Small businesses, explained

The US Small Business Association (SBA) classifies a small business as a privately-owned and operated business with a small number of employees. However, this can include up to 1,500 employees for some industries or profits less than $7 million (in some industries). In other instances, the SBA uses receipts or revenue to identify a small business.

In this article we will explain the difference between a small business and a commercial business, as well as the advantages and disadvantages of a small business. 

What is a small business?

As previously mentioned, a small business can be identified by either the amount of employees or its annual revenue. When running a small business, it is important to remember that there are different rules to follow, whether it comes to accounting or the law. A small business is

  • A profitable business with a legal structure
  • Located and run in the USA
  • Independently owned and operated
  • Not a monopoly in its field

When starting a small business, you also need to decide whether you are a small business owner or self-employed – after all, it can affect what your profits are. If you are self-employed, you can either be a sole proprietor, part of a partnership, or an independent contractor. As a sole proprietor, you are essentially a one-man business, responsible for all elements of the business and finances without a legal entity. Being in a partnership is very similar – it essentially involves two or more individuals who own the business and act as sole proprietors without a legal entity. Independent contractors are freelance workers who undertake contract work for other businesses. In all three categories, you are not considered to be an employee. Instead, the business begins and ends with you (and your partners).

If you run a small business, then you have employees. Having employees means taking responsibility for their taxes and salary, and requires a whole new area of accounting knowledge. One of the most common business types for a small business is a limited liability company. These are companies that bring together the concept of a corporation with a partnership or sole proprietorship. LLC members are not responsible for company debts or liabilities.

Commercial activities

The SBA has a variety of different criteria that define a small or large business depending on the industry. Here are the most common ones:

  • Manufacturing: As an employer, you may have anywhere from 500-1,500 employees and still be considered a small business. For example tobacco manufactures are allowed up to 1,500 employees, but retail bakeries can have a maximum of 500 to still be considered a small business.
     
  • Services: To be considered a small business in the service industry, your yearly receipts must not exceed $38.5 million.
     
  • Wholesaling: A small business wholesaler would have less than 500 employees.
     
  • Retail: A retail small business does not have annual receipts totaling more than $38.5 million.
     
  • Agriculture: Annual receipts must not exceed $750k in order to be considered a small business farmer.
     
  • Special trade contractors: As a small business owner in this field, your annual receipts must not exceed $15 million.
     
  • General and heavy construction: Your annual receipts must stay below $36.5 million to remain in the small business category.

Your business must adhere to SBA sizing classifications in order to file for small business tax returns, or to avail of contracts designated for small businesses.

Business name

There are a number of legal requirements that small business owners must adhere to when setting up their small business. Once you have come up with an idea for your business and created a business plan, you will have to:

  • Register your business name
  • Learn about and adhere to federal, state, and local taxes
  • Learn about and adhere to the relevant business laws and regulations
  • Obtain any relevant business permits and licenses

Registering your name

Depending on the type of business you are running, you may need to register your business. For the majority of small businesses, this will just involve registering your business name with local and state governments. It is often sufficient to register with a “Doing Business As” (DBA) or “Fictitious Business Name” (FBN). If you do not choose one of these, the company will simply be named after you. You are not required to register with the federal government to create your company, other than registering to receive a federal tax ID. If your small business is a non-profit, you can register as a tax-exempt entity with the Internal Revenue Service (IRS). You will also need to file with the IRS if creating an S or C corp.

If you are planning on expanding your business in the future to locations out of state, it is worth registering your name with the United States Patent and Trademark Office to ensure that only you have legal rights to the title.

Tax and accounting requirements

As previously mentioned, the US federal government does not legislate for any particular accounting method. As long as your accounts are clear, accurate, and can stand up to an inspection, the government is satisfied. You must also ensure that your chosen accounting method will allow you to accurately assess and pay your taxes. Cash basis and accrual accounting are acknowledged as best practice for small businesses. Cash accounting records income and expenses when money is exchanged, while accrual accounting records income and expenses when they are earned or billed, but perhaps not yet paid.

Small business tax obligations

The kind of taxes you pay as a small business owner depends on what kind of business you are. Sole proprietors, partnerships, and LLCs all have different tax obligations. Here is an outline of which taxes are relevant to which kinds of business:

  • Sole proprietors include their business taxes on their personal tax returns by preparing a Schedule C (profit or loss for a small business) and attaching that to Form 1040.
     
  • Partnerships file a separate tax return, and each partner in the partnership must also provide paperwork. The partnership itself is required to file an information tax return Form 1065, and each individual partner in the business will receive a Schedule K-1 that they include in their own Form 1040.
     
  • LLCs use either one of the above methods, depending on how many owners the company has. This is because an LLC is not a taxing entity.

As well as paying income tax, small business owners must pay self-employment tax which currently stands at a rate of 15.3% of income from self-employment business. Small business income taxes can be filed online or in the mail to the IRS, through their official website, or mailed to the address provided on Form 1040. If your business is in the retail sector, you will also be liable to pay state and/or federal sales taxes on your products. The SBA has a comprehensive guide to help you assess whether you are liable.

Since small business tax returns are filed as part of an individual’s personal tax returns, the deadline is the same as their personal income tax deadline which is April 15th of each year. Extensions are available for up to six months after the deadline.

Overview

There are plenty of advantages and disadvantages to starting a business of any kind. Risks are always going to be taken, things might not work out – but by starting a small business, you are in control of all aspects of your career which can be an exciting (and sometimes daunting) process. There are a whopping 28 million small businesses registered in the USA, and these businesses inject almost $8.5 trillion into the economy – that is almost half of the GDP for the entire nation. However, one must also keep in mind that almost 50% of businesses fail, and there are plenty of legal and bureaucratic hurdles to overcome, as well as endless hard work to make your business a success.

Click here for important legal disclaimers.