2.1 Legally Starting a Business

Learning Objectives

By the end of this section, you will be able to:

Chapter 1 asked what kind of business you should be — sole proprietorship, partnership, LLC, S-corporation, or C-corporation. This chapter asks the question that comes next: now that you have chosen a structure, what do you actually have to do before you can legally open the doors?

The honest answer is that there is no single office you visit and no single form you file. Starting a small business in California means dealing with four different levels of government at once, and each one wants something different from you:

None of these agencies talks to the others on your behalf. Registering with the IRS does not register you with the state; getting a seller's permit does not get you a city business license. The burden of assembling the full set is yours, and this section walks through each piece in the order most new owners encounter it.

It helps to see the federal side as one connected checklist. The IRS frames the whole start-up decision as a series of questions a new owner has to answer, and points to where each answer lives:

Notice what that table implies. The federal government's view of "starting a business" is overwhelmingly about identification and recordkeeping — proving who you are, and being able to show what you did. That is the thread running through this entire chapter, and it is why registration (§2.1) and recordkeeping (§2.4) belong in the same unit rather than in separate ones.

One caution before we begin. The federal publications this section draws on address only tax considerations. Choosing and registering a business also has legal consequences — liability, contracts, employment law — that a tax publication deliberately does not cover. Chapter 7 returns to the question of when those consequences call for a licensed professional.

2.1.1 Business name registration (DBA / Fictitious Business Name Statement)

The first thing most new owners want is a name. The rule that governs it is simpler than it looks, and it rests on a single public-policy idea: anyone doing business with you should be able to find out who you actually are.

When a filing is required. If you operate a business under your own legal surname, no special name filing is generally needed — the name already identifies you. But the moment you operate under a name that does not reveal your real identity, you are using a fictitious business name, commonly called a DBA (short for "doing business as").

Examples make the line clear:

The last row matters. When you form an LLC or a corporation, the entity's registered name is created by the state filing itself, so no DBA is needed to use it. A DBA is needed when a business — of any structure — trades under a name other than its legal one.

Why the filing exists. A fictitious business name statement is a transparency device, not a protection device. It is a public record connecting a trade name to a responsible owner, so that a customer with a complaint, a supplier chasing an invoice, or a court serving papers can determine who stands behind "Riverbend Bookkeeping." Three consequences follow, and new owners routinely get all three wrong:

1. A DBA is not a business structure. Filing one does not make you an LLC and does not create any liability protection. A sole proprietor with a DBA is still a sole proprietor with unlimited personal liability (see §1.1.2).
2. A DBA is not a trademark. Registering a name with the county does not give you exclusive nationwide rights to it. Trademark protection is a separate federal and state regime.
3. A DBA is often a practical prerequisite for banking. Banks generally will not open an account in a trade name, or accept checks payable to that name, without evidence that the name is registered to you — which is why this step usually has to happen before §2.2's business bank account.

Where the filing is made. In California the fictitious business name statement is filed at the county level — with the county clerk of the county where the business has its principal place of business — rather than with the state. Counties commonly require the statement to be published in a local newspaper of general circulation for a set number of weeks after filing, with proof of publication returned to the clerk. Registrations expire and must be renewed periodically, and a new statement is required when the owner or the name changes.

Practical sequence. Because the DBA is frequently a prerequisite for the bank account, and is sometimes requested during local licensing, most owners file it early — typically right after settling on a structure and confirming the name is not already in use in the county.

Definition 2.1.1 — A fictitious business name (DBA): the county filing is what links a trade name back to a real, identifiable owner.

2.1.2 Obtaining an Employer Identification Number (EIN)

Every business must be identifiable to the IRS by a number. That number is a taxpayer identification number (TIN), and the whole of this subsection is really about one question: which TIN does your business use?

The three kinds of TIN. There are three, and they are not interchangeable.

An SSN is formatted 000-00-0000; an EIN is formatted 00-0000000. An ITIN is issued for tax use only — it does not entitle the holder to social security benefits and does not change the holder's employment or immigration status. An ITIN also expires if the taxpayer files no federal return, and is not claimed as a dependent on another's return, for three consecutive years.

Definition 2.1.2 — The three taxpayer identification numbers, and the question that routes a taxpayer to one of them.

Who must have an EIN. A sole proprietor with no employees can often operate using only an SSN. You must obtain an EIN if you do either of the following:

• pay wages to one or more employees, or
• file pension or excise tax returns.

Beyond those bright-line rules, EINs are assigned to sole proprietors, LLCs, partnerships, and corporations generally for tax filing and reporting purposes, and the instructions to Form SS-4 set out which businesses are required to have one. In practice, many owners who are not strictly required to get an EIN obtain one anyway, for two reasons worth understanding:

• Privacy. An EIN lets you give clients, suppliers, and payers a business number on Form W-9 instead of your personal social security number.
• Banking. Financial institutions typically ask for an EIN when opening a business account (see §2.2.1).

How to apply. There are several routes, and they differ sharply in speed:

Timing and edge cases. Apply early enough to have the number in hand by the time you must file a return or statement or make a tax deposit. If the EIN has not arrived when a return comes due, file the return anyway — write "Applied for" and the date you applied in the space for the EIN. Do not substitute your social security number for an EIN on a return that requires one.

You should have only one EIN for a business entity. If you find you have more than one and are unsure which is correct, contact the IRS Service Center where you file, give the numbers you hold along with the name and address each was assigned to and the address of your main place of business, and the IRS will tell you which to use. Certain changes in the form of a business can require a new EIN.

Collecting other people's TINs. Identification runs in both directions. Once you are in business you will make payments that must be reported on information returns, and those forms must carry the payee's identification number:

• Employees. Get an SSN from each employee, and record the name and SSN exactly as shown on the social security card. If the name on the card is out of date — after a marriage or divorce, for example — the employee should request a new card from the SSA.
• Non-employees. For a reportable payment to someone who is not your employee, obtain that person's SSN; for a reportable payment to an organization such as a corporation or partnership, obtain its EIN. Request either using Form W-9.

Definition 2.1.3 — The employer identification number: either bright-line trigger turns an EIN from optional into required.

Note the mirror-image obligation on your own side: you must furnish your TIN to anyone who will report payments made to you — including interest, dividends, royalties, dependent-care payments, and other amounts totaling $600 or more for the year — and failing to do so can expose you to penalties.

Definition 2.1.4 — Backup withholding: when no TIN is furnished, a portion of the payment is withheld and remitted to the IRS.

2.1.3 City and county business licenses and permits

Federal and state registration make your business identifiable. Local licensing is what makes it authorized to operate where it sits.

The general business license. Most California cities require any business operating within city limits to hold a general business license, and businesses in unincorporated areas typically license with the county instead. The license is usually renewed annually, and the fee is often scaled to gross receipts or number of employees. Its purpose is partly revenue and partly administrative: it tells the local government who is operating, where, and doing what.

Beyond the general license. A general business license is rarely the only local requirement. Depending on the work, a business may also need:

• zoning clearance or a use permit, confirming the activity is allowed at that address — the requirement most likely to derail a home-based or storefront plan late;
• building, sign, or fire permits for the premises;
• health permits for any business handling food;
• state occupational or professional licensing for regulated trades — contractors, cosmetologists, dentists, and dozens of others — which sits alongside, not instead of, the local license.

The practical problem, and the tool that solves it. No new owner can be expected to know, unprompted, which of the above applies to their particular trade in their particular city. California's answer is CalGold, a state-maintained permit-assistance website. You select your city or county and enter your business type, and it returns the permits and licenses that apply, along with contact information for each of the various agencies that administer and issue them.

CalGold is the single most efficient starting point for this subsection's work, because it converts an open-ended research problem ("what do I need?") into a bounded list with phone numbers attached.

2.1.4 California Seller's Permit (CDTFA) for businesses selling taxable goods

The last registration is the one with the sharpest test attached, and the one whose consequences reach furthest into the rest of this book.

Read that rule in pieces, because each phrase does work:

• "engaged in the business of selling" — this is about being in the trade, not about making a single sale. Occasional private sales of your own used property are not what the rule targets.
• "or leasing" — leasing tangible property can be a taxable activity too, which surprises owners who think of themselves as renting rather than selling.
• "tangible personal property" — physical goods. This is why a business that sells only services generally does not need a permit, while one that sells goods does. Many small businesses do both, and the presence of taxable goods sales is enough to trigger the requirement.
• "that would ordinarily be subject to sales tax if sold at retail" — the test looks to the character of the property, not to whether one particular sale turns out to be taxable.
• "for each place of business" — a second location generally means a second permit, not a shared one.

How to register. Registration is done through the CDTFA's website, www.cdtfa.ca.gov, where a business can:

• register for a California seller's permit;
• apply for a license or account for most other CDTFA-administered tax or fee programs;
• verify a CDTFA-administered permit, license, or account (useful when checking a supplier or customer);
• file a return and make a payment;
• find small business seminars and basic sales-and-use-tax classes.

Why this permit matters more than it looks. A seller's permit is not merely permission to sell. It creates an ongoing obligation to collect sales tax from your customers, hold it, report it, and remit it to the state on a schedule the CDTFA assigns you. That money is never yours — Chapter 5 develops the point at length under the heading of trust fund liabilities, and shows that misusing it can create personal liability for an owner regardless of whether the business is an LLC or a corporation.

Holding a permit also carries a recordkeeping obligation with its own retention period, separate from the IRS's. That rule is covered in §2.4.2.

Two related registrations frequently arrive alongside the seller's permit and are covered elsewhere in this book: the resale certificate system, which lets a permit holder buy inventory for resale without paying tax on the purchase (Chapter 5), and the filing basis — yearly, quarterly, or quarterly-with-prepayment — that the CDTFA assigns when the permit is issued (also Chapter 5).

Definition 2.1.5 — The seller's permit: Regulation 1699 read as five tests, all feeding one CDTFA registration per place of business.

Where this leaves you. At the end of §2.1 the business exists on paper: it has a name the public can trace, a number the IRS recognizes, local authorization to operate, and — if it sells goods — a state permit to collect tax. What it does not yet have is any separation between its money and yours, or any system for recording what it does. Those are the subjects of §2.2 and §2.3.

Problem Set 2.1

Key Terms