Disclaimer: This article is meant as a general introduction to starting a business and it does not cover all of the infinitely possible specific tax issues for your business. Be sure to consult with a business tax professional or business lawyer – do not rely on this guide for legal or tax advice.
Starting a Small Business in Hawaii – Business Entity Types
The most basic type of business you can set up is known as a sole proprietorship. As an entity type, the sole proprietorship does not require any official set-up or legal filing of articles, etc, and it is the easiest type of business to start. Federal and state income taxes are reported and handled on Schedule C of your personal tax return every year. The business will be in your name and you may be liable for the financial and other actions of the business.
To avoid this liability, many small business owners prefer to organize a corporation, partnership, or single member LLC. This requires a little bit of legal filing, but is generally not too costly or difficult.
Income tax filing may be more complicated with a partnership or a corporation. Federal and state income taxes are often handled differently for partnerships and corporations, often requiring their own tax returns to be filed.
A single member LLC, however, can be treated as a sole proprietorship for tax purposes unless it elects otherwise. This is a pretty nice feature of single member LLCs – it’s good to have both simplicity when you start and more options later on when your business starts to grow.
What Business Entity Type Should I Choose
Your best bet is to seek council from a tax professional or even a business lawyer. But generally, if you expect your business to start small, organizing as a sole proprietorship is likely to be the easiest and cheapest option.
Always keep in mind, however, that setting up an LLC might be worth a look to avoid liability problems.
If you start making a ton of money (a great problem to have), then you should probably explore the more advanced methods of business taxation such as the S-Corporation election. Please contact a tax professional for advice on this.
You can always start as a sole proprietorship and change things as you become more successful.
Whatever you decide, figure out this part first. When it comes to registering your business with Hawaii you need to have your business organization information handy.
Hawaii Business Registration
A new business is going to need two things* – a business registration and a Hawaii GE Tax License. Think of it like a car registration. Note that more advanced businesses that will be hiring employees will also have to create an account with the department of labor.
*Please note – some business trades require permits, licenses, and from the State of Hawaii and/or the Federal Government. Obvious examples would be “you can’t open a Doctor’s office or start an airline without the proper credentials and government approval”. Less obvious examples would be “you can’t open a tour company or be a general contractor in Hawaii without a very specific license”. Please do your due diligence and research the occupational and government licenses you might need.
Generally, to register your Hawaii Business, you need to fill out Form BB-1 (basic business application).
The State of Hawaii has somewhat simplified it’s business registration procedures, and they even have an online wizard that you can fill out and it will create the forms you need. Use the link provided for the online registration of your business.
The Tax ID or “FEIN”
Remember that any business entity (separate to you – not a sole proprietorship) will be required to have it’s own federal tax number, known as a “FEIN” or a “TIN”.
FEIN stands for “Federal Employers Identification Number”, but it’s not just for employers. It’s like a social security number for your business specifically. You apply for an FEIN (can be done online here) when you set up the business.
Even a sole proprietorship can register for an FEIN, and if your are hiring employees, you are required to do so.
Some self employed individuals choose to create an FEIN even when not required – as it is fast, easy, and free to get one. The advantage is that you do not have to give your social security number out to everyone that pays you as a contractor. You give them the FEIN instead.
There may be other advantages as well, depending on your situation (this part may be complicated).
The Disregarded Entity
One critical thing to know about a sole proprietorship is that, if you form a specifically “single” member LLC, it defaults to be taxed as a sole proprietorship.
In other words, the entity exists for legal, liability, and financial purposes, but it is “disregarded” for tax purposes. So for income tax reasons only, the entity is not even considered to exist.
This is helpful as you will not at first need to complete an expensive business tax return. As a sole proprietor, you just list your business activities along with your personal tax return.
It’s much more simple that way, but there are some disadvantages to sole proprietorship taxation. If you start to do a lot of business and make a reasonable amount of net profit, this may no longer be the best option for you.
A huge advantage of a single member LLC is that you can easily elect different forms of taxation in the future with it – such as S Corporation taxation. Just keep in mind that if you do want to elect to be taxed as an s corporation, it has to be done in advance or at the very beginning of the year. It can’t be elected retroactively – though in some cases the IRS will grant late election relief.
Your Tax ID Situation Changes the Way You Register Your Business with Hawaii
Back to the tax ID and business registration. If you organized your business as a corporation, partnership, or single member LLC, use the tax number of your business (FEIN) for the state registration forms – not your social security number. In most cases, you would only use your social security number on these forms if you are starting a simple sole proprietorship with no underlying LLC.
As a disclaimer, please consult with a professional if you are not sure how to fill out the form. The advice given on this website is very general and may not be correct for your specific situation.
Hawaii General Excise Tax
Hawaii imposes a General Excise Tax on all of your gross income (your gross proceeds, before expenses). This is separate to income tax. Part of setting up your small business is obtaining a GE Tax License.
Fortunately, form BB-1 not only registers your new business but it applies for this license. You will receive a certificate in the mail with your new GE Tax License Number. So as far as “starting” the business this is all you need to do for GE Tax.
As your business generates revenue, however, you will have to file periodic GE Tax Forms and send in payment at certain intervals depending on how much in sales your business makes.
Even if you have no revenue, you are still required to file the GE Tax returns.
Also, unlike income tax, Hawaii General Excise Tax is imposed on the “gross” income of your business, BEFORE expenses. It’s kind of like a sales tax. So even if you operate at a loss, you are required to pay GE Tax. Fortunately you are allowed to pass along this expense to your customers. So be sure to collect the correct amounts of GE Tax when you bill them.
We offer a GE Tax preparation service but it’s somewhat easy to figure out how to complete these forms and pay your GE Taxes. Just read the instructions.
While we officially recommend that you have a professional file your GE Taxes, if you need to save costs, you might consider doing this yourself. Be sure to be on time to avoid late penalties or other actions.
At the bottom of that page are links to more information on paying Hawaii General Excise Tax.
Starting a Small Business in Hawaii – Keeping Books
You have to keep a record of your sales income and all of your expenses of your new business, but keeping books does not have to be overly complex. You can simply keep a journal on a legal pad and save your expense receipts and bank deposit statements.
If you are computer savvy, you can use programs like “Quickbooks” to track your business income and expenses. A simple spreadsheet might work well for you too.
You will refer to your journal or spreadsheet when it comes time to pay income and GE Taxes, and it’s essential to have your books at hand if you are ever examined for tax purposes.
Also, it’s important not to “co-mingle” business and personal funds. You should have a dedicated bank account (and perhaps a credit card account) specifically for business transactions. This is also handy because your bank and credit card statements can help serve as your journal.
At tax time, you will have to convert your records into a profit and loss statement. This is simply a record of your income and your expenses, but the expenses must be in categories. Examples of expense categories are “office supplies”, “rent”, and “license fees”.
More active businesses do this on a monthly basis, otherwise there is just too much work to do at the end of the year.
As your business becomes more complex, this becomes a more difficult task as the data to manage tends to grow very quickly. Also, if you have inventory, payroll, etc, the basics of general bookkeeping become much more technical. At some point you may want to hire someone (like us!) to do your bookkeeping. You can see about our bookkeeping services here.
Small Business Income Taxes
If you are a sole proprietorship or a single member LLC, you will most likely disclose your income and expenses on federal Form 1040, Schedule C.
I have been very forthcoming about doing things yourself so far, like doing your own bookkeeping, if simple, or how you might choose to file your own GE Tax returns. For income taxes, however, I would very much recommend a business tax specialist.
That last thing you want to do is try to deduct things that will get you into trouble – but you certainly do not want to miss legitimate business tax deductions either.
I can’t tell you how many times I’ve seen the IRS or the State of Hawaii audit a self-prepared tax return to where the taxpayer owes a large amount in adjusted taxes and penalties – but on the same tax return they missed legitimate deductions.
Paying Estimated Income Taxes for Your Business
Another thing to be aware of is having to pay estimated income taxes throughout the year.
If you find yourself making lots of money (again – a good problem to have), you can’t just pay a huge tax bill at the end of the year. Well, you can, but you will be penalized with interest charges.
The tax system is “pay as you go”, not “pay at the end of the year” and you are expected to make quarterly estimated payments.
Another great reason to make estimated tax payments is so that you do not bury yourself with a huge business income tax bill when you file your taxes. Let’s face it, human nature tends to spend money as it comes in, and we all know and joke about how it’s not exactly cheap to live and do business in Hawaii.
Facing a huge tax bill might be stressful or even damaging anyway. When you don’t pay, it’s not the end of the world – you can make a payment plan, etc. but the problem is that the IRS will put a lien on most tax debts, and that will mess up your credit.
Also, in this spot, you will be forced to make monthly payments for both the prior year and estimated tax payments in the current year. That’s usually part of the payment plan “deal” that the IRS offers. Now you are getting bogged down by two years of taxes. It’s viscous cycle.
The answer is to do your absolute best in paying in your taxes quarterly or even monthly as you go. So if you start making lots of money be sure to talk to a professional to do your tax planning to see just how much you should be paying.
As a rule of thumb, you can plan on the government being a one-third partner in your net profits. In other words, if you make $30, 000 net profit (after expenses), then you should be ready to pay $10,000 of it to the government. If you make $90,000, plan to pay $30,000.
But this is just a rule of thumb. Again, please, talk to a tax professional.
There’s more to starting a small business in Hawaii that we can include in this guide.
This guide is not the “end-all be-all”.
It would be very hard to provide that in one page.
For example, if you pay contractors you must file form 1099 in every January or face not being able to write off your contract labor (and maybe face penalties).
There are many other such traps waiting for a new business owner – which is why these online guides are not always the best places to go to for help. We try to write our guides as best as we can, but officially we have to recommend that you consult in person with a professional.
If you think you might want to hire us to help prepare your taxes, please contact us here. Our email is email@example.com and our phone number is 808-744-5314. Aloha.
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