Lesson 2: Business Structures
What You’ll Learn: Choosing the right business structure might not seem like a big deal, but it can have a significant impact on your taxes, legal exposure and even your personal assets. It’s not as complex as it may seem, and in this lesson, we’ll take you through the advantages and disadvantages of each.
“The first one gets the oyster, the second gets the shell.”
~ Andrew Carnegie
As a creative, chances are pretty good that you already have a business structure. Most creatives start out as a sole proprietorship, which is simple to set up and offers you a basic way to collect money and pay taxes. It’s not necessarily the best structure, depending on what else is going on in your life. For instance, if you were to be sued by someone, your personal assets and bank accounts become part of the piggy bank the courts can tap. This type of structure can also mean you’re paying more than your fair share in taxes since everything you make is reported as personal income, not business income. You and the business are the same in the eyes of the courts, the IRS and lenders.
Before we go through the advantages and disadvantages of each business structure, let’s start with a quick disclaimer. None of this is meant to be advice. We highly recommend you consult with an attorney, mentor or CPA before you settle on a specific business structure. Every situation is different, and you want to make sure that the choice you make fits your needs, especially long term.
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Introduction: Are You Ready?
1. Thinking Like a Business
2. Business Structures
3. Access to Capital
4. Creating Revenue Streams
6. Finding Customers
8. Creating a Winning Pitch
9. Effective Negotiation
10. Intellectual Property
11. Managing Your Money
12. Going Global
Each business structure has its advantages and disadvantages. As your creative endeavor morphs into a full-fledged business, the structure you were in may no longer work for you. You don’t want to change your structure too many times, but you do want to select the right one, even if you have to grow into it. Again, a legal or accounting professional should be able to give you a good recommendation.
Here are some of the things to consider:
Legal liability. Different structures expose you to varying levels of personal and professional liability if you are sued or the business becomes insolvent. The type you choose can affect your personal and professional life, mainly because some structures legally separate you from your company, meaning your personal assets won’t be included in a proceeding.
Tax implications. Taxes have to be paid no matter what. The real question is how they are reported and what additional tax benefits are offered within a particular business structure. Corporations typically get better tax breaks than sole proprietorships or partnerships, and you don’t have to be Amazon.com to be a corporation.
Administration: Corporations require more record-keeping and paperwork compared to other structures, which is why many new business owners choose the sole proprietorship, partnership or limited liability corporation instead.
Future needs: It may be a lot easier to purchase a home if you incorporate, as you are considered an employee of the business. Instead of drawing money from your bank account as you need it, the company pays a regular salary. Some lenders are reluctant to lend to the owner of a sole proprietorship because the assets of the business and the owner are so tightly interwoven. A corporation can also simplify the transfer of the company to family members and make it easier to raise funds by selling shares of stock.
Regardless of your chosen structure, you will need to follow the same steps to register your business initially. Missing any of these steps or not doing them in the correct order can cause delays. Steps 5 & 6 are industry-specific and won’t apply to all businesses.
Here are the eight steps the state requires to set up and operate a business:
- Research and make a plan
- Register your business with the Secretary of State (SOS)
- License your business with the Department of Revenue (DOR)
- Report your new employees to the Department of Social and Health Services (DSHS)
- Apply for a Reseller Permit with the Department of Revenue (DOR)
- Register as a contractor with the Department of Labor & Industries (L&I)
- Contact your local health department for food handling requirements
- Check with your City and/or County for their requirements
Let’s move on to the various structures, starting with the most basic, the Sole Proprietorship.
A Sole Proprietorship is the simplest structure and, in Washington State, the least frequently used since you and the company are one. The income and expenses of the business are reported on your personal income tax filings (Form 1040). The profits and losses from the company are reported on Schedule C, which you file with your 1040 form.
You also need to file Schedule SE, which reports your self-employment taxes. These taxes need to be paid quarterly to the IRS and are based on your estimated taxes for that period. There is some art to getting the estimated payments correct. If you’re under, you may owe a penalty for underestimating.
There are some disadvantages with this structure you should be aware of.
First, you may be personally liable for your company’s liabilities, such as a lawsuit, a workplace accident due to negligence or bankruptcy. Your personal assets – cars, real estate, etc. – may become part of any legal action since you and the company are one. Raising money as your business grows can also be problematic as your business and you are one. If you have poor credit or a less than optimal credit-to-debt ratio, you may find it hard to get a loan. Additionally, lenders are less likely to consider your application for a mortgage for your dream home since you are self-employed, which they see as being riskier than an employee of a business.