Avoid W-2 Status and Extra Tax: Become a Licensed Business

Photo credit: ID 8861152 © Paul Jantz | Dreamstime.com

Photo credit: ID 8861152 © Paul Jantz | Dreamstime.com

One of the benefits of being self-employed is paying less tax than you would if you were paid like an employee on a W-2 tax basis. If you’re smart, you’re getting paid on 1099 tax basis, deducting your business expenses, and contributing to your own retirement plan to lower your tax bill. (This two-minute video explains how this works.)

But California’s new law, AB5, is making it harder to qualify as an independent contractor and get paid on a 1099 tax basis. Even if you don’t work in California but do business with a national corporation, you’ll likely have to follow these new rules because companies follow the strictest state rules when it comes to compliance. Plus, other states like New York and New Jersey are already working on similar legislation. 

Basically, AB5 requires all gig workers, freelancers, independent consultants, and other solopreneurs to be legitimate businesses because the client companies who hire you must be able to prove that you are indeed a business. There are lots of ways to do this (and I highly recommend doing more than one), but having a business license is one of the best pieces of proof. 

I’ve been advising some consultants about this recently and have learned valuable things to share with you, but first some Q&A.

Business License FAQs

Q.  Am I legally required to have a business license?

A: Most cities require businesses (including individuals) to obtain a business license.  If you live in an unincorporated area of a county, then usually the county requires a business license.  Not having a business license subjects you to various penalties. Moreover, you are usually required to have a license in all counties or cites in which you do business.

For example, if you work out of your home in San Francisco you would need a San Francisco business license. If you then travel to Los Angeles and do work there, you are probably required to have a Los Angeles business license too. Individuals often do not obtain these additional business license even though they are running the risk of incurring various penalties should the city or county audit them. Also, as a result of the new AB5 law, the business hiring you may ask you to show that you have a business license in the city or county where the work will be performed.

Q: Neither my county nor my city requires a business license, so do I really need one?

A: While you might not be required to have a business license if all of your work is done in that city or county, if you want to be paid on a business-to-business 1099 tax basis, your chances of will increase if you have a business license. Aside from a legal structure like an LLC or S-Corp (which I also recommend), nothing declares that you are a legitimate business like a government license.

Q: Do I need a business license if I work from my home? 

A: Yes. It doesn’t matter if you work from home, you still have to comply with whatever your city and county requires. 

Q: If I have a business structure filed with the state (for example, an LLC) do I need a business license?

A: Yes, if the city or county where work is done requires a business license; your business structure is irrelevant. If you’re structured as an LLC or corporation, the business entity must obtain the business license.

Q: I work with clients in other cities. Should I have more than one business license?

A:  If the city or county where the work is done requires a business license, then you may have to get additional business licenses to comply with those requirements. Additionally, the company hiring you may ask you to show that you have such a business license.

Q: How do I get a business license? 

A: Every city and county is different, so start with an online search. For example, “how to get a business license in Los Angeles County.” Then do the same search but use your city’s name: “How to get a business license in Beverly Hills, California.” (Note: Some municipalities call it a Tax Registration Certificate.)

Another option is to search for things like “how to set up a business in San Francisco,” or “small business registration San Francisco.” In addition to your local requirements, the federal Small Business Administration has information and links to register your business in your state. This sounds more complicated than it needs to be. Start with your county.

Q: How long does it take to get a business license?

A: Completing the online forms is usually pretty quick, but the government can be slow to mail you the actual license so I’d allow two or three weeks. Some municipalities require you to visit the county clerk’s office, but you’ll likely walk out with the license in hand.

Q: Do I need to renew the license every year?

A: Yes, or you’ll accrue penalties and interest. (A valid business license is proof that you paid the minimum business tax for that municipality.)

Tips and Cost Saving Tricks

Q: Do I need a DBA or Fictitious Name in order to get a business license?

A:  No. However, if you’re doing business with a name other than your personal legal name (“John Doe”), or if your business has more than one owner, you will need to file for a DBA or fictitious business name with your city, county, or state. Take care of the DBA first, then get a business license in the name of the DBA.

Q: Will getting a license trigger additional local tax? Quite possibly, and it’s your responsibility to know how much and pay it. The local government is probably not going to send you a bill, but they may surprise you with a nasty audit. This happened to my colleague Jennifer in Oakland, California. She was told she owed $10,000 in back taxes because there were taxes besides the basic fee she paid to get the license.

Like most things, the government doesn’t make this easy, and the process varies from one municipality to the next. Some charge a tax based only on payroll, some tax on gross receipts (revenue), and some are hybrids like San Francisco which taxes 1.5% of gross receipts if over $1,120,000 per year, and 0.38% of payroll if it’s above $300,000.

It took me several internet searches to find what the additional business taxes are in Oakland, and I knew what I was looking for.

Pro tip: Do several internet searches to see if a business license will trigger additional tax. Here are some samples.

  1. For the city: “Does Oakland tax on gross receipts.” 

  2. For the county: “Does Alameda County tax on gross receipts.

  3. To really find the details: “City of Oakland California tax classification and rate schedule.” (Take a look to see how complicated it can be. No wonder my friend Jennifer owed money! I’m not a tax professional, but my guess is she owed an additional tax of $1.80 per $1,000 of revenue over several years.) Or, use these similar search terms: “Business Tax Classifications Los Angeles County” and/or “Tax Rate Table Los Angeles.”

  4. Once you find the tax classifications list or tax rate table, search that document or page for “small business exemption.” Los Angeles, for example, doesn’t collect additional tax if your gross receipts are less than $100,000 per year. (You may still have to pay the basic business tax to get the license. In L.A. this is the case.)

 Tax-Saving Tip

If a business license in your city or county does trigger a gross receipts or revenue tax (highly likely if you’re in a major metro), check a nearby municipality and establish your business there. It’s a bit more hassle but it may save you several hundred dollars a year.

My colleague Brian figured this out. He lives in Los Angeles County and discovered that L.A. has a gross receipts tax of $4.50 on every $1,000 in revenue. In a good year, he would owe Los Angeles around $1,000 in extra tax. Instead, he joined a local co-working group in a nearby city for $50 a month and uses that location as his business address. He got his business license from that city for $114 a year and no extra tax. As an added bonus, he’s now able to keep his personal address out of the public records and protect his privacy too. 

Be careful though! PICA’s lawyer wants to point out that you can’t just choose a city that doesn’t have a tax and claim that is where you are doing work, if that claim is false. In my friend Brian’s case, if he’s still doing work in Los Angeles but gets a business license in another city to avoid having to pay the Los Angeles tax, this might be tax fraud, which would incur even greater penalties. 

Consulting can be a terrific career choice with flexibility, good money, excellent retirement options, and rewarding work. To qualify for 1099 payment status and pay less tax, though, you’ll need to put in the work to legitimately establish your own business.

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Additional references from the Professional Independent Consultants of America, Inc. (PICA):