I know what you might be saying . . . but I'm an artist!
Art is the opposite of business, and yet you must treat your art like it's a business, because it is.
Choosing the right business structure isn't glamorous, it's not as fun or creative as putting together your website, deciding your pricing strategy, or creating your art, but it's important to know your options so that you can choose the right structure for your business.
Your business structure will have implications on your taxes, and it can determine whether or not your personal assets are in danger should something go sour in a business deal.
Below are the different business structures that you can choose from:
So what the heck does all of this mean, and which one should you choose? Let's break it down.
The Sole Propretorship
An unincorporated business that is owned by one person who reports business profits on his or her individual tax return. A sole proprietorship is the simplest business structure and is straightforward to start. This can be a great option for artists.
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. This can be a great option if you collaborate with other artists to create your work together.
The Limited Liability Company (LLC)
An LLC is a hybrid business structure that limits the personal liability of its owners, called members, it's like a corporation but allows the profits to be taxed on either a member level or the corporate level. LLCs are created on a state level, and each state has different regulations and requirements for starting an LLC. This is a great option for artists who want to limit their personal liability should something go awry.
S Corporation (S-corp)
S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level. This is more complicated to establish, and might not be the best choice for a single artist.
In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders. The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation. Again, this is more complicated and might not be a great place to start.
So, how do you choose which structure you go with for your business?
It has a lot to do with risk, and how willing you are to take it. As a business you interact with the world, and when interacting with the world, you never know what could happen. In theory, when operating a business you are always at risk of a lawsuit. Anytime an exchange of money is involved, you're at risk.
If you run a sole proprietorship, should something go wrong and your business be sued, your personal assets could be target for people seeking to collect. This could include real estate, cars, bank accounts and more. The same could be true of defaulting on a loan. A similar situation occurs with partnerships, where you can be liable for the activities of your partners.
Another consideration is how you want the IRS to tax your company.
Sole proprietorships, partnerships and S corporations are pass-through entities, as are some LLCs. In a pass-through entity, profits are passed directly to the owners of the business. Come tax time, it is reported on the owners’ individual returns.
By default, the IRS views LLCs as pass-through entities unless they opt to be taxed as a corporation.
C corporations are separate entities from their owners, so their profits are taxed at the corporate level. If a corporation pays out dividends, which come out of its after-tax income, shareholders also must pay taxes on their proceeds. It's unlikely that an individual artist will be set up as a corporation, so you likely won't need to worry about this.
Other considerations are how formal you want your management structure to be, and how complicated your administrative needs will be. If you're looking for simplicity, an LLC structure generally allows the choice between being managed by members or overseen by a management team, which can include members or nonmembers. LLCs typically draw up an operating agreement that specifies roles and can be run by a single member, which in your case may simply be you, the artist.
I encourage artists to explore all their options, and research LLCs at the State level. The costs can vary widely, but LLCs may be a great way to get started and minimize risk. To view a comprehensive list of requirements for your state, click here!