Opening Your Own Martial Arts School:
A Planning Guide

CHOOSING A BUSINESS STRUCTURE

For income and other tax purposes, you must choose a business structure from among several options- the sole proprietorship, the partnership, and the corporation. Each has it's own legal considerations and advantages or disadvantages, depending on individual circumstances.

The following section will briefly outline each, but keep in mind a major point of advice- we highly recommend that you present your particular case to a specialist- a tax expert perhaps, or a lawyer. The reason is simply based on the continuing complexities of tax structures and their effect on business. Many people spend a great deal of time telling you how unnecessary experts are, but in the case of your new business, it is far more important that you do everything right the first time.

SOLE PROPRIETORSHIPS

A sole proprietorship is the simpliest of the business structures and means that you go into business for yourself, having no other partners.

For tax purposes, the paperwork is generally quite limited, with the exception of state and local licenses or other forms. You also have unlimited liability as to your taxes and financial/legal responsibilities. In terms of a martial arts school this means if you are the sole owner of the school and incur any debts, you are responsible for the entire amount of the debts to be repaid. If you did not have enough money to pay these debts, your personal assets could be sold.

Sole proprietors report the activities of the business on Income form 1040, Schedule C (Income or loss from a business or profession). Schedule C is an attachment to form 1040, and as such can be used, if there are losses, as credits against other earned income. The income tax rate for the sole proprietorship depends on the level of income. In the range of income from 0 to $43,149, the rate of tax is 28%. Over $43,150, the rate is 33%.

You must also pay other taxes as a sole proprietor. Instead of Social Security, you pay a self- employment tax, which is 12.3% of the first $43,800.

PARTNERSHIPS

The partnership is somewhat similar to the sole proprietorship but with several distinctions. A partnership usually has two or more people involved in the entity. While a sole proprietorship needs no legal forms to identify it as such, the partnership usually consists of one or more legal agreements spelling out the nature of the partnership pact- terms of agreement, responsibilities, salaries, and other business related details.

There are two types of partnerships- general and limited partnerships. General partners share in the status of having unlimited liability for the business in the same manner as the sole proprietorship. If one partner could not cover his part of the debt, the other can be held liable for the entire amount. Limited partners are not generally involved in running the business, and usually are liable for only the amount of money invested in the original partnership agreement.

Each partner, unless specifically stated otherwise in the agreement, can carry on the activities of the business. This indicates one of the major disadvantages of the partnership- if each partner can carry out business, problems can arise if communication is not kept open and smoothly flowing.

Partners file an additional tax form, Form 1065, to the federal government, as well as any state forms which are needed. Income or loss is reported on Schedule E of Form 1040. The partnership ends when either of the partners dies, when the agreement calls for the end of the partnership, or when a partner wishes to leave the arrangement.

CORPORATIONS

Broadly speaking, the last business structure is a corporation. Laws concerning corporations fill volumes, especially as the very from state to state. We will present basic information about corporations, and then show some of the complexities that can arise in a particular case. We will use the laws of the state of Ohio as our example.

While the sole proprietorship or the partnership is a legal entity in which you are the whole or part of the whole, a corporation is an entity unto itself. If you would die, the corporation could still remain in existence. You might set up the John Q. Smith School of Karate, Inc. and one day decide to give the stock of the company to someone else, in which case, the basic structure would remain.

There are several reasons for choosing the formation of a corporation, with the most outstanding reason being limited liability of the corporation's stockholders. Where the owner in the sole proprietor is held responsible for all the debts of the business including the selling of personal assets to pay, the corporation's liability is generally limited to the assets of the corporation.

Occasionally an event called piercing the corporate veil can take place, which means that the courts find reasons to hold some or all of the stockholders responsible for the company's liabilities. This might occur in a martial arts school as a corporation if the courts thought that the company was grossly mismanaged and your were the sole stockholder.

FORMING A CORPORATION

We will use the state of Ohio as our example. In order to form a martial arts school as a corporation. Ohio, like many other states, has a center set up to assist you in this regard- the center is called the One Stop Business Permit Center, which can be reached by calling a 1-800 telephone number. The One Stop center sends you a packet containing all the forms and information you need to start the business.

To form a corporation in Ohio, several steps must be followed. You must file articles of incorporation (see figure ), which include the following information: Corporate name, ending with or containing, Company, Co., Corporation, Corp., Incorporated, or Inc. the location of the principal office in Ohio. the purpose of the corporation. Authorized number of shares and their par value if any. Amount of beginning capital, which must be at least $500.

A fee must be paid for forming the corporation on the following scale: 1-750 shares.................... $75.00 751-1,000 shares................ .10 per share 1,001-10,000 shares............. .05 per share 10,001-50,000 shares............ .02 per share 50,001-100,000 shares........... .01 per share 100,001-500,000 shares.......... .005 per share 500,000- shares................. .0025 per share

All corporations must pay Ohio Corporate Franchise Tax, at tax which is figured either on income or net worth, which ever leads the greater tax liability. There is a minimum tax of $50. Estimated tax payments must be started on Forms FT-1120E, FT 1120ER, and FT-1120EX.

There are several other laws concerning Ohio corporate taxes which are too complicated to be explained here. Again, this is a general overview and we recommend seeing a tax expert.

Besides forming the corporation, Ohio demands several other things related to the business.

When you choose a name for your business, you must check to insure that the name is not already being used, which is done with the Ohio Secretary of State's office. In order to register a trade name or fictious name for your business, the following steps must be taken: File the name with the Secretary of State's office within thirty days of it's first use. A fee of $10 is required to register a fictious name, and the registration is good for five years. You can renew the registration six months before it's expiration. To register a trade name costs $20 and means that noone else can use the name; also lasts five years. A vendor's license is needed for the purpose of collecting Ohio sales tax, obtained from the county auditor. There are several other complicated procedures which must be followed if you employ anyone.

You must also pay federal income tax according to the following rates:

TAXES FOR THE MARTIAL ARTS SCHOOL

Much of this information appeared previously in an article which William wrote for Inside Kung-Fu (December, 1986). The most important point to remember is that we are not offering you a definitive guide to the nature of taxes, rather we are illustrating some general guidelines. With any information of such a complex nature, you are best advised to seek counsel with a competent tax specialist, especially as the structure of the martial arts school becomes more complicated.

You might also consider help from the Internal Revenue Service. There are several verbatim quotes contained in this portion which are taken with permission from IRS Publication 334-M, Tax Guide for Small Business. There are also many other excellent publications from the IRS, many free, which we highly recommend. See figure for information about them.

Because a focus is needed to clearly present this material, we will assume the perspective of a person who is the sole proprietor of his school, has no employees, and rents his location. The first important thing to consider is recordkeeping.

BASIC RECORDKEEPING

The sole owner will eventually report his taxes on Schedule C of Form 1040- Profit or Loss from Business or Profession. Because this schedule is used for presenting businessincome and expense deductions, records must be kept to support and justify these figures. Probably the simplist method to use for the martial arts school is single-entry bookkeeping. Detailed and helpful information can be obtained about this system by Ordering IRS Publication 583- Information for Business Taxpayers (see figure ).

This system uses records of daily cash receipts, a monthly statement of cash receipts, and a monthly summary of cash disbursements. This type of system would be effective for schools receiving all forms of income, such as weekly, monthly, and individual lesson payments. Regardless of the system, there are several guidelines that new or existing schools should consider to be sure that their records provide accurate tax information.

The IRS suggests small- business owners should at least do the following: Keep the school's finances in a seperate bank account from personal accounts. Try to pay by check to give extra documentation of both receipts and expenses. Keep supporting material for all entries if possible- for example, canceled checks, deposit slips, paid bills, and receipts. Keep all past records on file in case of audit. Sources of income should be identified, i.e. John Smith, Monthly dues. Record all deductible expenses when they occur, and keep all supporting receipts and vouchers.

INCOME AND EXPENSES

Income and expenses are recorded and filed for a given tax year, which in our hypothetical case would be January 1-December 31. A sole proprietor, as in our mythical case, would have the same due date as the normal 1040 filer- April 15.

When figuring taxes, IRS defines income as what you receive for services rendered, and could include cash, property, or services. Since martial arts are usually limited to cash, we will immediately move to deductible expenses.

To qualify as a deductible expense, four rules set forth by the IRS must be conformed with: Expenses must be incurred only with the business. Expenses must be ordinary and necessary. Ordinary is is defined as common and acceptable in a particular business, in this case a typical martial arts school. Necessary is defined as an expense that is appropriate and helpful in developing and maintaining your business. Expenses cannot be items that will be used for more than one year. Expenses must be kept within reasonable limits.

With these rules in mind, some typical expenses related to the martial arts school might include the following.

Rent- Rent can be deducted if and only if the property is used for business and you do not own it. If you use part of your home for the school, you may be able to deduct a portion of the rental or mortgage cost. The IRS is becoming very stringent on the meaning of this rule, so you should consult a tax specialist and IRS publication 587- Business Use of Your Home.

Advertising- Advertising expenses can be deducted if they are reasonable and bear a direct relationship to your business.

Dues and subscriptions- Dues paid to professional organizations, such as the USKA, USTU, ATA, groups such as the Chamber of Commerce, and other entities can be deducted if the membership promotes your business interests.

Licenses and fees- Any licenses or fees paid by the school to local or state governments are deductible.

Supplies and materials- Expenses such as office supplies, and other materials used to run the school on a day to day basis are deductible during the year they are used.

Utilities- Expenses for heat, electricity, telephone, and other utilities are deductible if they are directly business related.

Uniforms- Martial arts uniforms for the instructor are deductible because they are worn solely for business and would not be considered street wear.

Other expenses are martial arts school might be able to deduct are insurance premiums for liability insurance, certain franchise expenses, and transportation expenses involved in promoting the school. This chapter by no means constitutes the entire list of possible deductions for a martial arts school. You are well advised to present your business situation to a tax accountant or specialist who is knowledgable about current tax regulations.

FOR MORE INFORMATION

There are several methods to obtain information and help. First is the Small Business Administration, which puts outs several publications either free or at little cost.

A second source is the information available from the Internal Revenue Service. The IRS provides several valuable services including TELETAX. TELETAX allows you to call the IRS and receive recorded answers to many tax questions in about 150 different subject areas. TELETAX is not toll-free, but the IRS does have other toll-free numbers available- the Federal Tax Question Hotline, and the Forms line, from which you can order forms and publications. Both numbers are listed in the telephone book under Internal Revenue Service, and are listed in the Instruction Book for Form 1040.

CASH RECEIPTS

A martial arts school usually receives payment in the form of cash, check, or perhaps money order. To record the income properly, you must develop a system which reflects the needs of your particular business. The daily entries, monthly summaries, cash disbursements, and other needs should all be recorded in such a way that you can have the financial information you need quickly and precisely.

CASH PAYMENTS

Because you as the sole proprietor must file a Form 1040 Schedule C, it is helpful to record these expenses which must be listed in part II, as well as any other cash payments.

The IRS recommends a monthly summary of Schedule C entries taken from the cash payments journal and entered into a journal similar to figure . At the end of each month, the columns of the cash payments journal are totaled and the total is recorded into the summary journal. Then at the end of the year, the totals from the Schedule C summary journal are accounted for on the Schedule C, part II (see figure ).

Other devices helpful to the martial arts school are a contract register, a student file system, a long distance telephone call record, and class attendance records.

Contract Register

Assume for the moment that you have decided to use training agreements or contracts (which will be discussed shortly). The contract register is used to keep track of when each contract is nearing completion so that you can begin the process of renewing it. One way the system can be used is when someone joins and fills out a contract, you put a copy of the contract in the student's file, and then enter the contract in the register, one month prior to it's expiration date.

The key to this system is to get in the habit of checking the register each month as a reminder. You could also enter other important notes in the register such as the expiration of insurance policies, leases, and the like.

Student File System

The file is kept with such information as the emergency data sheet , test records, contract copies, and other pertinent information. Some might argue that this is unnecessary work, but the file takes little time, keeps information organised, and can be extremely useful of a number of reasons.

Long-Distance Telephone Call Record

This record is useful when the phone company claims you are trying to recruit students in Alaska even though you live in Florida. Record the phone calls as shown and then when you receive your monthly bill, check it against the charges listed. You may find mistakes often.

Class Attendance Records

This is a good record if used for such things as testing and encouraging the student who hits a plateau. Keep the record simple. Post it somewhere that the students have access to and let them fill it in.

Contracts and Training Agreements

Many instructors now use some sort of contract or training agreement, consisting of the terms of training, the length of enrollment, and the price. There is usually a statement of health condition before training, and some form of liability waiver stating that the instructor or the school will not be held responsible for any accidents or other injuries which may occur.

We should first consider the nature of contracts before journeying through this minefield. Contracts in a traditional sense are extensions of a business agreement. You decide that there is something you want to enter into as an agreement, in this case accepting a new student for training in exchange for the certain sum of money which the two of you agree on.

The problem in recent years has been that some martial arts instructors have used the contract as the magic pill to cure the whitebelt dropout blues. Consider the way this tactic works. A potential student comes to the school and investigates the classes. The instructor tells the student that in order to join, a six-month contract must be signed. "It's the way we do things- protects us both". Several weeks later, the student decides that training is not for him, or perhaps something happens to prevent training- a new job or relocating. The student is faced with the remaining time and payments on the contract, which by law can usually be collected by the instructor.

Contracts today are a touchy subject with many students and instructors, both sometimes claiming that such written agreements are needed to protect, while others claim that the martial arts has a tradition of only a verbal contract binding the student and instructor together. If the martial arts school is approached strictly as a business venture, then perhaps the former position makes sense, but at the same time, based on tradition, the latter seems appropriate.

The authors make no recommendation on whether you should use a contract, rather we simply want to state the following. A student wanting to train will stay until he is ready to leave and then he will go. A contract will not make him stay if he does not want to. From the instructor's point of view, people often claim that an instuctor promised something, i.e. a test every six days, when no such promise was made. For an instructor then, a written agreement may be good protection. So which to choose?

George Will said it best when he complained that hotels and motels will do everything in their power to entice a customer to stay with them, but then they think so little of the customer's character that they use clothes hangers which cannot be removed from the rod- a ruse to prevent theft.

It's not whether you choose contracts or not, it's how you use them.

Subsidiary Sales

One way to help your income is to offer equipment for sale- uniforms, patches, and books. You become a wholesale buyer which means in most states that you must obtain a vendor's license. You must also purchase the initial inventory from a source.

This section has tried to outline some of the day to day activities and business concerns of the martial arts school. In the next section, we examine the importance of marketing and advertising.