The first question to ask in setting up your art business is how you should set it up – i.e., what structure it should have. This may seem like a silly question, but it is a very important one, as it determines how you report your income and expenses. And report them you must!
There are several types of organization to choose from, and the determining factor is risk. How much risk are you willing to take? Are you willing to pay more for less risk? I will demonstrate what this means:
- SOLE PROPRIETORSHIP
The most risky organization is the sole proprietorship. This is because if someone sues you as a sole proprietorship, they can, theoretically, take your home, your car, and all your worldly possessions in a lawsuit. There is no separation between the business and you, so any lawsuit can take everything. However, most art businesses have little lawsuit risk attached to them. I am unlikely to get sued for damages unless I steal someone else’s art. (don’t do that!) If I was installing stairs, on the other hand, I would definitely want to limit my risk. The term for this characteristic is ‘unlimited liability.’
Now, there are advantages to being a sole proprietorship. There is little to no cost in setting it up, no legal forms to fill out, no paperwork to file with the state. When you report your income and expenses, it goes on the Schedule C of your own personal tax return (1040), and isn’t taxed separately.
There are also disadvantages, such as the aforementioned unlimited liability. There is also the fact that the company has a limited life – when you pass away, so does the business. (Ask Disney if this is important!). It is also more difficult to get financing from banks and therefore difficult to expand.
- CORPORATION
If you are willing to pay a little more money on a regular basis, you can get the advantage of limited liability with a corporate setup. A corporation is a separate entity from you as a person, therefore if it is sued, only those assets owned by the company can be taken, not your personal home and possessions. This is the main advantage of having a separate corporation. It is also easier to expand, as banks are usually more willing to offer financing for this. It can have a life beyond the life of the founder, as many corporations have (i.e., Sears, Disney).
Now to the disadvantages; The main one is the cost and complication of setting up and upkeep. There are fees to setting up the corporation with the state (none for the federal government), and annual fees to keep the license in good standing every year. In my home state of Florida, it is about $75 to set up the corporation, and $150 a year to keep it going. There is also additional paperwork, as you need to file a separate tax form every year (1120 or 1120S) with the federal government. You may also need to file one for your state. And, you may have to pay taxes at a corporate rate, which is usually higher than your personal rate.
I would like to go into the differences between a C corporation and an S corporation. C is the corporations we are most familiar with – corporate monsters like Microsoft, IBM, Disney, Sears, etc. These get taxed at a corporate rate, which is currently 15% up to $50,000 in profit, and goes up from there. An S Corporation (S stands for Small) has to have less than 100 stockholders (among other requirements) but does NOT get taxed at the corporate level. Let me repeat that – no tax is paid on the corporation itself. Instead, the income gets reported on each shareholder’s tax return, and is paid at their personal rate. This is usually the better deal for small companies, as personal returns are not taxed at all for the first $7000 in income.
- LLCs and LLPs
Many people ask me about Limited Liability Corporations and Limited Liability Partnerships. These are both fairly new entities, and as such, don’t have (as of yet) their own share of rules and laws by the IRS. The main benefit is, of course, limited liability – which means your personal house is safe if someone trips over your sculpture and sues you. However, you also get that with an S Corp, and both can be either single member or joint ownership between spouses. They can also have more members, unlike a Schedule C, but until they’ve ‘settled’ in as accepted entities, I cannot recommend them as corporate structures. Each state has different rules for these entities as well, so if you are interested in setting one up, you will want to consult with a lawyer or CPA in your state. - Partnerships
Usually, art is not a partnership style of business, but some of us are lucky enough to know the right person, and trust them enough to go into business with them. This person could be a spouse, a child or parent, or a good friend. However, do PLEASE set up the partnership rules in writing beforehand. Nothing ruins a relationship more easily than arguments about money! Partnerships file a 1065, and the business itself is not taxed. Like an S Corporation, the profits are listed on the Schedule K-1 and go to the partners’ individual tax returns, to get taxed there.
- RECOMMENDATIONS
In my personal opinion, most artist would do best as a sole proprietorship, unless there is a significant possibility of liability (i.e., you do 3D installations that someone could trip and fall on). In that case, I would recommend S corporations as the best alternative.
Since sole proprietorship is usually the most beneficial to artists, I will continue the essay under the assumption that this is the structure chosen.
