The Fair Credit Reporting Act
This federal law deals primarily with credit reports issued by credit reporting agencies. It's intended to protect consumers
from having their eligibility for credit thwarted by incomplete or misleading credit report information. The law gives
consumers the right to a copy of their credit reports. If they see an inaccurate item, they can ask that it be corrected or
removed. If the business reporting the credit problem doesn't agree to a change or deletion or if the credit bureau refuses
to make it, the consumer can add a 100-word statement to the file explaining his or her side of the story. This becomes a
part of any future credit report.
5. The Fair Debt Collection Practices Act
This federal law addresses abusive methods used by third-party collectors -- bill collectors you hire to collect overdue bills.
Small businesses are more directly affected by state laws that apply directly to collection methods used by a creditor.
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Copyright 2006 Nolo

Keeping Your Contracts Simple -- and Enforceable


From the Nolo Business & Human Resources Center
For most contracts, legalese is not essential or even helpful. On the contrary, contractual agreements are best
expressed in simple, everyday English.
Although lots of contracts are filled with mind-bending legal gibberish, there's no reason why this has to be true. For most
contracts, legalese is not essential or even helpful. On the contrary, the agreements you'll want to put into a written
contract are best expressed in simple, everyday English.
All that is necessary for most contracts to be legally valid are the following two elements:
1. All parties are in agreement (after an offer has been made by one party and accepted by the other).
2. Something of value has been exchanged, such as cash, services, or goods (or a promise to exchange such an
item) for something else of value.
In a few situations, a contract must also be in writing to be valid. State laws often require written contracts for real estate
transactions or agreements that will last more than one year. You'll need to check your state's laws to determine exactly
which contracts must legally be in writing. Of course, it is wise to write out most business agreements, even if not legally
required, because oral contracts can be difficult or impossible to prove.
Let's look a bit more closely at the two elements necessary for a valid contract: agreement between the parties and
exchange of things of value.
1. Agreement Between Parties (a.k.a. Offer and Acceptance)
Although it may seem like stating the obvious, an essential element of a valid contract is that all parties really do agree on
all major issues. In real life, there are plenty of situations that blur the line between a full agreement and a preliminary
discussion about the possibility of making an agreement. To help clarify these borderline cases, the law has developed
some rules defining when an agreement legally exists.
The most basic rule of contract law is that a legal contract exists when one party makes an offer and the other party
accepts it. For most types of contracts, this can be done either orally or in writing.
Let's say, for instance, you're shopping around for a print shop to produce brochures for your business. One printer says
(or faxes) that he'll print 5,000 two-color flyers for $200. This constitutes his offer. If you tell him to go ahead with the
job, you've accepted his offer. In the eyes of the law, when you tell the printer to go ahead, you create a contract, which
means you're liable for your side of the bargain (in this case, the payment of $200). But if you tell the printer you're not
sure and want to continue shopping around (or don't even respond, for that matter), you clearly haven't accepted the
offer, and no agreement has been reached. Or if you say the offer sounds great, except that you want the printer to use
three colors instead of two, no contract has been made, since you have not accepted all of the important terms of the
offer. You have actually changed one term of the offer. (Depending on your wording, you have probably made a
counteroffer, which is discussed below.)
In day-to-day business, the seemingly simple steps of offer and acceptance can become quite convoluted. For instance,
sometimes when you make an offer it isn't quickly and unequivocally accepted; the other party may want to think about it
for a while or try to get a better deal. And before the other party accepts your offer, you might change your mind and want
to withdraw or amend your offer. Delaying acceptance of an offer and revoking an offer, as well as making a counteroffer,
are common situations in business transactions that often lead to confusion and conflict. To minimize the potential for a
dispute, here are some general rules you should understand and follow.

How Long an Offer Stays Open


Unless an offer includes a stated expiration date, it remains open for a "reasonable" time. What's reasonable, of course, is
open to interpretation and will vary depending on the type of business and the particular fact situation.
To leave no room for doubt as to when the other party must make a decision, the best way to make an offer is to include
an expiration date.
If you want to accept someone else's offer, the best approach is to do it as soon as possible, while there's no doubt that
the offer is still open. Keep in mind that until you accept, the person or company who made the offer -- called the offeror
-- may revoke the offer.

Revoking an Offer
Whoever makes an offer can revoke it as long as it hasn't yet been accepted. This means if you make an offer and the
other party wants some time to think it through, or makes a counteroffer with changed terms, you can revoke your original
offer. Once the other party accepts, however, you'll have a binding agreement. Revocation must happen before
acceptance.
An exception to this rule occurs if the parties agree that the offer will remain open for a stated period of time.

Offers With Expiration Dates


An offer with an expiration date is called an option, and it usually doesn't come for free. Say someone offers to sell you a
forklift for $10,000, and you want to think the offer over without worrying that the seller will withdraw the offer or sell to
someone else. You and the seller could agree that the offer will stay open for a certain period of time, say thirty days.
Often, however, the seller will ask you to pay for this 30-day option -- which is understandable, since during the 30-day
option period the seller can't sell to anyone else.
Payment or no payment, when an option agreement exists, the offeror cannot revoke the offer until the time period ends.

Counteroffers
Often, when an offer is made, the response will be to start bargaining. Of course, haggling over price is the most common
type of negotiating that occurs in business situations. When one party responds to an offer by proposing something
different, this proposal is called a "counteroffer." When a counteroffer is made, the legal responsibility to accept, decline or
make another counteroffer shifts to the original offeror.
For instance, suppose your printer (here, the original offeror) offers to print 5,000 brochures for $300, and you respond by
saying you'll pay $250 for the job. You have not accepted his offer (no contract has been formed) but instead have made a
counteroffer. If your printer then agrees to do the job exactly as you have specified, for $250, he's accepted your
counteroffer, and a legal agreement has been reached.
While it's true that a contract is formed only if the accepting party agrees to all substantial terms of an offer, this doesn't
mean you can rely on inconsequential differences to void a contract later. For example, if you offer to buy 100 chicken
sandwiches on one-inch-thick sourdough bread, there is no contract if the other party replies she will provide 100 emu
filets on rye bread. But if she agrees to provide the chicken sandwiches on one-inch-thick sourdough bread, a valid
contract exists, and you can't later refuse to pay if the bread turns out to be a hair thicker or thinner than one inch.
2. Exchange of Things of Value
In addition to both parties' agreement to the terms, a contract isn't valid unless both parties exchange something of value,
in anticipation of the completion of the contract. The "thing of value" being exchanged -- which every law student who ever
lived has been taught to call "consideration" -- is most often a promise to do something in the future, such as a promise to
perform a certain job or a promise to pay a fee for a job. For instance, let's return to the example of the print job. Once
you and the printer agree on terms, there is an exchange of things of value (consideration): the printer has promised to
print the 5,000 brochures and you have promised to pay $250 for them.
The main importance of requiring things of value to be exchanged is to differentiate a contract from a generous statement
or a one-sided promise, neither of which are enforceable by law. If a friend offers you a gift without asking anything in
return -- for instance, such as offering to stop by and help you move a pile of rocks -- the arrangement wouldn't count as
a contract because you didn't give or promise your friend anything of value. If your friend never followed through with her
gift, you would not be able to enforce her promise. However, if you promise your friend you'll help her weed her vegetable
garden on Sunday, in exchange for her helping you move rocks on Saturday, a contract exists.
Although the exchange-of-value requirement is met in most business transactions by an exchange of promises ("I'll
promise to pay money if you promise to paint my building next month"), actually doing the work can also satisfy the rule.
If, for instance, you leave your printer a voice-mail message that you'll pay an extra $100 if your brochures are cut and
stapled when you pick them up, the printer can create a binding contract by actually doing the cutting and stapling. And
once he does so, you can't weasel out of the deal by claiming you changed your mind.
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Taking a Business Customer to Small Claims Court


From the Nolo Business & Human Resources Center
Businesspeople can resolve their disputes in small claims court cheaply and without a lawyer.
The very people that business owners rely upon -- their subcontractors, suppliers, and customers -- can also be the source
of all kinds of disputes. Subcontractors may leave work unfinished, suppliers may deliver subpar goods, and customers
may not pay their bills. Fortunately, recent increases in small claims court dollar limits make small claims court an
increasingly attractive arena in which to resolve such disputes quickly and cheaply.
Business owners typically can use small claims court in two main ways: to collect overdue bills or to resolve disputes with
customers or other businesses.
Collecting Bills in Small Claims Court
Small claims court is particularly cost-effective for collecting unpaid bills because it eliminates the need for bill collectors
and lawyers -- who often keep, as their fee, up to half of what they collect. Indeed, small claims court works so well that in
many courts over 60% of the cases are filed by businesses. Because a substantial percentage of these claims are
uncontested by the defendant (they know they owe the money and don't show up), little preparation or court time is
needed. And best of all, many defendants who don't want their credit rating damaged pay voluntarily -- sometime between
the time they receive a final demand letter threatening a small claims suit and the date the judgment is entered.
Your must have hard evidence that a debt is owed. If you think the small claims court deck is stacked in favor of allowing
small businesses to collect doubtful debts, think again. When defendants believe they have a good defense and fight back,
they have a decent chance of winning or at least of paying substantially less than the plaintiff claims. For example, in a
study of 996 small claims cases that went to trial, the National Center for State Courts found that 20% of the time, the
defendant won outright. In another 20% of the cases, the defendant was ordered to pay substantially less than the plaintiff
demanded.
Resolving Disputes in Small Claims Court
Disputes between two small businesses or a business and a customer are also common in small claims court. Most involve
a contract. Commonly, a business argues that goods or services were of poor quality, or provided late, or not at all. For
example, suppose Ted, an independent graphic designer, sues Tip Top Excavators because it won't pay him for redesigning
its logo and newsletter. Tip Top's defense is that because the work was both substandard and late, the contract was
broken and no payment is due.
If the parties don't negotiate their own solution or arrive at one through mediation, each would have a chance to present
their side of the story to a small claims court judge. A succinct and well-organized court presentation is always important.
And in a close case, chances are good that the side with the most convincing written evidence will have the edge.
For example, if Ted can produce a written contract (or other documents showing that a contract existed), a decent-looking
sample of the redesigned newsletter, and a letter from someone with expertise in the field stating that the work met
industry standards, he will be in an excellent position. Ted would also be wise to prepare to rebut the likely points the
opposing business will make. For example, if the design work was a few weeks late, Ted would want to present a good
excuse, such as the fact that Tip Top asked for time-consuming changes.
When Ted's presentation is complete, it will be up to Tip Top to back up its version of the story. It will want to present
evidence that either the work was delivered so late that it amounted to a serious breach of the contract or that Ted failed
to meet other important contractual specifications (designed a 4-color, 24-page newsletter template when the contract
called for a 2-color, 12-page job). Again, the more hard evidence Tip Top has (such as a letter to Ted pointing out the
project was over deadline and asking for immediate completion), the better Tip Top's chances.
After both parties have their say, it will be up to the judge to decide. And again, there is good news. Instead of waiting
around for months, as can happen in regular court, the judge will either announce a decision on the spot or mail it out in a
few days. Either way, both sides will know where they stand and be able to get back to business.
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Deciding Whether to Pursue Payment by a Bankrupt Customer


by Attorney Stephen R. Elias
From the Nolo Business & Human Resources Center
Learn how to assess each bankrupt customer's case, balancing the time you're likely to spend against your
odds of collecting the money.
As a business owner, you've had to learn when to let go of a bad deal. Dealing with customers who don't pay is a classic
example. Sometimes it's not worth your time trying to get a customer to pay up; but sometimes it is. You have to decide:
Will your valuable time be wasted going after them -- especially after they've filed for bankruptcy? In some cases, the
answer might surprise you.
An awful lot of money gets left on the table during bankruptcy because creditors neglect to pursue their claims against a
customer who's gone bankrupt. Some customers who file for bankruptcy are actually hiding assets; others come into
money while their case winds its way through the court system. In addition, the bankruptcy system protects creditors
better than you might have thought it would, and the likelihood of getting your money is probably better than you think.
Of course, you'll still need to balance the amount that you're owed against the time you'd spend to potentially retrieve it.
Read on to help you estimate your probable time expenditure and chances of success.

What Is Bankruptcy?

Here's a quick review of what bankruptcy means for the debtor and for you. Individual and business
debtors file for bankruptcy because their debts have become overwhelming, and the debtors want
the court to relieve them of their obligation for some of the debts and to help them arrange (delay)
the orderly repayment of the others. The three types of bankruptcy you're most likely to encounter
include:

1. Chapter 7 bankruptcy. The most common bankruptcy, Chapter 7 is available to both


individuals and businesses. The court and a trustee assess everything the debtor owns, tell the
debtor what items of property he or she can keep, allow secured creditors to recover property that
the debtor had pledged to them as collateral, and sell the rest to pay the claims of unsecured
creditors.

2. Chapter 13 bankruptcy. Consumer debtors whose income is regular and who owe less
than $307,675 in unsecured debts and less than $922,975 in secured debts can make use of Chapter
13 bankruptcy. The court and a trustee allow the debtor to keep his or her property so long as the
debtor pays all or part of creditors' claims according to a plan and repayment schedule.

3. Chapter 11 bankruptcy. Chapter 11 is like Chapter 13, but is mainly for corporations. The
debtor acts as his or her own trustee and gets creditors to vote in favor of a reorganization plan, then
continues to run the business while paying a portion or all of creditors' claims according to the plan.
As soon as a debtor files for bankruptcy, something called the "automatic stay" kicks in, which stops
you and all other creditors from attempting to collect your debts. That means your only choice (with
rare exceptions) is either to learn about and participate in the bankruptcy, or to cut your losses.

How Much Time You'll Spend Pursuing a Bankrupt Customer


Below is a summary of the tasks that will be required of you in trying to retrieve money from a bankrupt debtor, and a
rough estimate of how long they'll take.

First, stop all collection activities. Whether or not you get involved with the bankruptcy case, as soon as you find
out that a debtor has filed for bankruptcy, you should mark the account as being in bankruptcy and advise your collection
personnel to stop their activities (in compliance with the "automatic stay"). Then decide whether it's worth going to court
to request lifting of the automatic stay (sometimes appropriate if you're a secured creditor who wants to foreclose on your
collateral).
Examine the debtor’s bankruptcy papers. If you spend an hour or two looking over the paperwork that the debtor filed
with the court, you'll gain information that will help you decide whether to proceed, and investigate whether there's more
money to be had than the creditor is confessing to. The papers will tell you what property the debtor claims to own, which
items the debtor thinks are safe from being sold in bankruptcy, and the identity of other creditors (both secured creditors,
who were given collateral, and unsecured creditors). With a little detective work, you may be the one to uncover mistakes
or omissions. For example, you may know about property that the debtor didn't mention. Or, you may figure out that
certain property must exist; for example, if the debtor lists a debt to a tire company but fails to mention owning a car, the
debtor may be concealing ownership of an automobile.
Attend a meeting of creditors. All debtors must submit to a public examination by their creditors. It's a great
opportunity for you to question the debtor about details relevant to your claim, such as what the debtor plans to do with
your collateral (if any), or your suspicions that the debtor hid assets, underreported income, or overreported expenses.
You'll probably wait 30 minutes to attend a meeting that lasts only a few minutes -- especially because so few creditors
ordinarily show up.
File a proof of claim. The proof of claim is a one-page form that essentially says "I want in on the bankruptcy
proceedings." You'll need to attach any documents proving your claim, such as contracts, notes, mortgages, and security
agreements. If you don't file a proof of claim with the court, you normally lose your opportunity to have a voice in the
proceedings and to be paid your debt from the bankruptcy proceeds. (Even if you're a secured creditor, you can't
necessarily count on collecting on your claim through your lien unless you file a proof of claim form.) The proof of claim
should take you about fifteen minutes to fill out, assemble, and mail to the court. If the debtor objects to any portion of
your claim, you’ll need to attend a court hearing, unless you and the debtor reach an agreement resolving the debtor’s
objection.
Attend a hearing regarding the debtor’s reorganization/repayment plan (Chapters 11 and 13 only). If the
debtor filed for a Chapter 11 reorganization, you may choose to propose a reorganization (and repayment) plan and will be
given an opportunity to vote on which proposed plan gets adopted. Voting is handled by mail. Consideration of any plan
you submit is done at a hearing.
If the debtor filed for a Chapter 13 reorganization, you’ll want to attend the hearing at which the court decides whether the
debtor's proposed repayment plan should be confirmed. Sometimes these confirmation hearings are held at the same time
as the meeting of creditors. At the hearing, you can object to defects in the debtor's plan.
Follow through to the extent necessary. With any luck, your participation in the previous steps will be enough, and the
bankruptcy trustee will see to administering a repayment plan (in a Chapter 11 or 13 case) or handling the sale of the
debtor's available property and repaying the creditors (in a Chapter 7 case). If, however, disputes or other unusual
circumstances arise, more court proceedings may be required. You would want to reassess the amount of money at stake
and decide whether it's worth hiring an attorney to continue.
Your Chances of Success
Is it realistic to hope that any money can be wrung from this debtor? You may be in a better position to answer that than
anyone. Based on your past knowledge of the debtor or on your alert perusal of the debtor's bankruptcy paperwork, you
may have formed an opinion about the debtor's financial prospects and level of honesty. Is the debtor the type likely to
have an overseas bank account and a hidden boat, or is the debtor someone who's truly down on his or her luck with
nothing left?
If you don't have a good sense of the debtor, consider the following:

1. Your active participation in developing a reorganization plan (in a Chapter 11 or 13 case) may lead to a better
deal for you and other creditors.
2. In most cases, the bankruptcy trustee will be looking for hidden assets and income, and if you've maintained
your role in the case, you will be among those who ultimately benefit.
3. Reorganization cases take many months to complete, during which time the debtor may get a pay raise, collect
an inheritance, or win a lawsuit, all of which will increase the amount of money available to you and other creditors.
If you decide to stake your claim against a bankrupt debtor, you'll want to obtain a copy of Nolo's Getting Paid: How to
Collect From Bankrupt Debtors, by Stephen Elias.
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Copyright 2006 Nolo

Ten Tips for Minimizing Losses Due to Customers' Bankruptcies


by Attorney Stephen R. Elias
From the Nolo Business & Human Resources Center
If you own or run a business, bankruptcies by customers who owe you money can be devastating.

1. Diversify Your Customer Base. You know the old saying: Don’t put all your eggs in one basket. If you’re
supplying goods and services to larger businesses, this can be all too easy to forget. By diversifying your
customer base, you can help ensure that you won’t be forced to file for bankruptcy because one of your
customers does.

2. Get Credit Applications from New Customers. Lending money or extending credit to customers without
checking their creditworthiness is asking for trouble, as you run the risk of not getting paid if the customer files
for bankruptcy. You can protect yourself from the risk of nonpayment and preserve your ability to challenge
fraudulently incurred charges by having a customer give you a detailed, written, and signed credit application.
For a sample credit application form, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold
(Nolo).

3. Verify the Customer’s Credit History. After the customer has completed the credit application, verify the
information -- or find out the truth -- by obtaining a credit report from one of the three major credit-reporting
agencies. You'll need to subscribe to one of their services. The big three are:
• Equifax, at 888-202-4025 or www.equifax.com
• Experian, at 888-217-6064 or www.experian.com
• TransUnion, at 312-466-7363 or www.transunion.com.
If your customer is a business, credit reports can be obtained from Dun & Bradstreet (888-814-1435). By reviewing the
credit reports you receive, you'll be better able to predict how likely the customer is to default on a loan. If the customer
ultimately does go bankrupt, you'll be better protected by showing you reasonably relied on a positive credit report.

4. Require a Cosigner or Guarantor. You need not rely on just one person to pay a debt. If the credit application
is from an individual, you can ask that someone else cosign for the debt. If the credit application is from a
business, see if one of the principals will guarantee the debt. By requiring a cosigner or guarantor, you will be
more likely to receive the money you are owed if the person you provided credit to files for bankruptcy.

5. Obtain Collateral. You can look to the debtor’s property for payment, by asking the customer to give you a
security interest. A security interest allows you to sell the property that is collateral for the loan in order to collect
your claim if the debtor doesn’t fully repay you. Although the customer's bankruptcy will hamper your ability to
sell the collateral, you'll be in a much better position than the "unsecured" creditors (who have no collateral).

6. Cash All Checks Promptly. Don’t let checks sit around your office. You may think you’ve been paid as soon as
the check arrives, but the law says the money isn’t yours until the debtor’s bank honors the check. If the debtor
is sliding toward bankruptcy -- a fact you may not know until it’s too late -- you’re better off getting that check
through the system as soon as possible.

7. Ask Customers to Pay by Cashier’s Check or Money Order. If you’ve got reason to worry about a particular
customer's financial situation, don't accept a personal check. Cashier's checks and money orders are legally
considered equal to cash, so the transfer occurs as soon as they're given to you.

8. Periodically Review Long-Term Customers' Creditworthiness. A customer who three years ago passed
your credit application with flying colors may be in very different straits today. Depending on how well you know
your customers, ask for updated credit information before extending new credit.
9. Look for Telltale Signs by Business Customers. A business customer who is at risk of filing for bankruptcy
may exhibit warning signs, which you can catch if your radar is up. Start asking questions if you notice your
customer’s:
• pattern of late payments
• selling off of assets
• changes in company personnel
• changes in payment practices
• changes in buying patterns, or

• doing business in an industry or region that’s undergoing economic decline.

10. Know When to Sue. If a customer has a delinquent account, don’t let a mere threat of bankruptcy stop you
from suing. The worst that’s going to happen is that the customer will file for bankruptcy before you receive a
judgment, in which case the automatic stay will simply stop matters in their tracks. The best that could happen is
that you’ll get a judgment and get paid by enforcing it against the debtor’s income or property. The upside clearly
outweighs the downside.
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Copyright 2006 Nolo

Collecting Business Debts


by Attorney Richard Stim
From the Nolo Business & Human Resources Center
Learn how to minimize late payments and communicate with clients who might be headed for collections.
Sometimes, the biggest challenge for a small business owner comes when it's time to get paid. Fortunately, with a little
preparation, you can minimize late payments and develop the business radar that lets you know when an account is
headed for collections. By communicating effectively and working with financially troubled clients as they make their way
through a rough patch, you may end up with devoted customers for life.
Late-paying customers usually fall into three categories:
1. Customers who want to pay but, because of real financial problems, can’t do it on time.
2. Customers who prefer to delay or juggle payments.
3. Customers who will do whatever possible to avoid any payment.
For the first two categories, there is hope. You may be able to manage these debts and convince the debtors to make
partial or full payment. As for the last category, you need to recognize this type as quickly as possible and take serious
action -- perhaps turning the account over to a collections agency, discussed below.
Whatever collections efforts you make, one rule always applies: Get busy as soon as possible and stay on the account until
you’re paid. Send bills promptly and re-bill monthly. There's no need to wait for the end of the month. Send past due
notices promptly once an account is overdue. Here are some more tips:

1. Don’t harass. Don't harass people who owe you money, but let them know that you follow these matters
closely. Don’t leave more than one phone message per day for a debtor, and never leave messages that threaten the
debtor or contain statements that put the debtor in a bad light.

2. Be direct, listen, and don’t get personal. Keep your calls short and be specific. Your goal, according to
collections expert Carol Frischer, should be to prevent the debtor from taking the call personally -- that is, from associating
the failure to pay as meaning a failure in life. Always stay calm but always maintain a sense of urgency about getting paid.

1. Get creative. If the customer has genuine financial problems, ask what amount they can realistically afford to
pay. Consider extending the time for payment if the customer agrees in writing to a new payment schedule. Call the day
before the next scheduled payment is due to be sure the customer plans to respect the agreement.

2. Write demand letters. Along with phone calls, send a series of letters that escalate in intensity. Save copies of
all correspondence with the customer and keep notes of all telephone conversations. You may need these if you hand the
matter over to a collections agency or take the customer to court.
3. Use a collections agency to send letters. You can pay a collection agency a fixed fee to write a series of
letters on your behalf. This is different than turning over the debt to an agency. For example, Dun & Bradstreet Small
Business Solutions (http://smallbusiness.dnb.com) will write a series of three letters for under $30. They will also make
telephone collection calls on your behalf. Other companies such as Transworld Systems (www.transworldsystems.com) and
I.C. System (www.icsystem.com) offer similar services.

4. Offer a one-time deep discount. If an account is fairly large and remains unpaid for an extended period (say
six months) and you're doubtful about ever collecting on the debt, consider offering in writing a time-limited, deep
discount to resolve the matter. You can finalize this with a mutual release and settlement, a legal document that
terminates the debt.

5. Learn from the pros. Debt collectors can offer helpful tips. You can learn some by reading either Collections
Made Easy, by Carol Frischer (Career Press), or Paid in Full, by Timothy R. Paulsen (Ragnar), both of which are friendly,
succinct, and helpful.

6. Turn the account over to a collection agency. Turning a debt over to collections is your last resort. A
collection agency will usually pay you 50% of what it recovers. Of course, in some cases, half is better than nothing. Dun
and Bradstreet Small Business Solutions, and the similar business services Transworld Systems and I.C. System, all offer
debt collection services. The Commercial Collection Agency Association (www.ccascollect.com) provides more information
on debt collection agencies.
For more information on collecting debts for your small business, see Whoops! I'm in Business: A Crash Course in Business
Basics, by attorneys Richard Stim & Lisa Guerin (Nolo).
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Copyright 2006 Nolo

Listings: Advertising That Works


From the Nolo Business & Human Resources Center
Inexpensive listings such as the Yellow Pages or local business directories are cost-effective -- and they get
results.
The types of "ads" that often work for small businesses without huge advertising budgets include the Yellow Pages,
business directory listings, and "notification" type ads placed in all sorts of appropriate locations, from free "penny saver"
newspapers to the program of the local symphony.
For most businesses, listings are essential -- particularly for businesses that people use primarily in an emergency -- for
example, a drain cleaning service, a plumber, or a locksmith. Listings in the Yellow Pages and, where appropriate, the
Silver Pages for seniors, and various ethnic Yellow Pages for ethnic customers are invaluable.
In a few instances, the concepts of listing and advertising have all but merged. For example, in many areas of the country,
Wednesday is traditionally the day grocery stores put items on sale. Thrifty shoppers therefore check the full-page lists
(ads) of items for the best bargains.
Similarly, in the computer software business, a great deal of software is sold at discount prices by companies that regularly
advertise their wares in computer magazines. The ads feature, in very small print, long lists of available software.
Sophisticated customers know to check these listings first whenever they need software, because the prices offered are
usually lower than retail stores.
The chamber of commerce, employment and rental agencies, professional newsletters, magazines and journals, and
special interest books, such as those geared to the writer or photographer, are commonly accepted places to list goods or
services. And in some instances, newspapers have developed such strong special interest sections that it also makes sense
to list one's services there. For example, a travel agency specializing in charter flights to Asia might place a list of prices in
the Sunday travel section. Similarly, small community newspapers exist primarily thanks to local advertising, which usually
consists of listings of goods and services. Many merchants find that this type of listing produces good results for a small
investment.
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Copyright 2006 Nolo
Marketing Without Spam
From the Nolo Business & Human Resources Center
Email marketing can be an effective marketing tool or an incredible annoyance. Here's how to do it right.
Spam is any message that you send electronically to lots of people who have not specifically requested mail from you -- in
other words, junk email. Like a telemarketing call during dinner, spam almost always annoys, and sometimes offends,
those who receive it. While sending spam may result in a sale or two in the short run, it will almost surely damage your
reputation, so it's good advice to stay clear of it. There are many better ways to use email to keep in touch with current
and potential customers. Here are a few of them:
1. Invite people to subscribe to an email newsletter instead of sending unsolicited emails. Have a sign-up form on
your website and explain that you'll send only timely, informative email to subscribers.
2. Include late-breaking, useful information in the email you send to subscribers. Because it can be delivered so
quickly, email is a perfect vehicle for alerting people who are already part of your community to new and interesting
developments. Even a modestly self-serving message will go over well if you package it with enough truly unique and
valuable content.
3. Make it easy to quit receiving email. Every message should include brief, friendly instructions for getting off your
mailing list. Even people who keep subscribing will appreciate knowing that you've made it easy for them to say, "Enough
already!" when the time comes.
Here are a couple of good email newsletter examples. Both are basically promotional, but their content is so interesting
that each has collected tens of thousands of volunteer subscribers. And of course, that's what we all want to do! To see
these emails, go to the authors' websites and subscribe.

1. Web Marketing Today (http://www.wilsonWeb.com) is a free weekly email from Ralph Wilson, who sells design
and marketing services to people who own and operate websites. This newsletter combines Ralph's gentle self-promotion
with useful information about developing and promoting websites. And the newsletter always includes links to free, in-
depth articles posted at Ralph's site.

2. Web Reference Update (http://webreference.com/new) is a free email newsletter from Andy King who offers
technical services to website developers. It offers short, newsletter-style articles and each one is hyperlinked to more
detailed information posted at websites including Andy's and others. You could spend 20 seconds or 20 minutes reading
Andy's emails, depending on how much of the linked information you want to explore.
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Copyright 2006 Nolo

Ten Ways to Help Your Customers Find You


From the Nolo Business & Human Resources Center
Being able to attract customers means the difference between success and failure.
There is no better, more cost-effective form of marketing than word-of-mouth. If new business comes by referral, then you
already have a marketing team in action: your customers. If you aren’t getting new customers, you may need a marketing
fix.
There are no one-size-fits-all rules when it comes to marketing. You may be able to handle all of your marketing with a
series of beautifully designed postcards or with a well-designed booth at a national trade show. What works for you
depends on your personality and your business. For example, a gregarious, extroverted business owner may be well-suited
for live product demonstrations and similar public events. But an arty, introverted business owner may do a better job of
reaching customers with personalized letters or customized mailings. You'll need to explore the marketing resources
available and choose what feels right for you and your business.
Inexpensive Marketing
Postcards, handouts, and brochures. For centuries, small business owners have relied on a relatively inexpensive
method of conveying marketing information: cards, brochures, and circulars. For example, you can purchase 1,000 color
postcards for your business for approximately $100 to $200; you can get 1,000 two-page color brochures for $400 to
$500. Be sure to put forth a simple message and include your contact Information.
Samples and free offers. Can your business afford to offer something for free? Giving away something you make is
usually an inexpensive marketing gesture that will have customers appreciating the value of your products. Customers
never seem to tire of these special offers and gifts. But if you say that goods or services are "free" or "without charge," be
sure there are no unstated terms or conditions that qualify the offer.
Coupons. Consider using a coupon mailing service to send coupons to homeowners in specific neighborhoods in your area.
Typically, it costs about $300-$400 to reach 10,000 households in a specific zip code. Check
out valpak.com and moneymailer.com or, even better, a local coupon service in your area.
Yellow Pages. Despite the continuing growth of the Internet, a large number of consumers still use the local Yellow
Pages. Over 70% of the respondents in one survey had used the directory to contact a local firm, and half of them had
made a purchase. If you place a Yellow Pages ad, emphasize your specialties and put in as much access information
(address phone number, email address, hours) as you can. Compare what your competitors are doing and track responses,
test new ads, and modify when necessary.
Public relations. How often have you stopped to read a restaurant review posted in a window or a framed article posted
in a waiting room? That’s public relations at work. To get your business in the news, send a press release you draft
yourself to every newspaper in the area. The trick is to give the reporter an angle or hook that makes the story interesting
to readers, such as a grand opening, a contest, or charitable activities your business is sponsoring.
Signs. Don’t forget about "signage." Signs work best if they’re bold, professionally done, consistent with your business,
well-lit, and tell the viewer your message quickly. Signs don’t have to be in fixed locations -- T-shirts, shopping bags, and
bumper stickers are also signs and can do a swell job of advertising your goods to the general public. And don't forget your
car -- you can get a magnetic sign for your car door with your business name and a slogan or some art for about $25
apiece.
Moderately Priced Marketing
Classified ads. Depending on the size and publication, you may spend $20 to $50 for a first insertion of a classified ad.
You’ll get a “frequency discount” if you run it three or four times. In addition, many newspapers now run classified ads in
print and online. As with all your advertising, your message must be succinct and convincing. If possible, log responses to
the advertisement to measure its effectiveness.
Direct mail. If you’re considering direct mail, know that the response statistics are not good. It’s often difficult for a small
business owner to compete with the big-buck marketers who are content with a response rate as low as five per thousand
mailings (0.5%). Where do you get your direct mail address list? Contact one of the many companies that sell or rent them
to small business owners (the largest of which is www.infousa.com).
Trade shows. For many small business owners -- especially those in a business-to-business market -- trade shows are a
key marketing tool. It’s at the trade show that you meet the sales people and retailers. Choose a trade show with good
attendance and get the biggest booth you can afford, in a decent location at the show. If cash is really tight, consider
sharing a booth with a related business. You can find trade show listings for your industry in a trade publication, at
industry websites, or by using the search feature at the Ultimate Trade Show Resource (www.tsnn.com).
Seminars and product demonstrations. This type of presentation may be a class -- for example, cooking lessons at a
kitchen supply store -- or you may want to demonstrate a product or service -- for example, if you offer framing services,
ask a local photography club to let you demonstrate how to best preserve photographs. Seminars and demonstrations can
add vitality to your business and provide value to customers. For more information, see Marketing Without Advertising, by
Michael Phillips and Salli Rasberry (Nolo).
Expensive Marketing
Outdoor advertising. What about large outdoor signs like billboards? Considering current traffic statistics, you can
probably get a decent number of exposures (number of viewers) for outdoor advertising. But the cost is prohibitive for
most small businesses -- between $3,000 and $5,000 per month to rent a billboard. A less expensive way to reach people
with outdoor advertising -- between $500 and $1,500 per month -- is to purchase transit advertising, such as shelter
panels at bus stops or bus posters.
Radio and television. Radio (80%) and television (75%) reach more people than newspapers (70%) on a daily basis.
Repetitious radio and TV ads can build awareness of your business rapidly. But for small business owners, using radio and
TV can pose so many problems that it’s probably not worth pursuing. First, you must target your advertisement so that
you’re reaching the right listeners or viewers. Second, you must allot quite a bit of your ad marketing budget to produce
radio and television advertising. (You may pay $1,000 to $20,000 per minute for video production, depending on the
quality.) Third, more than other forms of advertising discussed in this chapter, radio and TV ads require that you develop a
style or angle -- for example, humorous, real-life, educational -- and that you engage listeners or viewers for 15 to 60
seconds of air time. Finally, the expense and uncertainty of their effectiveness make radio and TV ads an unlikely
marketing tool for many small businesspeople.

Want to Learn More?


For more information on marketing your business, see Whoops! I'm in Business, by attorney Richard
Stim (Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo

Ten Ways to Build and Market Your Business Image


From the Nolo Business & Human Resources Center
Every action your company takes sends a marketing message and builds your brand -- use it to your
advantage.
Building a business image is not something invented by a public relations firm: It’s a reflection of what you do and how
you do it. Marketing means running a first-rate business and letting people know about it. Every action your company
takes sends a marketing message.
When most people think about letting the world know about their business, they imagine a clever ad. But advertising is
one of the most expensive and least effective forms of marketing. After all, why broadcast your message to many
uninterested members of the public, when you can address people who have a demonstrated interest in what you do,
merely by creating a strong referral system?
To begin learning how to market your business effectively, check out this list of tactics.
1. Make it look good. Creating a solid, strong physical impression lends credibility to your business and invites customers
in, whether you have a store front, a brochure, or a website. You’ll want to suit your look to the type of business you have.
An accountant’s office should be well-organized and tastefully decorated with business furniture. A dog groomer might
choose a whimsical design with bright colors and fun murals on the wall.
2. Create a website. A simple website is relatively inexpensive and can work wonders in terms of drawing people to your
business or telling them more about who you are and what you do. Be sure to create a professional look and feel, one that
suits your business, and take care to optimize your site for search engines.
3. Create straightforward, easy-to-understand pricing. You’d be surprised how many businesses use a complicated
pricing structure -- and try to hide their prices from their customers. Streamline your pricing and make it clear, especially
if you run a service business. Exactly how much can your customers expect to pay for which services? A pricing menu is
often a good idea.
4. Encourage personal recommendations. The single best way to get new customers is through personal
recommendations. Why? Because almost nothing is as powerful as an endorsement from a friend or relative (and because
it’s free). Or you can consider rewarding customers for referrals. For example, a hairdresser might give a client who has
referred a friend half off her next cut.
5. Maintain good employee relations. The people who work for you can be strong assets to your marketing strategy.
Employees who love their jobs and believe in your business will not only display/wear/use your merchandise or services,
they will also recommend you to their friends and families. Treat them right, and they could be the foundation of your
personal recommendations web.
6. Use the press. It always helps to get a little PR -- and you don’t need to hire an expensive firm to do it. If you can
come up with a newsworthy angle on your business (for instance, your grand opening, your "story," what you offer that’s
different), you can write a simple press release and send it to local publications.
7. Do a referral exchange. If there's a related business you find yourself referring clients to, or have a business referring
clients to you, set up an exchange. Place brochures or cards at the other business’s office (or store), and display their
marketing materials in your place of business. Examples of successful referral exchanges are those between chiropractors
and massage therapists, dentists and orthodontists, and financial planners and tax preparers.
8. List creatively and widely. Unlike advertising, listing your business is usually low-cost or free, and it’s a great way to
draw people to your business. Make sure to list in the obvious places, such as the Yellow Pages and Chamber of
Commerce, and find some not-so-obvious places to list as well. For example, does your city have a website where parents
make referrals about services for their children? Does a nonprofit organization in your area have a listing of businesses
with good environmental and social practices? Get on as many lists as you can.
9. Maintain a customer database. A customer who used your business once will likely use it again (assuming that the
customer had a good experience). Keeping an existing customer database to mail or email promotions to is much less
expensive than acquiring a new one. Maintain a database with your customers' the contact information, and ask customers
whether they’d like to be on your mailing list to receive special offers. A direct mail campaign is much more successful
when targeted to existing customers who have opted in to the mailing list.
10. Make a marketing plan. Draw up a marketing plan. A formal plan should outline your mission, and include an
analysis of your market and your competitors, your marketing objectives, and marketing ideas: How do you intend to
market your business? Will you use a referral program? A website? Issue press releases? Also, outline your marketing
budget, set specific performance goals, and determine how and when you’ll meet them. Check back regularly to track your
progress.

Want to Learn More?

For more help marketing your business, see Marketing Without Advertising: Inspire Customers to
Rave About Your Business to Create Lasting Success, by Michael Phillips and Salli Rasberry (Nolo).

Click here for related information and products from Nolo


Copyright 2006 Nolo

Seven Rules for Legal Advertising


From the Nolo Business & Human Resources Center
Be sure you comply with laws against deceptive or misleading advertising.
Advertising is regulated by both federal and state law. Under the law, your ad is unlawful if it tends to mislead or deceive.
Your intentions don't matter. If your ad is deceptive, you'll face legal problems even if you have the best intentions in the
world. In addition, if your ad contains a false statement, you have violated the law. The fact that you didn't know the
information was false is irrelevant.
The Federal Trade Commission (FTC) is the main federal agency that takes action against unlawful advertising. State and
local governments also go after businesses that violate advertising laws; usually this is the responsibility of the state
attorney general, the consumer protection agency, and the local district attorney. Consumers and competitors may also be
able to proceed directly against the advertiser.
The Federal Trade Commission
For the most part, the FTC relies on consumers and competitors to report unlawful advertising. If FTC investigators are
convinced that an ad violates the law, they usually try to bring the violator into voluntary compliance through informal
means. If that doesn't work, the FTC can issue a cease-and-desist order and bring a civil lawsuit on behalf of people who
have been harmed. The FTC can also seek a court order (injunction) to stop a questionable ad while an investigation is in
progress. In addition, the FTC can require an advertiser to run corrective ads -- ads that state the correct facts and admit
that an earlier ad was deceptive.
Over the years, the FTC has taken action against many businesses accused of engaging in false and deceptive advertising.
A significant number of those administrative actions have been tested in court. By and large, courts have upheld even the
most stringent FTC policies.
State Laws Against False Advertising
Most states also have laws -- usually in the form of consumer fraud or deceptive practices statutes -- that regulate
advertising. Under these laws, state or local officials can seek injunctions against unlawful ads and take legal action to get
restitution to consumers. Some laws provide for criminal penalties -- fines and jail -- but criminal proceedings for false
advertising are rare unless fraud is involved.
Consumers often have the right to sue advertisers under state consumer protection laws. Such cases usually are based on
one of two legal theories: unfair competition or commercial disparagement. A competitor harmed by unlawful advertising,
or faced with the likelihood of such harm, generally has the right to seek an injunction and possibly an award of money
(damages) as well, although damages are often difficult to prove. For example, someone who purchases a product or
services in reliance on a false or deceptive ad might sue in small claims court for a refund or join with others (sometimes
ten of thousands of others) to sue for a huge sum in another court.
The following rules will help keep your ads within safe, legal limits.
Rule 1 -- Be Accurate
Make sure your ads are factually correct and that they don't tend to deceive or mislead the buying public. Don't show a
picture of this year's model of a product if what you're selling is last year's model, even if they look almost the same.
Be truthful about what consumers can expect from your product. Don't say ABC pills will cure headaches if the pills offer
only temporary pain relief. Don't claim a rug shampooer is a wizard at removing all kinds of stains when in fact there are
some it won't budge.
Waterproof or fireproof means just that -- not water resistant or fire resistant under some circumstances. The term polar,
when attached to winter gear, suggests that it will keep people warm in extreme cold, not that it's just adequate when the
temperature drops near freezing.
Rule 2 -- Get Permission
Does your ad feature someone's picture or endorsement? Does it quote material written by someone not on your staff or
employed by your advertising agency? Does it use the name of a national organization such as the Boy Scouts or Red
Cross? If so, get written permission.
Under U.S. copyright law, the "fair use" doctrine allows limited quotations from copyrighted works without specific
authorization from the copyright owner. In some circumstances, this doctrine provides legal justification for the widespread
practice of quoting from favorable reviews in ads for books, movies, and plays -- and even vacuum cleaners. However,
with the exception of brief quotes from product or service reviews, you should always seek permission to quote protected
material. For more on the fair use doctrine and many other aspects of copyright law and practice, see The Copyright
Handbook: How to Protect and Use Written Works, by Stephen Fishman (Nolo).
Rule 3 -- Treat Competitors Fairly
Don't knock the goods, services, or reputation of others by giving false or misleading information. If you compare your
goods and services with those of other companies, double check your information to make sure that every statement in
your ad is accurate.
Rule 4 -- Have Sufficient Quantities on Hand
When you advertise goods for sale, make every effort to have enough on hand to supply the demand that it's reasonable
to expect. If you don't think you can meet the demand, state in your ad that quantities are limited. You may even want to
state the number of units on hand.
State law may require merchants to stock an advertised product in quantities large enough to meet reasonably expected
demand, unless the ad states that stock is limited. California, for example, has such a law. In other states, merchants may
have to give a rain check if they run out of advertised goods in certain circumstances. Make sure you know what your state
requires.
Rule 5 -- Watch Out for the Word "Free"
If you say that goods or services are "free" or "without charge," be sure there are no unstated terms or conditions that
qualify the offer. If there are any limits, state them clearly and conspicuously.
Let's assume that you offer a free paintbrush to anyone who buys a can of paint for $8.95 and that you describe the kind
of brush. Because you're disclosing the terms and conditions of your offer, you're in good shape so far. But there are
pitfalls to avoid.
1. If the $8.95 is more than you usually charge for this kind of paint, the brush isn't free and you shouldn't call it
free.
2. Don't reduce the quality of the paint that the customer must purchase or the quantity of any services (such as
free delivery) you normally provide. If you provide a lesser product or service, you're exacting a hidden cost for the brush.
3. Disclose any other terms, conditions, or limitations.
What counts is the overall impression created by the ad -- not the technical truthfulness of the individual parts. Taken as a
whole, your ad must fairly inform the ordinary consumer.
Rule 6 -- Be Careful When You Describe Sales and Savings
You should be absolutely truthful in all claims about pricing. The most common pitfall is making doctored price
comparisons with other merchants or with your own "regular" prices.
Rule 7 -- Observe Limitations on Offers of Credit
Don't advertise that you offer easy credit unless it's true. A business that's not careful in this area can be charged with
engaging in an unfair or deceptive practice that violates FTC law. You don't offer easy credit if:
1. You don't extend credit to people who don't have a good credit rating.
2. You offer credit to people with marginal or poor credit ratings but you require a higher down payment or shorter
repayment period than is ordinarily required for credit-worthy people.
3. You offer credit to poor credit risks, but once all the fine print is deciphered, the true cost of credit you charge
exceeds the average charged by others in your retail market.
4. You offer credit to poor risks at favorable terms but employ draconian (although legal) collection practices against
buyers who fall behind.
If you advertise specific credit terms, you must provide all relevant details, including the down payment, the terms of
repayment, and the annual interest rate.
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Copyright 2006 Nolo

Making Contracts Online: Electronic Signatures


From the Nolo Business & Human Resources Center
When electronic signatures are used, contracts created online are now as legal as those on paper.
Electronic contracts and electronic signatures are just as legal and enforceable as traditional paper contracts signed in
ink. Federal legislation enacted in 2000, known as the Electronic Signatures in Global and International Commerce Act
(ESGICA), removed the uncertainty that previously plagued e-contracts.
This 2000 e-signature law made electronic contracts and signatures as legally valid as paper contracts, which was great
news for companies that conduct business online, particularly companies that provide financial, insurance, and household
services to consumers. The law also benefits B2Bs (business-to-business websites) who need enforceable agreements for
ordering supplies and services. For all of these companies, the law helps them conduct business entirely on the Internet.
This results in substantial savings to businesses, which can be passed on to consumers. For example, one online company
estimated that eliminating paperwork fees reduced the cost of processing a home loan by $750.
What Are Electronic Contracts and Electronic Signatures?
An electronic contract is an agreement created and "signed" in electronic form -- in other words, no paper or other hard
copies are used. For example, you write a contract on your computer and email it to a business associate, and the business
associate emails it back with an electronic signature indicating acceptance. An e-contract can also be in the form of a "Click
to Agree" contract, commonly used with downloaded software: The user clicks an "I Agree" button on a page containing
the terms of the software license before the transaction can be completed.
Since a traditional ink signature isn't possible on an electronic contract, people use several different ways to indicate their
electronic signatures, including typing the signer's name into the signature area, pasting in a scanned version of the
signer's signature, clicking an "I Accept" button, or using cryptographic "scrambling" technology.
While lots of folks use the term "digital signature" for any of these methods, it's becoming standard to reserve the term
"digital signature" for cryptographic signature methods and to use "electronic signature" for other paperless signature
methods.

Cryptographic Signatures (PKI)


Cryptography is the science of securing information. It is most commonly associated with systems that scramble
information and then unscramble it. Security experts currently favor the cryptographic signature method known as Public
Key Infrastructure (PKI) as the most secure and reliable method of signing contracts online.
PKI uses an algorithm to encrypt online documents so that they will be accessible only to authorized parties. The parties
have "keys" to read and sign the document, thus ensuring that no one else will be able to sign fraudulently. Since the
passage of the e-signature law in 2000, the use of PKI technology has become more widely accepted. Many online services
offer PKI encrypted digital signature systems that function much like we use PINs for our bank cards.

XML-Based Signatures
Other e-signature systems have been developed, including a method for digitally recording a fingerprint, and hardware
that electronically records your signature. In addition, the organization that sets Web standards for the Internet, the
Worldwide Web Consortium (W3C), developed XML-compliant guidelines for digital signatures. The results of their working
group are discussed at the W3C website at www.w3.org/Signature.
Opting Out of Electronic Contracts
While the federal e-signature law makes paper unnecessary in many situations, it also gives consumers and businesses the
right to continue to use paper where desired. The law provides a means for consumers who prefer paper to opt out of
using electronic contracts.
Prior to obtaining a consumer's consent for electronic contracts, a business must provide a notice indicating whether paper
contracts are available and informing consumers that if they give their consent to use electronic documents, they can later
change their mind and request a paper agreement instead. The notice must also explain what fees or penalties might apply
if the company must use paper agreements for the transaction. The notice must also indicate whether the consumer's
consent applies only to the particular transaction at hand, or to a larger category of transactions between the business and
the consumer -- in other words, whether the business has to get consent to use e-contracts/signatures for each
transaction.
A business must also provide a statement outlining the hardware and software requirements to read and save the
business's electronic documents. If the hardware or software requirements change, the business must notify consumers of
the change and give consumers the option (penalty-free) to revoke their consent to using electronic documents.
Although the e-signature law doesn't force consumers to accept electronic documents from businesses, it poses a potential
disadvantage for low-tech citizens by allowing businesses to collect additional fees from those who opt for paper.
Contracts That Must Be on Paper
To protect consumers from potential abuses, electronic versions of the following documents are invalid and unenforceable:
1. wills, codicils, and testamentary trusts
2. documents relating to adoption, divorce, and other family law matters
3. court orders, notices, and other court documents such as pleadings or motions
4. notices of cancellation or termination of utility services
5. notices of default, repossession, foreclosure, or eviction
6. notices of cancellation or termination of health or life insurance benefits
7. product recall notices affecting health or safety, and

8. documents required by law to accompany the transportation of hazardous materials.

These documents must be provided in traditional paper and ink format.


Consumer Concerns
Although it is expected that secure methods of electronic signatures will be become as commonplace and safe as credit
cards, some consumer advocates are concerned that if a consumer uses an insecure signature method (such as a scanned
image of a handwritten signature), identity thieves could intercept it online and use it for fraudulent purposes.

Federal Law Versus State Law


Some states have adopted the Uniform Electronic Transactions Act (UETA), which establishes the legal validity of electronic
signatures and contracts in a similar manner as the federal law. If a state has adopted the UETA, or a similar law, the
federal electronic signature law won't override the state law. But if a state has adopted a law that is significantly different
than the federal law, it will be trumped by the federal law. This ensures that electronic contracts and electronic signatures
will be valid in all states, regardless of where the parties live or where the contract is executed.

Government Filings
As for the government, transactions between citizens and the federal government were addressed in 1998's Government
Paperwork Elimination Act (GPEA), which created requirements and incentives for the federal government to make
electronic versions of their forms available online. A good deal of progress has been made, as many online consumer
transactions -- such as paying taxes and registering trademarks -- are now available from the feds. State governments are
slowly catching up, as some states now allow you to register your business online.
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Copyright 2006 Nolo

Terms and Conditions for Your Website


by Attorney Richard Stim
From the Nolo Business & Human Resources Center
Find out what legal notices you need to post on your website.
Many sites post “terms and conditions” somewhere on the site. Do you need them, too? If you have anything more than a
small, information-only site, you probably do.
Refunds, Returns, and Losses
If your site sells products, you may need notices regarding credit card use, refunds, and returns (known as “transaction
conditions”). For example, you might want to announce that your business will accept returns up to 30 days after
purchase.
You may also want to include disclaimers -- statements that inform customers that you won’t be liable for certain kinds of
losses that might incur. For example, you may disclaim responsibility for losses that result if pottery breaks when a
customer ships it back for return.
Privacy Policy
If you are gathering information from your customers, including credit card information, you should post a privacy policy
detailing how this information will be used or not used. Yahoo!’s privacy policy (http://privacy.yahoo.com) is a good
example of a broad, easy-to-understand policy.
You can check out other policies by typing “privacy policy” in a search engine. Pick and choose the elements that apply to
your site. Whatever policy you adopt be consistent and if you are going to change it, make an effort to notify your
customers of the change.
Limiting Your Liability
If your site provides space for chats or postings from the Web-surfing public, you’ll want to limit your liability from
offensive or libelous postings or similar chat room comments. There are three things you can do:

1. Monitor postings. Regularly review all postings and promptly take down those you think are offensive or
libelous.

1. Remove suspect postings. If asked to remove a posting by a third party, remove it while you investigate. If
you determine -- after speaking with an attorney -- that you are entitled to keep the post, then you can put it back up.

2. Include a disclaimer. Your disclaimer should explain you don’t endorse and aren’t responsible for the accuracy
or reliability of statements made by third parties. This won’t shield you from claims, but it may minimize your financial
damages if you’re involved in a lawsuit over the posting.
Copyright Notices
Regardless of what your site does, you should include notices regarding copyright and trademark -- for example “Copyright
© 2006 RichandAndrea.com” or “Cyzuki is a trademark of Cynthia Lloyd.”
If you want to use someone else's work on your website, read the following article: Getting Permission to Publish: Ten Tips
for Webmasters.
Protecting Minors
If you are catering to an audience under 13 years old, special rules apply. You should learn more about dealing with
children at the Federal Trade Commission’s website, www.ftc.gov/kidzprivacy.
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Copyright 2006 Nolo

Sales Tax on the Internet: Who Pays It, Who Doesn't


From the Nolo Business & Human Resources Center
Here's the skinny on Internet sales tax.
The Internet takes tax-free shopping to a new level. In fact, no-tax shopping has become a prime lure of online retailers
looking to hook consumers on click-and-charge buying. Despite what you sometimes hear, however, some Internet sales
are subject to sales tax, and even when a site doesn't collect sales tax, consumers are technically responsible for remitting
any unpaid sales tax on online purchases directly to their state.
Collecting Sales Tax: Some Sites Have To, Some Don't
If an online retailer has a physical presence in a particular state, such as business offices or a warehouse, it must collect
sales tax from customers in that state. If a business does not have a physical presence in a state, it is not required to
collect sales tax for sales from customers in that state.

EXAMPLE

Margo is passionate about rare orchids but can't find them in Indiana, so she orders her supplies online from an orchid
supplier with headquarters in Vermont. The supplier has all of its facilities in Vermont and collects payment in Vermont.
Margo does not have to pay Indiana sales tax (or Vermont sales tax) on her orchids.
A few months later, the supplier opens a warehouse in Indiana to handle its online orders for the entire country. Margo
continues to order her orchids from the headquarters in Vermont but she must now pay Indiana sales tax. Her ride on
the tax-free train is over.

How Big Sites Avoid Charging Sales Tax


Some big retailers with local stores can sell their products tax-free over the Internet because they have established
separate legal subsidiaries to handle Internet business. For example, the Barnes & Noble website that you buy a book from
online is a different company from Barnes & Noble at the mall. If the online Barnes & Noble doesn't have a physical
presence in a certain state, such as business offices or a warehouse, no sales tax is charged for online purchases to
customers in that state. The practice of establishing a separate legal entity principally to avoid sales taxes has raised the
ire of thousands of brick-and-mortar retailers whose customers must still pay tax.
The issue becomes even stickier when a company's online and offline entities experience some customer interaction. For
example, a consumer buys tax-free golf clubs from Wal-Mart.com but is allowed to return them offline to the local Wal-
Mart store. Whether such entities are legally independent of each other is a matter that has not been tested in the courts.
Consumers' Responsibility to Pay Sales or Use Taxes
Consumers who live in a state that collects sales tax are technically required to pay the tax to the state even
when an Internet retailer doesn't collect it. When consumers are required to pay tax directly to the state, it is referred to
as "use" tax rather than sales tax.
The only difference between sales and use tax is which person -- the seller or the buyer -- pays the state. Theoretically,
use taxes are just a backup plan to make sure that the state collects revenue on every taxable item that is purchased
within its borders. But because collecting use tax on smaller purchases is so much trouble, states have traditionally
attempted to collect a use tax only on big-ticket items that require licenses, such as cars and boats.
Some states, including Connecticut, Maine, Nebraska, New Jersey, and North Carolina, have changed their attitudes and
are stepping up efforts to collect use taxes. But bureaucracy, complex tax rules, and limited state resources have thus far
prevented most states from pursuing use taxes. Since state governments are losing substantial revenue, the collection of
use taxes may become a priority if the federal government continues its ban on Internet e-commerce taxes.
The Internet's Future as a Tax-Free Zone
Will Internet purchases remain tax-free? We'll find out in coming years as Congress and state legislatures wrestle with this
issue. In 1998, Congress passed the Internet Tax Freedom Act (ITFA), which established a three-year moratorium on
taxing Internet access services at the state or local level. And in December 2001, President Bush signed a two-year
extension of the Internet sales tax ban. That extension expired in 2003, and as of December 2004, has not been renewed.
Regardless of whether the ban is made permanent, as some in Congress are seeking, the basic rules regarding sales tax
continue to apply -- collection of sales tax for items sold over the Internet is only required if a business has a physical
presence in the state.
Naturally, there is a great deal of opposition to this tax moratorium from state governments and brick-and-mortar
retailers. A look at the numbers explains why. Sales tax revenues currently amount to about $150 billion annually and
make up approximately one-third of all state revenues. These taxes pay for everything from schools and police to roads,
parks, and other state services. California, alone, estimated losses of over a billion dollars per year.
States that don't have a personal income tax, like Texas, are even more dependent on sales tax revenue. (The five states
that don't have a sales tax -- Alaska, Delaware, Montana, New Hampshire, and Oregon -- aren't hurt at all).
In 2002, state governments organized to fight back. Under a state-led initiative known as the Streamlined Sales & Use Tax
Agreement (SSUTA), 40 states and the District of Columbia banded together to simplify their sales tax codes in order to
make sales tax collection easier. Under SSUTA, the collection of sales tax still remains voluntary. However, if ten states
representing 20% of the U.S. population vote for the rules, the organization will pressure Washington D.C. for federal
legislation. The SSUTA has gained traction recently. Several national retailers have negotiated with member states for
amnesty deals in return for future collection of sales tax, and more are expected to follow. The SSUTA expects to
implement a multistate arrangement effective October 1, 2005, and a number of states are preparing certificates of
compliance with the SSUTA. In addition, several states have already amended their tax laws to conform to the SSUTA.
With all of this pressure from states, many expert believe that within the next few years you'll be throwing a few more
dollars into your shopping cart for state sales taxes.

More Information About Internet Sales Tax

1. E-fairness (www.e-fairness.org) represents retailer organizations lobbying Congress for


equal taxation.
2. The Sales Tax Institute (www.salestaxinstitute.com) provides a range of services and links
associated with sales tax.
3. E-Commerce Tax News (www.ecommercetax.com) provides news and feature articles about
e-commerce taxation, including email updates from an e-commerce expert.

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Copyright 2006 Nolo

Obtaining a Business Method Patent


From the Nolo Business & Human Resources Center
A company that develops a new way of conducting e-commerce may be able to prevent others from using it
for almost two decades.
Since 1998, an increasing number of patents have been issued to software and Internet companies that have devised
novel ways of doing business -- for example, new online ordering processes or a unique Internet advertising scheme.
These patents, which usually combine software with business methodology, are commonly referred to as business method
patents or Internet patents.
These patents are important because any company that develops or acquires such a patent can stop others from using the
patented business method for approximately 17 years. And, of course, the owner of the patent can exploit it by licensing
the method -- that is, charging a fee for others to use it.
For example, Amazon.com devised a method for expediting online orders, known as the "1-Click" system. The method
allows a repeat customer to bypass address and credit card data entry forms, because Amazon can access that information
directly from the customer's account. Amazon was granted a patent on this business method in September 1999 (U.S. Pat
No. 5,960,411).
Protection for Business Methods: The State Street Case
Business method patents are part of a larger family of patents known as utility patents, which protect inventions, chemical
formulas, processes and other discoveries. A business method is classified as a process, because it is not a physical object
like a mechanical invention or chemical composition.
During most of the last century, the U.S. Patent and Trademark Office (USPTO) rarely granted business method patents,
claiming that a process could not be patented if it was simply an abstract idea, something the USPTO believed described
most business methods. Similarly, software patents were usually held to be unpatentable by the USPTO and the courts,
based on the view that they were unprotectible algorithms.
These rules changed in July 1998, when a federal court upheld a patent for a method of calculating the net asset value of
mutual funds. State Street Bank & Trust Co. v. Signal Financial Group, Inc. 149 F.3d 1368 (Fed. Cir. 1998) cert denied 119
S. Ct. 851 (1999). The court ruled that patent laws were intended to protect any method, whether or not it required the
aid of a computer, so long as it produced a "useful, concrete and tangible result." Thus with one stroke, the court
legitimized both software patents and methods of doing business, opening the way for Internet-related patents. In the six
months following the ruling, patent filings for software/Internet business methods increased by 40% and the USPTO
created a new classification for applications: "Data processing: financial, business practice, management or cost/price
determination."
Since the State Street case, patents have been issued for an online shopping rewards program, referred to as the
"ClickReward" (U.S. Pat. No. 5,774,870); a system that provides financial incentives for citizens to view political messages
on the Internet (U.S. Pat. No. 5,855,008); an online auction system by which consumers name the price they are willing to
pay and the first willing seller gets the sale, also known as "name your price" or as a "reverse auction" (U.S. Pat. No.
5,794,207); and a process that supposedly blocks the auction practices described in the previous patent (U.S. Pat. No.
5,845,265).
In response to recent criticisms that patent examiners are ill-equipped to investigate whether business methods are novel
and nonobvious, the USPTO added an additional "layer of review" to business method patent applications and hired
technology specialists to aid examiners in the areas of finance, e-commerce, insurance and Internet infrastructure.
Using Internet Patents as a Sword or Shield
Internet patents can be used offensively against a major competitor or they can be used defensively as a bargaining chip
against an aggressive competitor who threatens to sue based on one of its patents. Experience has shown that rivals are
less likely to go to court when they know that their opponent can wield a patent. Such competitors often prefer to reach a
truce under which each company cross-licenses the other's patents.
Example:

Company A and Company B both sell concert tickets online, including services for exchanging
unwanted tickets and earning rewards for frequent purchases. Company A holds a patent on a
method of exchanging concert tickets. Company B has a patent on a method of offering rewards to
concert promoters for group ticket purchases. Although each company believes the other is infringing
its patent, neither seeks to enforce its rights in court, fearing that the other is almost sure to file a
lawsuit in response. Instead, after a few months of legal posturing, Company A and B agree to share,
or "cross-license," their technology.

Determining Who Gets a Patent


What happens if a competing business claims that it was already using the particular method that is the subject of a patent
application? If Business A files for a business method patent, but Business B can show that it was using the method
publicly more than a year prior to the filing, Business B can thwart the patent application or, if necessary, invalidate the
patent later. The key is that Business B's use of the method must have been public. If Business B used the method
confidentially, the patent will be issued to Business A. However, under a 1999 amendment to the patent law, if Business B
used the method confidentially before Business A filed for a patent, it can continue using the method without liability for
infringement.

Example:

Company A has been using a business accounting method for years, but never publicly disclosed it.
Company B independently develops the method and obtains a patent on it. Company B sues
Company A. Under the amendment to the patent law, Company A has not infringed the patent.

If Company A had been using the method publicly for more than year before the patent application was filed, Company B's
patent would be invalidated or, more likely, never would have been granted in the first place.
Legal Requirements for Getting a Business Method Patent
In order to qualify for patent protection, a business method or software must meet four requirements:
1. The method or software must fall within the classes of patentable subject matter. Anything that is created by
humans falls within these classes; laws of nature, natural phenomena and abstract ideas do not.
2. The method or software must be useful. This requirement is fairly easy to satisfy because any functional purpose
will suffice. A business need only demonstrate that its method or software provides some concrete tangible result. For
example, the Amazon 1-Click patent provides a tangible result -- an expedited purchase.
3. The method or software must be novel. This requirement means the method must have an aspect that is
different in some way from all previous knowledge and inventions. This requirement is discussed in more detail below.
4. The method or software must be nonobvious, meaning that someone who has ordinary skill in the specific
technology could not easily think of it. This, too, is discussed just below.

The Price of Power

The cost of obtaining a business method patent depends on several factors, including the subject
matter of the patent, the complexity of the examination process and whether a lawyer's fees are
involved. You can expect to pay between $3,000 and $15,000 to acquire a business method patent
unless you do it yourself, in which case the costs are much reduced. After a patent is issued, the
owner must pay maintenance fees to the USPTO after 3.5, 7.5 and 11.5 years. Of course, if the
patent is challenged -- and many are -- the costs can skyrocket.

Novelty
An Internet method will flunk the novelty test if it was put to public use -- or described in a published document -- more
than one year before the patent application for the business method was filed. (If the method is exposed to the public in
one of these ways, it loses its novelty.) For this reason, a business that is seeking to acquire a patent must research the
prior art and promptly file its patent application or it risks losing valuable patent rights.
A business method is considered novel when it is different in at least one element from all previous methods -- known in
patentspeak as the "prior art." Prior art consists of:
1. any published writing (including any patent) that was made publicly available either: (1) before the date of
invention of the business method or (2) more than one year before the patent application for the business method is filed
2. any U.S. patent that has a filing date earlier than the date of invention of the business method
3. any relevant method or process (whether described in writing or not) existing publicly before the business
method was conceived, or

4. any public or commercial use, sale, or knowledge of the business method more than one year before the patent
application for the business method is filed.
For purposes of prior art, the date of invention of the business method is the date that the business can demonstrate that
the method works. The USPTO will consider all prior art, whether Internet-related or not.

Nonobviousness
Meeting the nonobviousness test turns on whether or not the method provides a result that would be new or unexpected to
someone with ordinary skill in the field of the business. Or put another way, if the differences between the business
method and the prior art would not have been an obvious development to someone in the field, it is probably nonobvious.

Example:

An economist devised a method of avoiding taxes by using a credit card to borrow money from a
40l(k) fund. The method did not exist previously and differed substantially from previous methods of
avoiding taxes. Since the method was new and was not obvious to accountants or tax experts, the
economist acquired a patent (U.S. Pat. No. 5,206,803).

Timeline for Obtaining a Patent


It usually takes two and a half to three years from the date of filing an application until a business method patent is
issued. The period between filing and issuance is called the "pendency period." A patent owner cannot stop a competitor
from using the process during the pendency period, regardless of whether the competitor purposefully copied the method
or stumbled upon it independently. Only after a patent is actually issued can a company stop another from using making or
selling the process. The patent is then valid for 20 years from the date of filing.

Alternate Protection for Business Methods

Business methods and software can also be protected under trade secret laws. A trade secret is any
confidential business information developed by a company that gives it an advantage over
competitors. As long as it's kept secret, this protection does not expire.
Patent protection, however, although more expensive and shorter in duration, is often preferable to
trade secret protection because a patent owner can stop others from using the patented method
even if the new user developed the method on its own, without stealing or copying directly from the
patent owner.
In addition, a patent owner can use the business method publicly or license it to others without losing
its rights in the method.

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Challenging or Infringing Another's Business Method Patent


From the Nolo Business & Human Resources Center
Has another company patented a technology that you need to use? Learn your rights and options.
Many think the U.S. Patent and Trademark Office (USPTO) has gone hogwild granting business method patents on obvious
technologies and abstract ideas, unfairly preventing others from using them for the common good. If you find yourself in
this boat, there are a few things you can do.
Challenging a Business Method Patent
There are two ways to challenge business method patents after they are granted. A disgruntled competitor can sue in
federal court or can institute a procedure in the USPTO known as a re-examination.
Filing a lawsuit can be expensive (often costing hundreds of thousand dollars and sometimes running into the millions), but
some companies choose to fight it out in the hopes that they can invalidate the adversary's business method patent. The
challenging party normally seeks to prove the patented process was not novel or was obvious, and therefore that the
USPTO shouldn't have issued the patent. This is usually done by demonstrating that the patent examiner overlooked
important prior art.
Initiating a re-examination procedure with the USPTO can also invalidate a patent. The USPTO will reconsider the patent in
light of recently uncovered prior art. A re-examination is not as costly as litigation. But if re-examination fails and the
patent survives, it will be "strengthened" to the extent that others will be less likely to challenge it and the patent owner
will feel more confident enforcing it.
However, the result of many current USPTO and court challenges may be that at least some recent business method
patents will be invalidated. One of the most vocal critics of business method patents, Gregory Aharonian of the Internet
Patent News Service (www.bustpatents.com) provides an archive of questionable business method and software patents.
Avoiding Patent Violations (Infringement)
Determining whether someone has infringed an Internet patent depends on a close examination of the patent "claims," a
brief statement in the body of the patent application that defines the scope of the business method. You can read claims
for any U.S. business method patent by visiting the USPTO website (www.uspto.gov) and searching the patent database
by name, subject matter or other criteria.
Think of the claims as the boundaries of the patent owner's rights. Or put another way, if the elements or steps in your
business method match all of the elements or steps elaborated in someone else's patent claims, then you have infringed
their patent. Even if the other owner's claims don't literally match your business method, a court may still find
infringement if the methods are very similar. In doing this, courts will apply what's known as the "doctrine of equivalents."
This means if the steps in the patent and the allegedly infringing method are sufficiently alike, a court will find that
infringement has occurred.
Since your business method will not infringe someone else's patent unless each and every step (and limitation) of their
claims is found in your method, it is often possible to write around or redesign a business method so that it does not create
a violation. For example, in a lawsuit involving Amazon's 1-Click patent, the judge stated that Barnes and Noble could
avoid infringement with "relative ease" by modifying its "Express Lane" feature. If true, this at least to some extent
negates or narrows the power of the Amazon patent.
If you're concerned about whether a valuable business method you want to use infringes someone else's patent, it's wise
to obtain the opinion of a patent attorney. The attorney may determine that your method does not infringe, or if it does,
he or she can help you determine the modifications you'll need to implement to avoid infringement.
Defending a Claim of Patent Infringement
If you are accused of violating another company's patent, your only real defense is to prove that the other company's
patent is invalid. This is done by challenging the patent on the basis of lack of novelty or nonobviousness. However, if the
patent owner wins the lawsuit, the owner can obtain a court order preventing your infringing activity and can recover
financial damages to compensate the company for lost revenue and, in exceptional cases, triple damages and attorney
fees.

Willful Infringement: A Bad Idea

If you know that your business method infringes an existing patent and you continue to use it,
particularly after being warned by the patent owner, you may be found liable for willful infringement.
If this occurs, you might be required to pay up to three times the actual damages. In other words,
the court will determine the patent owner's lost profits and then multiply them by three. In addition,
you may be responsible for paying the patent owner's attorney fees (as well as your own lawyer's
charges).

If you are accused of violating another company's patent, you'll no dount need the help of a patent attorney to defend
yourself and prove that the other company's patent is invalid.
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Copyright 2006 Nolo

Getting Your Business Online


by Attorney Richard Stim
From the Nolo Business & Human Resources Center
How to create a simple online information website or a robust e-commerce store for your business.
If you’re looking for an efficient, relatively inexpensive way to reach customers, clients and fans, establishing a website can
fit the bill in many respects. Your website can provide access to your business that is constantly and globally available to
customers. If you want to invest a little more time and effort, your site can be used for direct sales -- a great way to
increase your profits.
If you have a computer and you’re willing to learn, you can probably have your website up and running in a few weeks.
Creating and hosting a website can now be accomplished by even the most tech-challenged. If you’ve got other priorities,
you can hire a website developer to custom design the site for you. Here are some quick solutions and pointers that will
eliminate some of the mystery surrounding the creation of websites.
Information-Only Website
If you plan to use your site primarily to provide information about your business, you can design and launch a site pretty
easily. Here are a couple of routes you can take.
Quick and easy: Create a blog. Blogs, short for web logs, were initially used as journals. Nowadays, blog has come to
mean any easily updated Web page that you regularly add information to. To create a blog, all you do is start an account
(check out www.blogger.com or www.typepad.com), pick a template and the background colors for your blog, and then
upload text. The advantage of a blog is that you can establish one in less than an hour. The disadvantage is that in order
to maintain interest, you’ll need to regularly refresh with new information.
More time-consuming: Build a site from scratch. Millions of people have done it and you can, too. Once you master
the website software, you can create a basic website of five to ten separate Web pages in a few hours. To create these
basic sites, you’ll need three elements:

1. A domain name. You can get your domain name (your address on the Web -- for example, www.nolo.com) at a
domain name registrar or through a hosting company. Expect to pay between $10 and $35 a year.

2. Website development software. You create your website on your own computer using development software
and then transfer it to your hosting company. There is a learning curve for website software, and of the three leading
products -- Macromedia Dreamweaver, Adobe Go Live and Microsoft FrontPage -- FrontPage is considered the easiest to learn.

3. A hosting company. A hosting company, sometimes referred to as an Internet Service Provider or ISP, rents
out space on its equipment. You give the host your domain name information (or they’ll get the domain name for you) and
your website design, and they broadcast your website for the world to see. Expect to pay $5 to $50 a month for Web
hosting, depending on the bells and whistles.
Selling Products Online
If you’re interested in selling products online, you’ll need to do more than if you’re setting up an information-only site.
There are two ways to do this: set up a community business on someone else's site, or create your your store from
scratch.
Quick and easy: Set up a community store. A community store on a site such as an eBay or Yahoo offers a complete
turnkey solution. eBay or Yahoo will help you quickly set up your site and make it possible for you to accept credit card
payments. All you’ll need to do is pay the fees and provide photos and copy for your products. For a good example of a
successful community store, check out the Yahoo! Store for Vermont Teddy Bear Company at
http://store.yahoo.com/vtbear.
More time-consuming: Build a store from scratch. Building a store from scratch is not as simple as creating an
information site from scratch, as described above. You have to go through the same basic steps -- get a domain name,
design your site, and locate an ISP -- with one added twist: You need to incorporate a shopping cart and credit card
payment system. And when you do business online, the mechanics of accepting credit cards is different than in person or
over the phone -- and avoiding fraud is more difficult. You have two options for collecting payments:

1. Shopping cart and gateway. To collect money from a customer, you deal with an intermediary known as a
transaction processor, or transaction clearinghouse, that handles credit card transactions for your merchant bank. The
transaction clearinghouse checks the validity of the customer's card and okays (or rejects) the purchase. For online
purchases, the gateway is the method of connecting your online business to the transaction clearinghouse. You can have a
company (a gateway service) provide this connection service, or you can purchase gateway software on disk or in
hardware that acts as the digital equivalent of the card-swipe machine used in a store.

2. PayPal. PayPal (www.paypal.com), an online payment system owned by eBay, is an intermediary for credit card
payments as well as for bank transfers. If you’re selling only a few items, you may be able to avoid the shopping cart
system with a simple order form and a link to PayPal. You can start accepting credit card payments instantly by signing up
for a free PayPal account. (With PayPal, you don't need a gateway or merchant account.)
Few business owners can handle setting up a shopping cart and gateway themselves, and the great majority outsource
these tasks to companies that provide shopping cart solutions. These companies will handle all of your back end details
and deposit payments into your account.
Hiring a Website Developer
If you can’t or don’t want to deal with website creation, get a developer to do it for you. Expect to pay between $500 to
$2,000 for a basic site (five to ten pages). You can find developers online or in your local Yellow Pages.
Keep in mind that websites are not static; they need to change as your business changes. So unless you set up a system
to update the site yourself, you’ll have to keep returning to a developer for every fix. The best solution: Have the
developer set up the site and then teach you how to update it.

Want to Learn More?

Once you've got a website, you'll need get some user traffic coming to it and connect it to other
sites. Here are some other questions to consider:
1. How will you encourage visitors to your site?
2. Will you submit your site to search engines?
3. Will you provide links to other sites?
For help answering these questions and step-by-step coaching on taking your business online, see
Whoops! I'm in Business, by attorney Richard Stim (Nolo).

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Copyright 2006 Nolo

Ten Good Reasons Not to Buy a Franchise


From the Nolo Business & Human Resources Center
Thinking about buying a franchise? Here are ten reasons why you should consider investing your time and
money elsewhere.

1. Questionable profitability. Most franchisors do not provide much information to potential franchisees regarding
earnings possibilities, making it difficult to assess how lucrative investment in the company could be. Even the
franchisors who do supply this information usually only give average sales figures and profits before expenses are
deducted, numbers that aren’t very helpful when trying to determine if your individual franchise will be
successful.

2. High start-up costs. Before opening your franchise, you may be required to pay a non-refundable initial
franchise fee, which can cost from several thousand to several hundred thousand dollars. In addition to the initial
fee, there are also usually high start-up costs associated with furnishing your franchise with the necessary
inventory and equipment. It can easily take several years to recoup the expenses connected with getting your
franchise off the ground.

3. Encroachment. Imagine the following scenario: You have just spent thousands of dollars opening your own
GasMart station, when another GasMart station opens across the street, essentially cutting your customer base in
half. This type of thing happens to franchisees all the time, as nearly every franchisor reserves the right to
operate anywhere they want.

4. Lack of legal recourse. As a franchisee, there is little legal recourse that you can take if you are wronged by
the franchisor. Most franchisors make franchisees sign agreements waiving his or her rights under applicable
federal and state law, and some agreements contain provisions allowing the franchisor to choose the venue and
the law under which any dispute would be litigated. Shamefully, the Federal Trade Commission (FTC), which is
supposed to regulate fairness in franchising, investigates less than 6% of the franchise-related complaints it
receives.

5. Limited independence. When you buy a franchise, you are not just buying the right to use the franchisor’s
name, but you are buying its business plan as well. As a result, most franchisors impose price, appearance, and
design standards on franchisees, limiting the ways you can operate the franchise. While these regulations can
help promote uniformity, they can also be stifling to franchisees who feel they could run the business more
effectively their own way.

6. Royalty payments. Franchisees are generally required to make continuing royalty payments to the franchisor
each month based on a percentage of his or her franchise’s sales, eating into the franchisee’s net profits.
7. Inflated pricing on supplies. In many cases, the franchisor can designate your franchise’s supplier of goods
and services. Franchisors argue that this is done to maintain quality control, but almost all franchisors receive
kickbacks from the vendors. By not allowing you to shop around and subsequently limiting competition, you are
forced to pay higher prices on supplies.

8. Restrictions on post-term competition. Let’s say that you decide to purchase a McDonald’s, but after a
couple of years you determine that you could run a higher-quality, more profitable burger joint on your own.
Unfortunately, due to noncompetition clauses built into almost every franchise agreement, franchisees are not
allowed to become independent business owners in a similar business after termination of the franchise
agreement. By purchasing a franchise, you may be unwittingly limiting your business opportunities for years after
the expiration of your contract.

9. Advertising fees. Many franchisees are obligated to make regular contributions to the franchisor’s advertising
fund. Franchisors maintain broad discretion over how to administer the advertising fund, and the money you
contribute does not necessarily need to be used to target your specific franchise. In a case against Meineke
Discount Muffler Shops, for example, it was discovered that Meineke was using the advertising fund for costs
wholly separate from advertising, yet the case was ruled in Meineke’s favor under a verdict that stated that the
franchisor has no fiduciary duty to its franchisees!

10. Unfair termination. Even the slightest impropriety on your part, such as being late on a royalty payment or
violating the franchise’s standard operating procedure, can be cause for the franchisor to terminate your
agreement. While most franchisors are not this strict, the possibility of losing your entire investment for being
late on a payment is a scary thought.
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Copyright 2006 Nolo

When You Can't Pay Your Business Debts: Personal Liability and Bankruptcy Options
by Attorney Shannon Miehe
From the Nolo Business & Human Resources Center
If your business is in the red, take steps to protect your personal assets.
If your business is in distress -- you owe a lot of money but you can't pay -- your creditors will probably threaten legal
action against you personally. How much they can collect, and how they can go about collecting it, will depend on how
your business is organized, whether you personally guaranteed repayment of these amounts, and whether you decide to
file for bankruptcy.
Personal Liability for Business Debts
If your business's survival is threatened due to serious financial problems, you need to determine your potential personal
liability. The extent of your personal liability depends on two things: how your business is structured and whether you
personally guaranteed or secured any debts.

Payroll Taxes: You Are Always Personally Liable

The IRS holds all business owners personally liable for unpaid payroll taxes, regardless of your business's structure. If
your only debt is unpaid payroll taxes, skip ahead to "Payroll Tax Debt," below.

Sole Proprietors and Partnerships


If you are a sole proprietor, you and your business are one and the same in the eyes of the law, which means you are
personally responsible for all of the business's debts. If there isn't enough money in the business to pay these debts,
creditors can and will take your personal assets to pay them.
Partners in a general partnership have similar personal liability for business debts: Each partner is personally liable for the
entirety of the business's debts (and any partner can usually bind the entire partnership to a business deal -- a scary
combination). This means that if there isn't enough money in the business to pay the debts, and your partners are broke,
creditors can take your personal assets to pay all of the business's debts, not just your share.
Corporations and Limited Liability Companies
If your business is organized as a corporation or a limited liability company (LLC), your personal assets are usually
protected from business creditors as a matter of law. Shareholders and LLC members have a form of asset protection
called limited personal liability. Creditors cannot take owners' personal assets to pay business debts, unless a business
owner specifically gives up that limited liability protection.
Unfortunately, most small business owners are forced to give up their right to limited personal liability, at least for some of
their business debt. Many creditors require personal guarantees and/or personal security from small business owners
before they will loan money or extend credit to a business. And many landlords require a personal guarantee before they
will lease commercial property to a small business.
A personal guarantee is a promise by a business owner to hand over the owner's personal assets to a creditor if the
business can't pay its debt and its assets are not worth enough to cover the debt. A creditor can also ask a business owner
to secure a business debt by pledging specific personal property, such as an owner's house, boat, or car. When you sign a
personal guarantee or pledge personal property, you give up your protection against personal liability, and creditors can
come after your personal assets if your business can't pay.
Creditors' Collecting Personal Property
Before taking an owner's personal property, a creditor has to take the business owner to court and prove that the business
didn't or can't pay the debt. Then, the creditor has to get permission from the judge to take the owner's personal property
to cover the debt.
If the business owner didn't pledge specific property as collateral -- but just signed a general personal guarantee -- the
creditor can take only some of the business owner's personal property to pay the business debt. (Some personal property,
called "excluded property," is protected by law, but only a small amount.) This means a judge could allow a creditor to
take a business owner's house, car, or bank accounts as payment.
If a business owner pledged specific property as collateral, the creditor must look to that property first to satisfy the debt
before going after something else.
The Bankruptcy Option
If your business bank account is empty, you might be considering bankruptcy. Although it won't guarantee that you will
get to keep your house or other property, it can at least give you some breathing room while you try to work things out.
And in some cases, bankruptcy will protect your house, your car, and your furnishings.

Business vs. Personal Bankruptcy


If you are a sole proprietor, you can file for either Chapter 13 or Chapter 7 bankruptcy. Either type of bankruptcy can be
used for personal debts or business debts.
If you are a corporate shareholder, LLC owner, or partner in a partnership and you have signed personal guarantees or
pledged collateral for business loans, putting your business through bankruptcy will not protect your personal property. If
you have placed your personal property at risk, you must file for bankruptcy for yourself and your business separately to
protect your personal assets. In the rest of the article, we assume you are considering personal bankruptcy -- because
only personal bankruptcy will protect your personal assets.

Chapter 7 vs. Chapter 13 Bankruptcy


If you file for personal bankruptcy, most likely it will be a Chapter 7 or Chapter 13 bankruptcy. In a Chapter 7 bankruptcy,
your assets (except for property that is exempt under state or federal law) go into a bankruptcy estate to be sold, and the
proceeds are distributed to your creditors. At the end of the process, all of your debts that are eligible for discharge in
bankruptcy will be wiped out. In a Chapter 13 bankruptcy, you propose a repayment plan where you repay part or all of
the debt over three to five years.
How Bankruptcy Helps
When you file for bankruptcy, something called an automatic stay immediately stops your creditors from foreclosing on
your house or any other personal property that is at risk. In some situations, this can be reason enough to file for
bankruptcy, because it will buy you time, if nothing else.
In the end, the type of debt you have will affect how much bankruptcy can help you. Before you file, consider your
business's most significant source of debt. Is it payroll taxes? A bank loan? Back rent? Unsecured creditors, like suppliers?

Payroll Tax Debt


If you are looking to get rid of significant payroll tax debt, bankruptcy will not be of much help to you. The government has
made sure that a business owner's personal obligation for payroll tax won't go away. As a result, this debt is almost
impossible to discharge in bankruptcy. This is true even for owners of businesses that operate as corporations or LLCs.
You'll have to find some way to pay at least part of your payroll tax debt. Your alternatives include negotiating a payment
plan with the IRS, making an "offer in compromise" for less than you owe, or simply doing nothing and letting the IRS take
some of your personal assets (they usually will not take your primary residence).
The IRS is not a nice creditor. If you have a huge amount of payroll tax debt, your best bet may be to find an attorney
(not an accountant) who has experience negotiating with the IRS.

Bank Loan Debt


If your biggest debt is a bank loan, you almost certainly signed a personal guarantee or pledged personal property as
collateral for the loan.
In a Chapter 7 bankruptcy, the court will eventually allow the bank to foreclose on your personal property to pay the bank
loan. The only way a Chapter 7 bankruptcy will help you is if you owe the bank a lot more than your collateral is worth;
after taking the collateral to pay part of the loan, the bank will have to get in line with other unsecured creditors for the
rest of the money, and the debt may be discharged.
In a Chapter 13 bankruptcy, if you can keep up with agreed-upon loan payments to the bank, it won't be able to foreclose
on the debt. But if those payments are too hefty for you to make, your case might be converted to a Chapter 7.

Unpaid Rent
If your business owes your landlord back rent, you are probably personally liable for the debt. (Sole proprietors and
partners are automatically personally liable for rent payments, and most small business corporations and LLCs also get
stuck personally guaranteeing the lease payments -- check your lease. If you didn't, give yourself a pat on the back for
being a savvy negotiator.)
Filing for bankruptcy might keep the landlord from taking your personal property to pay the debt, especially if you file
under Chapter 13 and come up with a payment plan.

Ordinary, Unsecured Debt


If your business owes suppliers, you will be personally on the hook if you operated your business as a sole proprietorship
or partnership. Under the Uniform Commercial Code, suppliers of goods usually have the right to take the goods back.
Barring that, however, they can come after you personally for the unpaid amounts. If you have a lot of this kind of debt,
filing Chapter 13 could help you organize a payment plan (and Chapter 7 might wipe the debt out).
If your business is a corporation or an LLC, you may be off the hook for these debts. This kind of debt is typically
unsecured and is rarely personally guaranteed. If your business has no money and no assets left, the suppliers may be out
of luck -- your personal liability protection should protect your personal assets. So if your corporation or LLC has only
unsecured, unguaranteed business debt, there's no need to file a personal bankruptcy.
Does Bankruptcy Make Sense for You?
In the real world, just the threat of bankruptcy may be enough to help you work things out. Many creditors will think twice
before leaning on you too hard if they think you'll file for bankruptcy. Some creditors would rather work out a payment
plan, or settle for partial repayment, than become a creditor in your bankruptcy case. From a creditor's perspective,
bankruptcy is an expensive and long process that eats into profits. You can use that to your advantage in negotiations and
perhaps spread payments out far enough to be manageable.
If you think you are in imminent danger of losing your family's home or livelihood, however, and you need help quickly,
personal bankruptcy might be a good option for you. But before you file, get advice from a knowledgeable small business
attorney with bankruptcy experience. Bankruptcy does stay on your credit report for up to ten years, and can make it hard
for you to open another business.

Further Information

When your business has real debt problems, there are some steps you should take -- and some you
should avoid -- to stay out of trouble with the IRS and even the courts. For more information, see
Ten Tips for Financially Troubled Businesses.
If you're considering selling most or all of your business assets, see Eight Key Steps to Selling Your
Business.
When you've trying everything and nothing has worked, it may be time to close your doors. For
information on what you need to do to protect yourself and your business reputation, see Closing
Your Business: What You Need to Do.

Click here for related information and products from Nolo


Copyright 2006 Nolo
Ten Tips for Financially Troubled Businesses
From the Nolo Business & Human Resources Center
If your company is facing financial difficulties, read these tips to keep out of trouble with the IRS, bankruptcy
courts and your bank.
1. Keep Taxes Current. Rule Number One for the owner of any struggling business is to meticulously pay all payroll
taxes on time, especially those withheld from employees’ paychecks. Even if you operate your business as a corporation or
LLC, the IRS and state tax authorities can hold you personally liable for these taxes plus penalties if they’re not paid.
And even if the business goes bankrupt, you are still personally and legally on the hook to pay them.
2. Stave Off Cash Flow Problems. When you realize you don’t have enough revenue to pay the bills coming due, slow
your “burn rate” immediately by cutting expenses to the bone. Then prepare a short-term cash projection and plan for
your immediate needs. Make a list of the monies owed to you, and collect as much of it as possible. Pay the necessary
items like taxes and overhead costs, but delay paying other bills by working with suppliers and other creditors.
3. Don’t Lie About Debts. When a business starts to have financial troubles, its owner may frantically try to borrow more
money. Before doing this, think carefully about whether your business is really likely to do better in the near future or if
you’re only likely to compound your debt problems by borrowing more money. If you do decide to apply for a new loan or
to consolidate old ones, be forthright in disclosing the financial condition of your business. If you misrepresent your debts
to get a loan, the law may regard your new debt as having been obtained by fraud. This would mean you are personally
liable for the debts, even if you go through bankruptcy. Where big bucks are involved, the debt could haunt you for many
years.
4. Be Careful About Transferring Business Property. Sometimes, out of desperation, a business owner will try to
protect personal assets by hiding them. Since creditors are used to ferreting out such hidden assets, by and large these
tactics are ineffective and are likely to give rise to civil and even criminal charges of fraud. Specifically, a business owner
shouldn’t (1) transfer assets to friends or relatives in an effort to hide them from creditors or from the bankruptcy court, or
(2) conceal property or income from a court.
5. Avoid Preferential Payments to Creditors. The Bankruptcy Code frowns on your paying some creditors and not
others. This is called "making preferential payments.” If you file for bankruptcy, all payments you make during the year
before the filing will be scrutinized by creditors to make sure that some creditors weren’t given an unfair advantage by
being paid while others received little or nothing. Outside of bankruptcy, if you owe money to creditors who hold collateral,
the creditors have special rights in the property that is the security for the debt, but you may legally pay one unsecured
creditor ahead of the others.
6. Protect Your Bank Account. If you face serious financial problems and owe money to a bank, it’s often wise to keep
most of your checking and other accounts elsewhere. This is because typically your loan agreement gives the bank the
right to take your funds without prior notice if the bank thinks you’re in financial trouble. (This is called a "setoff.") It can
be a rude surprise to learn that your favorite lender has suddenly drained your checking account.
7. Plan for Ongoing Insurance Coverage. If your business winds up in a Chapter 11 reorganization or you end up in
a Chapter 13 reorganization under the Bankruptcy Code, you may have a tough time finding an insurance carrier that’s
willing to renew your business coverage or one that’s willing to issue a new policy. So if you’re planning to seek bankruptcy
protection, make sure you have insurance in place that extends at least 12 months into the future. You’ll need to make
payments on the policy as payments become due, but as long as you pay on time, the insurance can’t be canceled, and
you’ll enjoy some peace of mind as you continue in business.
8. Don’t Panic About Utilities or Your Lease. If you declare bankruptcy, the utility companies can’t use your
bankruptcy filing as an excuse for shutting off services, although they can require you to post a reasonable deposit to keep
on the lights, phone service and heat. Similarly, as long as you continue to pay your rent, your landlord can’t kick you out.
Don’t be spooked by the scary clause commonly placed in commercial leases that says you’re automatically in default if
you file for bankruptcy. These clauses are generally not enforceable (but may be enforceable against sublessees and
assignees).
9. Consider Returning Some Leased Property. If you’re leasing equipment and know you won’t want to retain it after
you file for bankruptcy, consider giving it back to the leasing company before you file. If you do so and the equipment is
currently worth less than what you owe under the lease, this “deficiency” will get discharged in bankruptcy. On the other
hand, if you prefer to keep the leased property, you’ll need to continue making your lease payments on time -- when you
choose to hang onto leased property, the obligation to make lease payments isn’t discharged by your going through
bankruptcy.
10. Don’t Borrow From the Company’s Pension Plan. Many pension plans don’t allow you to borrow (or remove)
money from the plan account. If you do, you could be assessed a penalty of up to 115% of the “borrowed” money. Worse,
the plan could be "disqualified," meaning that all deductions would be disallowed, all plan assets distributed, and income
tax and late payment penalties applied. Other plans may allow you to borrow money for approved purposes, but think
twice before you do this: It leaves you with a smaller nest egg, and if you fail to pay back the loan, you could end up
paying income taxes on the withdrawal, plus penalties of 10% to 25%.
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Copyright 2006 Nolo

Buying a Business: What You Need to Know


From the Nolo Business & Human Resources Center
Thinking about purchasing an existing business? Here are some things you should know before you take the
plunge.
For some people, buying an existing business is a better option than starting from scratch. Why? Because someone else
has done much of the legwork for you, such as establishing a customer base, hiring employees, and negotiating a lease.
But if you want to buy a business, you'll need to do some thorough research to make sure that what you see is what
you're going to get.
What Type of Business Should You Buy?
The kind of business you should buy depends on the types of work you've done in your life, classes you've taken, or
perhaps special skills you've developed through a hobby. It's almost always a mistake to buy a business you know little
about, no matter how good it looks. Not only will you have to struggle up a big learning curve after you buy it, but you
might not know enough about the industry to determine whether a particular company is a good value in the first place.
In addition to buying a business in an industry that you know, try to choose one that you love. It's less difficult -- and a lot
more fun -- to succeed in business when you enjoy the work you're doing.
Finding a Business to Buy
After you've decided what type of business you want to buy, you're ready to begin your hunt for the perfect company.
Consider starting your search close to home. For instance, if you're currently employed by a small business you like, find
out about the present owner's circumstances and whether she would consider selling the company. Or, ask business
associates and friends for leads on similar businesses that may be on the market. Many of the best business opportunities
surface by word of mouth -- and are snapped up before their owners ever list them for sale.
Other avenues to explore include newspaper ads, trade associations, real estate brokers, and business suppliers. Finally,
there are business brokers -- people who earn a commission from business owners who need help finding buyers. It's fine
to use a broker to help locate a business opportunity, but it's foolish to rely on a broker -- who doesn't make a commission
unless he makes a sale -- for advice about the quality of a business or the fairness of its selling price.
Research the Business's History and Finances
Before you seriously consider buying a particular business, find out as much as you can about it: thoroughly review copies
of the business's certified financial records, including cash flow statements, balance sheets, accounts payable and
receivable, employee files, including benefits and any employee contracts, and major contracts and leases, as well as any
past lawsuits and other relevant information.
This review (lawyers call it doing "due diligence") will tell you a lot about the company you're buying and will alert you to
any potential problems. For instance, if a major contract doesn't allow the current owner to assign it to you without the
other party's permission, you should enlist the owner to help you obtain the other party's consent.
Don't be shy about asking for information about the business. Here are some other details you should determine before
you commit yourself to buying a particular business:
1. who holds title to company assets
2. whether there is any potential or ongoing litigation
3. whether there have been any workers' compensation claims or unemployment claims made by company
employees
4. whether the company has consistently paid its taxes, and any potential tax liabilities
5. whether any commercial leases and major contracts can be assigned to the new owner
6. whether the company has given any warranties and guarantees to its customers
7. whether the company owns trade secrets, and how it protects them
8. whether the company owns patents and copyrights
1. whether the company holds registered trademarks
2. whether business licenses or tax registration certificates are transferable
3. whether the business is in compliance with local zoning laws
4. whether there are any toxic waste or environmental problems, and

5. if the business is a franchise, what it will take to get the necessary franchisor approval.

This isn't an exhaustive list; you should also review any business records that will provide you with information to help you
decide whether the business is a smart purchase. If the seller refuses to supply any of this information, or if you find any
misinformation, this may be a sign that you should look elsewhere for the right business to buy.
Closing the Deal
If you've thoroughly investigated a company and wish to go ahead with a purchase, there are a few more steps you'll have
to take. First, you and the owner will have to agree on a fair purchase price. A good way to do this is to hire an
experienced appraiser who can estimate the company's fair market value. Next, you and the business owner will agree on
which assets you will buy and the terms of payment -- most often, businesses are purchased on an installment plan with a
sizable down payment.
After you have outlined the terms on which you and the seller agree, you'll need to create a written sales agreement and
possibly have a lawyer review it before you sign on the dotted line. One good resource is Buying a Business: Legal &
Practical Steps, by Attorney Fred S. Steingold (Nolo), which contains a fill-in-the-blank sales agreement.
Click here for related information and products from Nolo
Copyright 2006 Nolo

Buying or Selling a Business: an Overview


From the Nolo Business & Human Resources Center
Here are the steps you'll need to take when you're considering selling or buying a business.
Each year some 700,000 American businesses change ownership. Most of these are small and mid-sized businesses: retail
stores, beauty salons, quick-print shops, restaurants, tax preparation services, landscapers, electrical contracting firms,
and modest manufacturing operations -- to mention just a few. If you are intending to buy or sell a business and want to
get the best deal possible, expect to do a lot of planning and preparation. Buying or selling a business is a big event in
most people’s lives.
Selling a Business
If you’re selling a business, keep in mind that no matter what kind of business you own -- a professional services
company, a neighborhood bagel shop, or a home-based website that sells imported garden tools -- there’s likely to be a
buyer out there looking for a business like yours if the price is right. But finding the right buyer and selling the business on
favorable terms will require both planning and hard work.
Your first step is considering whether you’re ready to sell. Other steps will include understanding the sales process,
preparing your company for sale, setting a price, seeking potential buyers, negotiating and preparing a sales agreement
and other documents, and closing the deal.
Buying a Business
If you’re planning to buy a business, you have also many factors to consider. These include whether owning a business is
right for you or for your lifestyle, what the potential for success in the field you’ve chosen is, and the risks involved in the
business you’re considering. Owning a business can mean that you have signed on for longer hours and more worries than
you’ve ever experienced as a hired hand -- but then again, if you succeed, the financial and personal rewards are yours to
savor. And of course, if you own your own business, no one can fire you.
After weighing those factors, if you decide to go ahead, there’s a slew of other things to consider, such as whether to buy a
franchise or an independent business, how to find a business for sale, and how to know whether the asking price is
reasonable, and how to research the business's history and finances (what lawyers call doing "due diligence").
Whether you're selling your long-held business or buying a new one, enjoy this next, fresh phase your life!
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Copyright 2006 Nolo
Figuring Out What Your Business is Worth
From the Nolo Business & Human Resources Center
You'll need to use several different methods to set a price that maximizes the value in your business.
Before you can put your business on the market, you need to figure out how much it's worth. Price your business too high
and you'll scare off potential buyers. Price it too low and you'll leave money on the table. But if you hope for precision in
pricing your business, you'll be disappointed. No pricing formula, expert estimate, or clairvoyant can provide a sales figure
that's exactly “right.” So while you need to price your business sensibly, you won't know how much it is really worth until
the day a buyer writes you a check.
Even though you can't know in advance exactly what your business will sell for, you can arrive at a reasonable asking
price, or a price range you may be willing to accept. Some approaches to pricing a business are:

1. Income valuation approach. Analyzing the business's revenue is one way to come up with a fair price for the
business. This assumes that the buyer is looking at a business as just one more type of investment competing with stocks,
bonds, real estate, and so on. The question then becomes “What kind of return can the buyer expect from an investment
in this business?”

2. Asset-based approach. This approach puts a price on the business by totaling up the value of all of the assets,
starting with tangible ones such a furniture and including intangible ones, such as trademarks or copyrights. This approach
is usually based on your assets' resale value, not how much it would cost to replace them.

3. Industry formulas and rules of thumb. There are formulas that may be used in your industry, such as three
times your earnings averaged over a three-year period, or two times the book value of your company. These rough guides
can give you an idea of the current market, but they may be too simplistic to do more than that.
But the closest to an ideal way to set a value on your business is to see what other enterprises like yours have sold for. In
the real estate business, this is called looking at comparables. But unlike house sales, where it's usually not too difficult to
find recent sales of homes more or less like yours, in the business world there may have been few, if any, recent sales of
businesses similar to yours. What's more, because small businesses tend to be unique, even if you are able to find a
somewhat similar sale in your field or area, the business won't be the same as yours in terms of location, sales volume,
number of employees, and a host of other important factors.
Professional resources you can use in pricing your business include accountants, brokers, appraisers, and seminars on
valuing a business. Accountants will help you organize and evaluate your financial data. Brokers, besides knowing about
potential buyers, may also be able to track down elusive information about sales of comparable businesses in your
industry. Appraisers can help you set a price for the business or just value your business's assets.
Depending on your business, the low end of your price range will probably be little more than the liquidation value of the
assets. The high end is likely to be based on income projections and what an enthusiastic buyer might pay for the right to
receive (and hopefully increase) those earnings in the future. If you have a healthy business -- especially one with a well-
established customer base and positive reputation -- you'll probably pick an initial asking price towards the top of your
range and then, if necessary, be prepared to back off a bit in negotiating the final price.
Several factors that don't involve the business's income, assets, or comparables also go into pricing a business. These
include:
1. terms of payment
2. type of buyer
3. market demand, and

4. your personal needs.

You'll need to take into account the general economic climate as well as trends in your industry -- positive or negative.
And, of course, if you have to sell quickly, you may be required to settle for less than you'd receive if you could take your
time.
And while of course you'd like the sale price to be as high as possible, you need to be sure that the overall deal -- price
and payment terms -- is realistic. You also need to feel reasonably certain that the buyer is unlikely to falter in making
payments over time, as installment arrangements are extremely common in business sales.

Need More Help?


Nolo's book, The Complete Guide to Selling a Business, by attorney Fred S. Steingold (Nolo), guides
you through the entire selling process, from setting and negotiating a price, to preparing a sales
agreement and going to the closing. It includes a sales agreement, promissory notes, and security
agreements, as well as confidentiality, noncompete, and consulting agreements.

Click here for related information and products from Nolo


Copyright 2006 Nolo

Deciding When and Whether to Sell Your Business


From the Nolo Business & Human Resources Center
Consider these questions before you sell your business.
Deciding to sell a business you have founded, nurtured, and grown can be agonizing -- or liberating. Owners choose to sell
their businesses for many reasons, from choosing to retire to deciding to transfer an unprofitable business to new
management with new ideas.
You should consider the factors that make your business saleable -- or might make it hard to sell. Your profits history, your
current sales trends, your location, and having premises and equipment in good repair are all elements that can make a
business desirable or less so. In addition, there are ways to make your business appear more profitable, such as lowering
your own cush salary or removing perks that you have been getting from the business, such as extensive travel and
expensive seminars.
You also need to choose the best time to sell your business. This will be affected by business cycles, which wax and wane
with the economy and other events. Obviously, you’d like to sell your business when market demand is high, not low. If
your geographical area or business sector is experiencing a recession, you may want to wait until things improve. Other
factors that can help you decide when to sell include changes in the neighborhood, the health of your business, interest
rates, and industry trends.
If you’re considering a sale, think about these questions to make sure you’re ready to move onto the next step, preparing
your business for selling:
1. Is my business saleable for a reasonable price?
2. Will I get enough money to justify all my hard work?
3. Will I really be improving my financial or personal situation?
1. Are there steps I can take to make the business more attractive to potential buyers?
2. Is this the best time to sell?

3. Do I want to maintain a relationship with the business? Explore ways to stay attached to your business if you so
choose -- at least for the short term.
4. What will I do next? Think about how you’ll earn a living after the sale so that a noncompete agreement with the
buyer of your business won’t sideline you.
In addition, understanding the steps involved in selling your business can help you make a better decision about whether
the time is right to sell your business and how to best go about it. For more information, see The Complete Guide to
Selling a Business, by attorney Fred S. Steingold (Nolo). It will walk you through the entire process step-by-step.
Click here for related information and products from Nolo
Copyright 2006 Nolo

What to Investigate Before You Buy a Business


by Attorney Fred S. Steingold
From the Nolo Business & Human Resources Center
Take these steps to make sure the business is a good investment.
Some call it “due diligence.” I call it “common sense.” It’s the idea that before you buy a business, you need to know what
you’re getting into.
Buying a business can be a fantastic opportunity -- or a disaster waiting to happen. You should x-ray a business to detect
any hidden problems, which you can do by knowing the questions to ask and the papers you should look at. Some
information, such as the extent of equipment liens, will be available from public sources. For other information, your main
source will be the owner of the business.
Before a business owner shares sensitive information with you, you may be asked to sign a confidentiality agreement.
That’s a reasonable request. It assures the owner that you’ll use the information only to check out the business, and not
for any other reason. Make sure the confidentiality agreement lets you share the information with your lawyer and
accountant.
There’s no hard-and-fast rule about when you’ll get your hands on the information you need. It can be early on -- for
example, before you’ve signed anything but a confidentiality agreement. Or it can be after you’ve signed a non-binding
letter of intent. It can even be after you’ve signed a purchase agreement. But if that’s the case, be sure you can walk away
from the deal if you’re unhappy with what your investigation discloses.
All right. Now let’s get down to the specifics.
Learn About the Business Finances
Learn all you can about the financial condition of the business. Even if you think you can make a decent profit, you need to
see how the current owner has done. Some of the documents worth looking at include:
1. the current balance sheet
2. profit and loss statement (for past 5 years)
3. tax returns (for past 5 years)
4. audited financial statements
5. unemployment tax returns
6. sales tax returns
7. accounts payable, and

8. accounts receivable (With accounts receivable, a list may not be good enough. You need to know more about the
individual accounts, as some of them may not be collectable.)
You also need a list of business debts -- and information on whether the creditors have a security interest (lien) on any
business assets. To double check on liens, you or your lawyer can do a lien check at the public office where liens are filed.
This is often called a UCC-1 search. UCC stands for Uniform Commercial Code -- the basic business law that’s in effect in
virtually every state.
Banks, suppliers, and other creditors typically file a UCC-1 form to protect their interests when they extend credit to a
business. If a secured debt isn’t paid, the creditor can seize and sell the secured assets.
Inspect the Physical Assets
Your purchase may include physical assets such as equipment and inventory. Make sure the equipment is in good working
order. Consider hiring an expert to check it for you. Also, find out if the business owns the equipment or is just leasing it.
If the equipment is being leased, look at the terms of the equipment lease and make sure you have the right to take over
the lease.
As for inventory, see that it’s up to date and marketable. You don’t want to pay good money for obsolete goods that you’ll
have to sell at distress prices or cart to the dump.
Get Consent to Take Over the Lease
Most businesses occupy leased space. You need to get a copy of the lease and review it carefully. How long will the lease
last? Will you have an option to renew it? Are the rent terms acceptable? Can you live with the lease's restrictions?
Make sure it’s okay for the business to continue to occupy the space under your ownership. The lease may require the
landlord’s consent for you to take over the lease -- especially if the current business is owned by a sole proprietorship or
partnership. Talk to the landlord directly about this.
While you’re at it, have the landlord confirm that the current business owner is up to date on rent payments. You’d hate to
take over the business, only to learn that the lease is in default and that you’re facing eviction.
In talking to the landlord, you may want to negotiate a new lease -- one with a longer term or lower rent, perhaps. Give it
a try. Be prepared to show why it’s in the landlord’s best interest to cut a deal with you.
Check the Business's Legal Status
If the business is owned by a corporation or LLC, there are two scenarios. One is that you’re buying the assets of the
business. The other is that you’re buying the business entity itself (which owns the assets). Buying the assets is usually
the better option for the buyer.
But if your plan is to buy the business entity -- the stock of the corporation or the membership interests of the LLC -- then
you need to see the documents that created the entity and also any related documents such as bylaws, resolutions, and
operating agreements.
Confirm that the business is in good standing with the state and that the owner has legal authority to sell it.
Finally, ask the owner of the business (no matter what its legal structure) to tell you of any pending or threatened lawsuits
or governmental proceedings. You and your lawyer can then evaluate your own exposure if you decide to buy the
business.
Get the Owner's Guarantee
Even after you’ve carefully investigated the business, other surprises may be lurking in the background. Have the current
owner personally guarantee that the information you have is complete and accurate. You can put this in the purchase
agreement under the heading, “Representations and Warranties.”
Hold Back Some of the Purchase Price
If you decide to buy the business, don’t pay the full purchase price at closing. Arrange for at least part of it to be paid six
months or a year down the road. That way, if you suffer a loss because the owner failed to disclose crucial information (a
debt, for example, or a tax liability), you can deduct the money from what you owe.
You can either withhold a set amount of money for a period of time or have the seller place some of your purchase money
in escrow. (Place money with a third party, called an escrow agent or escrow holder.) If you and the seller agree to place
money in escrow, write up a short escrow agreement (the escrow holder may have one for you).
Record the Terms of the Deal in a Contract
Be sure to record all the terms of the purchase in a written contract, including a list of all assets being purchased and their
value. Your contract should also mention your promissory note and security agreement, if you will sign these additional
documents. Nolo provides all of these documents in each of these products: Buying a Business: Legal and Practical Steps,
by Fred Steingold, and Quicken Legal Business Pro software.
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Copyright 2006 Nolo

Checklist for Closing Your Business: 20 Things You Need to Do


by Attorney Bethany K. Laurence
From the Nolo Business & Human Resources Center
Closing your business often requires more steps than starting it.
1. Vote to close the business following the procedures set out in your organizational documents or your state’s
business statutes. (This doesn't apply to sole proprietors.) Record the decision.
2. Dissolve your business officially: Obtain a "tax clearance" if necessary and file the required forms, such as a
"certificate of dissolution."
3. Cancel state or county permits and licenses, including your seller's permit, business license, and fictitious or
assumed business name.
4. Cancel your lease and insurance policies. Give your landlord the required notice stated in your lease -- at least 30
days.
5. Collect outstanding accounts receivable (before you notify customers you're going out of business).
6. Notify your employees and plan to pay them their last paychecks within the amount of time required by state
law, and if your state requires it, the value of accrued, unused vacation days as well.
7. Notify your customers and fulfill any contractual obligations, if possible. Return any deposits or payments for
goods not delivered or services not rendered.
8. If you're sitting on saleable inventory, consider a "going out of business" sale.
9. Make your final federal and state payroll deposits.
10. Submit final sales tax forms and funds due up to the closeout date.
11. Notify your creditors: suppliers, lenders, service providers, and utilities.
12. Comply with "bulk sales laws," if required. (If you plan on selling off the majority of your inventory and your
business is retail, wholesale, or manufacturing, you may need to notify your creditors a specific number of days
before you close your business, and in some states, to publish a notice of your impending closure in a local
newspaper.)
13. Settle or pay all of your business debts -- money owed to your landlord, bank, suppliers, utilities, and service
providers.
14. Ask for letters indicating that your bills are paid in full as you pay off each creditor.
15. Cancel your business credit cards.
16. Close your business bank account.
17. File your final employment-related tax returns:
○ IRS Form 940
○ IRS Form 941

○ state tax withholding and wage reporting forms.

18. File your final income tax returns, checking the box stating that this is your final return.

19. If you sell business assets, file IRS Form 4797, Sales of Business Property or, if you sell the bulk of your business
assets to one buyer, file IRS Form 8594, Asset Acquisition Statement.
20. Leave contact information with former business contacts, colleagues, and employees.
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Copyright 2006 Nolo

Eight Key Steps to Selling Your Business


by Attorney Fred S. Steingold
From the Nolo Business & Human Resources Center
Follow these steps on valuing your company, negotiating the deal, and creating a sales agreement.
This year, some 700,000 American businesses will be sold. Most will be small and mid-sized businesses like yours. If you,
too, are thinking of selling, consider these practical steps for making the process go smoothly.
1. Determine a Realistic Price Range
If you price your business too high, you'll scare away buyers. If you price it too low, you'll risk selling at a bargain
basement discount. Your goal is to figure out a range that's realistic.
Pricing a business is both an art and a science. There are several methods you can use -- and then maybe blend the
results. For example, you can base the price on the value of the business's assets, and add in a sum for the goodwill the
business has developed. Or you can see what comparable businesses in your industry and locale have recently sold for. Or
you can use an industry formula (for example, a value based on the number of units sold annually or a multiple of average
earnings) that will help set a price range.
2. Understand the Tax Consequences
Taxes can take a huge bite out of the money you receive for your business. It pays to know just how big that tax bite will
be -- and to try to lower it if possible. But be careful: taxes can get complicated. You'll probably need help from a CPA or
other tax expert.
Your tax bill will be influenced by two key factors: How your business is legally set up and -- in the case of a corporation or
LLC -- whether you're selling the assets or the entity. Sales of all sole proprietorships and almost all partnerships are asset
sales. So are the sales of many corporations and LLCs.
In an entity sale, you sell all of the corporate stock in the company or all LLC members' membership interests. The buyer
winds up owning the entity itself. In that case, the stock or membership interests are treated as capital assets. This means
the gain is taxed at the low, long-term capital rate (assuming you owned the stock or membership interests for more than
a year).
In an asset sale, you allocate the sale price to the various assets -- for example, furniture, equipment, supply contracts, the
business name -- and you classify the assets in seven IRS classes, such as inventory, other tangible property, and
goodwill. The gain from property in some classes is taxed at ordinary income rates. The gain from property in other classes
is taxed at the long-term capital gain rate, if owned for more than a year.
3. Prepare for a Sale
The getting-ready process, of course, includes sprucing up your business premises -- everything should be attractive and
orderly. But more important is getting your numbers in good shape. Consider recasting your tax-return numbers for
prospective buyers. This can involve, for example, adding back to your profits discretionary expenses such as:
1. medical insurance for you and your family
2. travel and entertainment
3. conventions and trade shows
4. expensive cars owned or leased by the business
5. club memberships
6. subscriptions to magazines, newspapers, and electronic services
7. continuing education expenses, and

8. salaries and bonuses paid to family members who work in the business.

For instance, let's say you enjoy travel so you've been attending trade shows at attractive locations. You've deducted the
cost as legitimate business expenses -- lowering your tax bill, but also lowering the bottom line.
A buyer needs to understand that the travel is discretionary. If it's eliminated, the business will show more profit for its
new owner. In recasting your tax numbers, you're not deceiving either the IRS or prospective buyers. You're simply
pointing out that the buyer may prefer not to spend money on some of these items in the future, even though you've
taken perfectly proper tax deductions for them.
4. Seek Potential Buyers
If your business is well known, word that it's for sale may be enough to bring prospective buyers to your doorstep. Or,
possibly someone close to you -- an employee, a relative, a friend, a supplier, or a customer -- could be an interested and
logical prospect.
But finding buyers may not be easy. More likely, you'll need to reach out to a bigger pool of potential buyers. This often
includes putting ads in newspapers, in trade publications, and on business-sale websites.
You may want to engage a business broker to reach more buyers -- though you'll pay a substantial commission for the
broker's services. Sometimes, too, you need keep a low profile in your marketing efforts to avoid alarming customers and
suppliers. An intermediary such as a broker can help keep information from leaking out prematurely.
5. Negotiate Your Deal
Once you attract an interested buyer, you need to work out the terms of the sale. Here are some key issues:
1. Will you sell your business entity or just its assets?
2. Will you keep some of the assets (a car or truck, perhaps) that are currently being used in the business?
3. Will the buyer pay you in one lump sum or make installment payments?
4. In an installment sale, how large will the down payment be and how long will the buyer be given to pay off the
balance?
5. After the closing, will you work for the buyer, either as an employee or an independent contractor?

6. Will the buyer require you to sign a non-compete agreement that limits your right to work in your current
industry?
6. Sign a Sales Agreement
Once you've worked out the key terms with the buyer, you need to put the deal in writing. Among other things, you'll need
to list all of the assets the buyer is purchasing and the value you will assign to those assets for tax purposes and any
business contracts the buyer is assuming, including business leases. Your sales agreement should also include protections
that assure you'll get paid the full sale price.
In an installment sale, it makes sense to require the buyer to have a spouse or other cosigner guarantee payment of the
balance owed. And, for sure, you'll want to retain a security interest in the business until the sale price is fully paid. You
may even find it prudent to take a lien (a second mortgage) on the buyer's home or other real estate.
If you attempt the first draft of the sales agreement yourself, have it reviewed by a business lawyer to make sure you've
covered all the bases.
7. Plan for the Closing
The closing is the meeting at which you transfer the business to the buyer. To reduce the chance of last-minute hassles,
make a checklist of all the papers you'll be bringing and all that the buyer is expected to bring. While every sale is
different, here's a list of common documents and items that you may need to bring with you.
1. Alarm codes, computer access codes, and safe combinations
2. Asset allocation statement (IRS Form 8594)
3. Bill of sale or transfer documents for license, real estate, and vehicles
4. Cashier's check
5. Consent of entity owners to sale of assets
6. Consulting contract (independent contractor agreement)
7. Covenant not to compete (noncompete agreement)
1. Customer lists
2. Employment contract
3. Escrow agreement for post-closing adjustments
4. Insurance certificates for the policy covering secured assets
5. Keys to file cabinets, premises, and vehicles
6. Mortgage or deed of trust
7. Owners' manuals for business equipment
8. Promissory note
9. Security agreement
10. Statement regarding absence of creditors
11. Supplier lists
12. Title insurance commitment
13. UCC financing statement
8. File Paperwork With the IRS
After the sale, you and the buyer need to complete IRS Form 8594, Asset Acquisition Statement and file it with your tax
returns for the year in which the sale took place. You and the buyer should fill out the form together, allocating the
purchase price among the assets purchased and classifying the assets among the various IRS categories, and file duplicate
copies of the form.

For More Information

Nolo's book, Sell Your Business: The Step-by-Step Legal Guide, by attorney Fred Steingold (Nolo),
guides you through the entire selling process, from deciding whether to sell to preparing a sales
agreement and going to the closing. It includes a sales agreement, promissory notes and security
agreements, and confidentiality, noncompete, and consulting agreements.

Click here for related information and products from Nolo


Copyright 2006 Nolo

Closing Your Business: What You Need to Do


by Attorneys Bethany K. Laurence & Shannon Miehe
From the Nolo Business & Human Resources Center
Follow these steps to close your business safely and legally.
So you've decided to close down your business -- maybe you're not making it financially, you don't have the time or will to
manage it anymore, or you're moving on to the next "big thing." Whatever your reasons for closing your business, there
are a few legal tasks you need to undertake to protect yourself, your credit, and your reputation in the community,
especially if you ever want to go into business again. Here are the main steps you'll need to take to shut your business
down legally and minimize the risk to your personal assets:
1. Vote to close the business
2. Dissolve your business with the government
3. Cancel permits, licenses, and fictious business names
4. Pay your taxes and debts
5. Notify your creditors, employees, and customers
Vote to Close the Business
If you have been operating as a sole proprietor, you simply make the decision on your own, or with your spouse, and skip
to the next step.
If you have been doing business as a corporation, limited liability company (LLC), or partnership, you and your business
associates must agree to dissolve the entity by following either the procedures set out in your organizational documents or
the rules set out in your state's business statutes. Usually, these rules require at least a majority of the owners to agree on
dissolution, but they could require a two-third's or even unanimous vote. Dig up those documents to make sure you
conduct the voting correctly, or check your state's corporation, limited liability company, or partnership statutes to find out
what the rules are. You can get to most states' business statutes by clicking here: www.nolo.com/statute/state.cfm.
Make sure you record your decision with a resolution in the minutes of a meeting or with a written consent form.
Dissolve Your Business With State and Local Government Offices
If you have been doing business as a corporation or limited liability company, you need to officially dissolve your entity so
that you are no longer liable for business taxes or filings in your state. Officially dissolving your business also puts creditors
on notice that your entity can no longer incur business debts.
Your state corporations or LLC unit -- usually a division of the secretary of state -- should have the necessary forms. For
instance, a California corporation must submit to the California Secretary of State a "certificate of dissolution" and a
"certificate of election to wind up and dissolve." These forms set out the disposition of your business's debts and liabilities,
the distribution of your business assets, and how you and your co-shareholders elected to dissolve your business. LLCs
have to file similar documents (sometimes called "articles of dissolution").
In some states, before you will be allowed to formally dissolve your business, you may also be required to obtain a "tax
clearance" or "consent to dissolution" from your state tax board, declaring that all of your business taxes have been paid.
The rules and forms for dissolving a business entity (including information or links to the state tax board requirements) are
usually posted on your state's secretary of state's website; you may have to look under FAQs for information. To find a link
to your secretary of state's website, go to www.statelocalgov.net.
If you have been doing business as a partnership, you may need to file a dissolution form with the state, particularly if you
filed paperwork with the state when you formed your partnership. (For instance, in California, if you filed a "statement of
authority" with the Secretary of State when you formed your partnership, you must file a "certificate of dissolution" when
you dissolve your partnership.) Required or not, it's a good idea to file dissolution paperwork if you can, to put creditors on
notice that the partnership can no longer incur debts. This is especially important if you are involved in a general
partnership, where any partner can usually bind the partnership to a deal and every partner is personally liable for all
business debts.
Cancel Permits, Licenses, and Fictitious Business Names
No matter what kind of business you have, you should cancel any kind of permit or license you hold with the state or
county -- you don't want anyone else to use your seller's permit or business name, for instance -- that could make you
responsible for any taxes and penalties incurred after you no longer operate the business.
If you have a seller's permit or business license, contact the agency that issued the permit or license and cancel it.
Likewise, if you've been using a fictitious or assumed business name, file an "abandonment" of the name and publish it in
a local newspaper -- contact your county clerk's office for a form.
Pay Your Taxes and Debts
First and most importantly, if you have employees, make your final payroll tax deposits and file all of your final
employment tax paperwork on time. Also, the federal and state employment tax authorities need to know you're going out
of business -- the federal unemployment tax return (IRS Form 940) and the employer's federal tax return (IRS Form 941)
have a box you can check indicating you will not be filing future returns, and your state withholding and wage reporting
return should have one as well.

If You Can't Pay Your Payroll Taxes

The IRS can hold you and any co-owners personally liable for payroll taxes, even if your business
operated as a corporation or LLC. This means the IRS could take your personal assets, such as a car
or a vacation house, to pay your business debts. Filing bankruptcy is of limited help in this area. Your
only options may be to negotiate a payment plan with the IRS or get the IRS to accept a settlement,
called an "offer in compromise."

If you will be selling off some business assets to recoup some of your investment, you'll need to file Form 4797, Sales of
Business Property. (See IRS Publication 544, Sales and Other Dispositions of Assets for more information.) If you're selling all of
your business assets as a group, you may need to file IRS Form 8594, Asset Acquisition Statement instead.
As for income taxes, during tax time you will need to file a final tax return with the IRS and probably with your state tax
agency as well. For partnerships, corporations, and LLCs, the federal return has a box you can check indicating that it's
your final return. Sole proprietors just stop filing Schedules C and SE with their Form 1040.
If your business collected sales taxes, be sure to submit the final forms and funds that are due up to the closeout date to
the state office that collects your sales tax.
Before your last day in business, if you have employees, make plans to pay them their last paychecks. Most states require
employers to give employees their final paychecks on their last day of work or within a few days. Also, some states require
businesses to pay out accrued, unused vacation days at the same time.
Apart from taxes, you may have run-of-the-mill business debts -- money owed to your landlord, bank, suppliers, utilities,
and service providers. Notify these creditors of your upcoming closure and make plans to pay in full, or settle, all of these
business debts. (See "Notify Your Creditors, Employees, and Customers," just below, for more information.) If you have
paid off a particular creditor, ask for a letter indicating that your bills are paid in full.

If You Can't Pay Your Bills

If you fear you won't be able to pay all of your debts, you need to understand what options you have
and how to minimize the risk to your personal assets.
If you can pay some but not all of your debts and you are considering bankruptcy for help with the
rest, be careful not to make preferential payments to creditors such as friends and relatives.

Invariably, after you close up shop, a creditor will come out of the woodwork. If you have assets left, or cash left from
selling the assets, you should set aside some money for pote