When starting a new art or creative business (or any other business for that matter) you will be faced with choosing a legal form of organization for your company. In fact you may have already made that choice whether you are aware of it or not.
There are several kinds of legal forms of organization – sole proprietorship, limited liability company (LLC), partnership and a corporation. Each one has its advantages and disadvantages depending on your needs for financing, the level of control you wish to retain, tax consequences and the level of risk or liability that you are willing to take.
This is easiest way to start (and dissolve) a business where there is one owner. There are no forms to complete and file although you may need a local license to do business. The characteristics of a choosing a sole proprietorship are:
- A sole proprietorship has only one owner.
- You cannot sell stock to raise money or bring in partners to the business.
- You have the freedom to do what you want in running and managing the business.
- Easy to start and easy to dissolve (just say you are in business and make a sale).
- Income is reported on your individual Federal and State tax returns with a separate schedule (IRS Form 1040 Schedule C). A business return is required for Federal and State Income Taxes.
- The owner must pay self employment taxes such as social security and Medicare.
- Typically you may not be required to register your company (i.e. your Secretary of State).
- May require a business license in many localities, counties states etc.
- Your business liability extends to you personally (unless you apply for a Limited Liability status).
- Debts and other liabilities of the business are also debts of the owner
- May have succession and management issues if the owner dies.
A partnership is a legal business form of two or more parties created to reach common goals or objectives. Partnerships may be for profit such as an art business or not for profit like an arts organization. Creating and running a partnership requires a bit of effort in developing a partnership agreement that will answer all of the “what ifs” that any business presents.
Here are some of the major elements of a partnership:
- Used if you have more than one owner.
- Owners or partners have a percent interest in the partnership not shares. An individual partner’s interest in the partnership may be determined by money or other assets contributed, time and expertise committed or a combination of both.
- A General Partnership where the profits, liabilities and management are divided among the partners according to the percent ownership defined in the partnership agreement.
- A Limited Partnership where certain partners (Limited Partners) have limited liability and management input. In a limited partnership there are one or more general partners in addition to the limited partner(s). Liability for limited partners is typically limited to the amount they have invested in the business; this is not the case for the general partner.
- A Joint Venture where the company is run as a general partnership for a limited time or for a particular project. This can be a useful form for many art related projects or ventures.
Can be used as a way to raise additional capital or attract other resources such as personnel, expertise, equipment or facilities.
- Partnerships are somewhat difficult to form and dissolve. They requires a partnership agreement spelling out ownership, liabilities, duties, contributions to the business, and partnership dissolution just to name a few key items – preferably written! It’s a good idea to enlist the help of an experienced attorney to help you develop your partnership agreement.
- Must be registered with your state, typically at your Secretary of State’s office. Some states may also require periodic reporting.
- Although the partnership does not pay taxes, it still must file an annual Federal “informational” return (U.S. Return of Partnership Income IRS Form 1065) on the partnership’s profits, losses, gains etc. Some states may also require the filing of a similar form – check with your accountant.
- The tax liabilities of a partnership flow or “pass” through to the individual partners who pay taxes on their personal tax returns. Individual partners are responsible for taxes on their portion of the income generated from the partnership as well as self employment taxes on this income.
- May have succession issues if a partner dies and this is not addressed in the partnership agreement.
When people usually think of corporations they think of big companies with a lot of shareholders whose shares are publicly listed and traded in the stock market. Corporations can also be small companies whose shares are not traded publicly with few or even one shareholder. The important point about a corporation is that it is a distinct entity that is separate from its shareholders or owners.
A corporation is created or incorporated by its shareholders who elect a board of directors to guide the overall direction of the company and appoint it management. Most corporations are formed with a profit motive in mind although many corporations are created as non profits.
Recent court rulings have affirmed the idea that a corporation has many of the rights and obligations of an individual. These rights and obligations include: the right to enter into contracts, the ability to own property or other assets, to borrow or lend and to be held liable for debts and other liabilities.
Here are some of the major elements of a corporation:
- Appropriate if you require multiple owners who do not want to accept any business risk other than their investment.
- Requires articles of incorporation, registration with your Secretary of State, and annual meetings/minutes/reports.
- Not easy to dissolve.
- The corporation is required to file income tax forms and pays income tax.
Income or profits are distributed via dividends where shareholder pays tax at an individual level. This should not be confused with salaries paid to owners.
- Easy form to raise additional capital by issuing additional shares (this does not mean it is easy to raise capital).
- Ability for shareholders to transfer or sell shares, although in a privately held corporation it may be difficult to find buyers in the absence of a formal market or stock exchange.
- Shareholder liability is limited to amount invested in the corporation and shareholders are not personally liable for the corporation’s debts.
- Corporations with 100 or less shareholders may elect to be treated as an “S Corporation” for tax purposes. An S Corporation is allowed to pass its income or profit on to the shareholders based on the percent of their ownership who in turn report and pay taxes due on their personal income returns. From a tax standpoint, an S Corporation treats shareholders much like partners in a partnership.
Limited liability companies or partnerships – LLC & LLP
By registering with your secretary of state and paying a fee you can limit the liability of a sole proprietorship or partnership to their business assets much in the same manner as a corporation. Limited liability companies (LLC’s) and limited liability partnerships (LLP’s) are established under state laws and may vary according to the state the business is located in.
Under these forms of legal organization a sole proprietor or partners are provided protection for their personal assets and other liabilities which are not a part of the business. In essence liability is limited to assets owned in the business. It is important to note that while these forms protect the owner(s) personal assets (as opposed to business assets) they do not protect against fraud or illegal activities nor do they lessen the necessity of separating the owner’s business activities from their personal affairs.
I urge you to look into the LLC or LLP options if you have or will have the potential of liabilities that you want to protect against and don’t want to go the corporation route.
The bottom line(s)…
Choosing the proper form of legal organization is an important part of starting and growing your art or creative business. Take some time to learn the advantages and disadvantages of each before you make a choice. It also a good idea to get advice from an attorney to help you choose the best form of legal organization to fit your current situation and future plans.
As with most articles on this subject I must warn you that I am not giving legal advice. When you are setting up your company it is important that you understand the basics and seek the advice from your lawyer or accountant. Your form of organization may need to change as your business requirements evolve. It is important that you set up your business right the first time in a manner that meets your requirements and resources – be sure to seek advice from competent legal and accounting professionals.
If you would like to learn more about preparing your own business and marketing plan, building your art business and selling more art I invite you to check out my book – The Artist’s Business and Marketing ToolBox. Good Luck!
Neil McKenzie is the author of The Artist’s Business and Marketing ToolBox – How to Start, Run and Market a Successful Arts or Creative Business available in softcover from Barnes & Noble and Amazon and as an eBook from iTunes, Amazon and Barnes & Noble. He has developed and teaches the course “Artrepreneurship” at the Center for Innovation at Metropolitan State University of Denver, and is also a visiting professor at University College at the University of Denver where he teaches “Marketing the Arts”.
Neil has over 30 years’ experience as a management consultant and marketing executive, working with some of the world’s top brands. Neil is a frequent lecturer to artists and arts organizations, a guest columnist for Colorado Biz Magazine, where he covers the creative sector of the economy, and the author of several articles for Americans for the Arts, a national arts organization. Follow Neil on Twitter: @neilmckenzphoto