It is the classic dream of entrepreneurship: to make a living doing what you love.
Whether it's taking a love of baking and starting a cupcake empire, or moving from a 9-to-5 job in IT to designing custom websites on your own schedule, there is are plenty of reasons to turn your personal talent into a money-making venture.
But all too often, budding business tycoons make the mistake of intermingling business affairs with their personal life. Some of you reading this right now might be wondering—am I doing well at my hobby, or am I starting to operate a company? It's important to realize that there are some immediate steps you can take to push your business to the next level. Follow these tips and you will be headed down the path from hobbyist to tycoon.
What's in a Name?
Many hobbyists that start selling their wares to friends, family and others often do so using a catchy name. If you operate a business (without a legal entity such as a corporation or LLC), you generally have to register this trade name with a state or county government. That way, your name is formally recognized.
The same thing goes for most business entities that want to do business under a name other than the company name. Without a “doing business as” name (also called a DBA, trade name, or fictitious business name), you can find it difficult to open a bank account--or transact business. Also, in states such as California, failure to register your business name can prevent you from taking legal action in the name of your business.
Of course, there are exceptions. For those that want to keep their personal name in the company name (for example “Rampenthal Law Firm”), you can generally do so without the need for a DBA.
One of the biggest business faux pas is commingling assets and funds. All too often a newly minted business owner keeps their personal bank account to deal with company expenses and income. I mean, if you are the only owner, what’s the point…right? Wrong!
You want to keep things separated. It might not be simple or convenient in the beginning, but it is worth it in the long run. As your company grows, you will be glad you set up bank accounts (checking, credit, etc.) detached from your personal life. One reason: at year-end, all business income and expenses will be in the same place, which makes bookkeeping and tax filing a lot easier. If you don't believe me, just go back six months and try to remember what expense was for the business or what deposit was personal. It gets tough! Annual record-keeping that is distinct from your personal finances also provides proof of business expenses--in case you get audited.
(Un) Limited Liability
Business owners who have taken the step to incorporate or form an LLC, but who haven't gotten around to separating assets and finances, are asking for trouble.
There is a concept in corporate law called "piercing the corporate veil"—which just means that someone suing your business can also sue you personally! One of the main reasons to have a legal entity is liability protection, and commingling funds is one way to undo all your hard work. When a court is deciding whether to allow a lawsuit to proceed personally against a business owner, it looks at a number of factors. If you commingle funds, you run the risk of a court buying the argument that since your assets are commingled, then so should be your liability. While piercing the corporate veil is rare, when it happens, it can be devastating for the business owner.
In addition to the record-keeping problems, having a formal business entity with separate accounts can give you tax flexibility as you grow your business. If you run a business without an entity, you are limited in filing your taxes--business loss and gain are recorded on Schedule C of your personal taxes. Many budding small businesses want the flexibility to offset their income with business losses. For the Schedule C filer, the goal is to offset personal income with your business losses. While this is possible, you can't do it forever. If your sole proprietor business runs a loss for three out of five years, the IRS will probably consider it a "hobby."
Once that happens, you will not be able to generate a tax loss that can be used to offset other taxable income. If you get a formal entity like a corporation or LLC, all this goes away. Try not to fret—it's not too late to take the steps needed toward legitimizing your hobby into a "real" business.
Chas Rampenthal is general counsel and vice president of product development at LegalZoom. This article first appeared on Inc.com.