Things to do BEFORE Making Your First App
- You might want to sell your app business down the road. If you put your apps in your individual iTunes account, that might cause some sticking points. This isn't as much of an issue as it used to be, since Apple now allows app transfers between accounts. But its still something to consider.
- Legal protection. You wouldn't start any other type of business without considering this angle, so don't treat the app business differently. Yes, you might get sued as a result of running an app business or run into tax trouble (lets hope not of course). So protect your personal assets by creating a company to run the app business.
Setting up a company is easy. This discussion is limited to working in the USA although there may be similarities elsewhere. As I see it there are basically two choices:
- Limited liability company
A limited liability company is a flexible form of enterprise that blends elements of partnership and corporate structures. An LLC is not a corporation; it is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions. ...
Kind of helpful, but also a little bit vague. But what we get out of this is that a limited liability company protects your personal assets. That's what we're after. Beyond this, I found the description on Wikipedia to be somewhat inaccurate, at least as far as the US. They talk about electing to be a S or C corporation, but if you do that you're not an LLC. In the US an LLC is a distinct type of entity that has advantages of simplicity but some slight disadvantages when it comes to taxation. In a nutshell:
- An LLC creates a seperate legal business entity that is not a sole proprietorship or partnership. So it protects your personal assets and you can take on investors for a share of the company.
- Income from an LLC is just passed through to the owners. Basically, you will pay the tax on your share of profits as ordinary income.
- You will pay tax at the higher income tax rate (as compared to capital gains or dividends).
- You will need to save social security and medicare tax to cover your earnings from the business.
- 12.4 percent for Social Security. For 2013, this part of the tax applies to the first $113,700 of earnings. If you earn more than that (from self-employment or, if you also have a job, from the combination of your job and your business), then the 12.4 percent part of the tax that pays for Social Security stops for the year.
- 2.9 percent for Medicare. The Medicare portion of the self-employment tax doesn’t stop. No matter how much you earn, you'll pay the 2.9 percent Medicare tax. For more information on this tax, see IRS Tax Topic 554: The Self-Employment Tax.
Setting up your LLC
This isn't a book on starting a business, so I'm not going to go into the details. However setting up an LLC is amazingly simple. It requires a couple of steps:
- Decide what to name your business.
- Go to your states corporation website. Check the availability of your business name. Find the paperwork required to start an LLC.
- Fill out the paperwork, submit with fee.
- The state will mail you a letter or some kind of certificate. Your business is now official.
- Visit a bank with your documents, and open a business checking account.
- When Apple distributes your sales money each month, you can pay it out to yourself and partners as profits or create salaries for yourself (the more complicated option).
- At the end of the year, the LLC will issue a 1099-MISC reporting how much money they paid out to each of the owners. You need to report your 1099 income on your 1040.
So what is an S-corporation? For the answer, we again turn to Wikipedia, who tells us:
An S corporation, for United States federal income tax purposes, is a corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. In general, S corporations do not pay any federal income taxes. Instead, the corporation's income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns.
So, basically an S-corporation is like an LLC. But it has a huge advantage. When you create an S-corporation.
you can distribute profits as dividends. If you're making a lot of money, this could provide some good tax savings. Of course this is subject to change depending on what the clowns in Washington decide to do with tax rates. But for now, the tax rates are significantly lower than taxes on ordinary income. Moreover, it gives you a way to avoid FICA taxes.
And where the extra income is earned from passive dividends how much extra in FICA and Medicare taxes would they be paying? $0.
Read more about cutting your tax bill with dividends at http://www.financiallyintegrated.com/saving/cut-your-tax-bill-with-dividends/.
Setting up an S-Corporation
At this point, hopefully you've realized creating an S-corporation is the way to go. How do you do that? Follow these steps:
- Pick a name for your business.
- Consider incorporating in Delaware or Nevada to avoid paying some state taxes related to corporations.
- Get on the corporation commission websites and search to make sure your name is available.
- Pay the appropriate fees and submit the appropriate forms.
- It's to your advantage to use a legal service like Legalzoom to do this for you. A corporation is required to have certain documents and stock certificates and they not only get the corporation set up for you, they create these required documents.
- When you get your corporation approved and receive the paperwork from the state government and/or legalzoom or other service, issue stock certificates. When you create your corporation you need to declare a certain number of shares. To make it easy, create 100,000. Then issue shares based on ownership percentages. If you have an equal partner issue a stock certificate to each of you with 50,000
- shares each. Remember that when the company pays out dividends you each get 50% in that case.
- At the end of the year, your income in this case will be reported by the corporation as ordinary dividend payments on a 1099-DIV.
A final task before setting up your Apple developer account is to make sure you have an Employer Identifier Number or EIN for the business. This is basically like a social security number to identify the business.