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Protect Your Creative Business by Incorporating

Now more than ever, visual artists and designers are exploring new ways to work for themselves as freelancers, self-employed workers, independent contractors and creative business owners. Working for yourself in these ways offers independence and flexibility to self-motivated individuals who are comfortable with a certain amount of risk. In exchange for the security of a full-time job with benefits, you get to call the shots and have more say about what you do and how you do it. However, there are some serious responsibilities you need to take on that would normally be covered by your employer. 

When most creatives start looking for work on their own, they don’t necessarily think about starting a company. They think about lining up work, taking on projects, and getting paid. They don’t think about taxes, hiring employees, insurance, operating costs, or any number of other items that are part of owning and running a business. These are concerns for your employer. However, when you are your own employer, they are now your responsibility.  Being self-employed without the structure of an incorporated business means that if you are sued by a client or customer, creditors can seize your personal assets like your home, car and even future income.   The way to protect what you own is to separate you from your business. This can easily be accomplished by setting up a corporation for your business, so you can be protected. 

Types of Corporations

Corporations protect owners from being personally responsible for things that the company does, assuming those actions are legal. When a corporation is formed, a new legal entity is created. A corporation is entitled to certain rights that are very close to many of the rights people enjoy. The corporation will be given a legal name, and it will receive a Corporate Tax ID, which is like a social security number, and it can enter into contracts and be punished for doing things that are illegal. 

The important part is that your creative business, your company, is separate from you. Any problems that the company has, as well as the advantages a company may receive, are the company’s. If your company is sued over a contract dispute, you can use company money for lawyers, and if you lose, the winner can only get money from the company. If there isn’t enough money in your company available to pay the lawsuit, the winner can’t try to take your personal assets as compensation. The same is true if someone who comes to your office or studio and falls, breaking their leg. They may sue for their injuries, but they can only sue the company. You are protected. The opposite is true if you are a non-corporation, like a sole proprietor or partnership. In that case, make sure you have liability insurance. 

Creative Freelancers Corporate Veil
Creative freelancers can protect their business and their personal assets by incorporating.

However, liability protection is only available to those who follow the rules. When rules are flaunted, creditors might be able to pierce the “corporate veil” as it’s termed in law, and target the responsible shareholders. For example, commingling personal funds with corporate funds, such as using the company bank account as your personal bank account, or if a shareholder committed fraud on behalf of the company, would likely pierce the corporate veil. So, if you are a corporate officer, always be sure to talk with an accountant to ensure that you don’t inadvertently do something that allows the corporate veil to be pierced.

There are other benefits in forming a corporation as well, such as lower taxes or being able to issue stock to investors, but each corporate structure also has unique benefits and downsides. 

The most popular are:

  • Corporation (C-corp)  make these three all links to each section where it’s talked about
  • Subchapter S (S-Corp)
  • Limited Liability Company (LLC)

C-Corp

Most of the big name companies you know are C-corps (also known as Inc.): Coke, Boeing, Walmart, Verizon, and Apple, to name a few. Almost all public companies on the myriad of stock exchanges are C-corps because the C-Corp has the advantage of being able to issue multiple types of stock that can be traded, with each type having its own rules. This can be very important when trying to raise funding for a business but for many creative business, this corporate form is probably overkill. There are lots of administrative requirements that are unnecessary for a small creative business, such as having a Board of Directors, officer elections, shareholder meetings and payment of estimated taxes quarterly, instead of yearly. 

Additionally, a major downside of the C-Corp model is double-taxation. Here is how it works.  Assume that you are a designer, and you generate $50,000 in gross revenue. You pay any company expenses and take the rest as salary, leaving no money in the company. The company then pays no tax, because it has no profit. The owner/shareholder pays income tax on their salary as personal income. However, if the owner decides to leave money in the company for any number of reasons, such as future growth and development or to have cash on hand to mitigate slow months or clients late paying bills, the remaining capital is considered income and the company must pay taxes on it. Now assume that the retained money, after taxes, isn’t used for anything, and the owner later takes it as a bonus, then the owner pays taxes on the bonus as personal income.  So, the revenue was taxed twice, once as corporate profit and once as personal income. As you can imagine, for a small business with only a handful of people, or even a single owner, the requirements of a C-Corp can be too burdensome. 

Subchapter S Corporation

An S-Corp provides many of the same benefits as a C-Corp without the double taxation. S-Corps allow the shareholders to “pass-through” the corporate income as profit and loss on their individual tax returns, rather than a corporate tax return. That also means no quarterly taxes, as in the C-Corp.  And just like the C-Corp, the company can attract investors through the sale of shares of stock. Think of an S-Corp as C-Corp lite. In fact, when the business initially files for corporation status, it is classified as a C-Corp. Once completed, you can file for S-Corp status if you meet the additional requirements, namely, that you have fewer than 100 shareholders, that you maintain only one class of stock, and that the owners are U.S. citizens or resident aliens. For small art-based business, these are fairly easy requirements to fulfill.

In addition, since an S-Corp is a corporation, it provides liability protection for the shareholders/investors. On the other hand, there are additional expenses associated with an S-Corp, such as workers’ compensation and unemployment insurance coverage, depending upon the state. Some states also require minimum annual state taxes, no matter how much money the company earns. For example, California requires an $800 annual minimum tax. So, the tax savings may not be enough to offset the additional expenses.

The Limited Liability Company (LLC)

By far the most popular structure for creative businesses is the LLC. LLCs combine the personal liability protection of a C-Corp or S-Corp with simplified tax structure and filing requirements. An LLC is identical to an S-Corp in so far as a company’s profits and losses flow through to the shareholders’ personal tax returns. No corporate tax return is required, which also means that you can avoid double taxation. Also, unlike the S-Corp, there is no residency requirement. Owners need not be U.S. citizens or permanent residents. And like any other corporate form, there is limited liability for business debts and obligations. 

The main difference between an LLC versus the other corporate forms is that LLCs do not issue stock.  There are no shareholders, shareholder meetings, or required elections. There is no Board of Directors that oversee the policy and direction of the company. Instead, LLCs have Members and Managers. Unlike stock shareholders, members of an LLC participate in the management of the company, unless the members agree to select a manager-managed LLC, where one person makes the decisions. Typically, however, LLC members actively participate, making decisions and offering input on the company’s direction. Member decisions are decided by a majority. 

Additionally, most states do not restrict ownership, and members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. However, not all states permit “single member” LLCs, those having only one owner. he way around that is to give a trusted relative 1% of the company so it has two members. 

For creative freelancers, especially self-employed or solo businesses, the LLC is probably your best approach. You can always change to another structure later. While we recommend hiring an attorney to start your company due to the variations of requirements in each state, an attorney can be expensive. Instead, you can try any number of online services such as Bizfilings or ZenBusiness to get an LLC opened for only a few hundred dollars. However, you should have an attorney review the paperwork to check for any deficiencies.

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About the author

Steve Schlackman

As a photographer and Patent Attorney with a background in marketing, Steve has a unique perspective on art, law and business. He is currently serving as the VP of Product Innovation at Orangenius, where he hopes that his many interactions with the various members of the Orangenius community will provide lots of important material for Artrepreneur. You can find his photogrphy at Orangenius.com or through Emmanuel Fremin Gallery in NYC.

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