Considerations in Selecting a Form of Business Organization

Business Classification  One of the first decisions that an artist will have to make as a business owner is how the business should be structured.  Until the artist sets up a formal entity, he or she is by default a sole proprietor. Most businesses begin as a Sole Proprietorship because it does not require any formal filings with a state or federal agency and requires no separate Federal Identification Number (FEIN) and most artist’s businesses begin without giving much thought to its legal form. However, if they have some degree of success and ownership and taxation become paramount factors, more consideration is given to the best form to conduct business.

In the selection process, artists must adopt some legal configuration that defines the rights and liabilities of participants in the business’s ownership, control, personal liability, life span, and financial structure.  This decision may have long-term implications, so the artist may want to consult with their accountant and attorney to help you select the form of ownership that is right for you.

In making a choice, you will want to take into account the following:

  • Your vision regarding the size and nature of your business.
  • The level of control you wish to have.
  • The level of “structure” you are willing to deal with.
  • The business’s vulnerability to lawsuits.
  • Tax implications of the different organizational structures.
  • Expected profit (or loss) of the business.
  • Whether or not you need to re-invest earnings into the business.
  • Your need for access to cash out of the business for yourself.

An overview of the four basic legal forms of organization: Sole Proprietorship; Partnerships; Corporations and Limited Liability Company follows.

Sole Proprietorship

The vast majority of small businesses start out as sole proprietorships. These firms are owned by the artist, usually the individual who has day-to-day responsibility for running the business. Sole proprietorships own all the assets of the business and the profits generated by it. They also assume complete responsibility for any of its liabilities or debts. In the eyes of the law and the public, the artist is one in the same with the business.

Advantages of a Sole Proprietorship

  • Easiest and least expensive form of ownership to organize.
  • Sole proprietors are in complete control, and within the parameters of the law, may make decisions as they see fit.
  • Profits from the business flow-through directly to the owner’s personal tax return.
  • The business is easy to dissolve, if desired.

Disadvantages of a Sole Proprietorship

  • Sole proprietors have unlimited liability and are legally responsible for all debts against the business. Their business and personal assets are at risk.
  • May be at a disadvantage in raising funds and are often limited to using funds from personal savings or consumer loans.
  • May have a hard time attracting high-caliber employees, or those that are motivated by the opportunity to own a part of the business.
  • Some employee benefits such as owner’s medical insurance premiums are not directly deductible from business income (only partially as an adjustment to income).


In a Partnership, two or more artists share ownership of a single business. Like proprietorships, the law does not distinguish between the business and its owners. The Partners should have a legal agreement that sets forth how decisions will be made, profits will be shared, disputes will be resolved, how future partners will be admitted to the partnership, how partners can be bought out, or what steps will be taken to dissolve the partnership when needed; Yes, it’s hard to think about a “break-up” when the business is just getting started, but many partnerships split up at crisis times and unless there is a defined process, there will be even greater problems. They also must decide up front how much time and capital each will contribute, etc.

Advantages of a Partnership

  • Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement.
  • With more than one owner, the ability to raise funds may be increased.
  • The profits from the business flow directly through to the partners’ personal tax return.
  • Prospective employees may be attracted to the business if given the incentive to become a partner.
  • The business usually will benefit from partners who have complementary skills.

Disadvantages of a Partnership

  • Partners are jointly and individually liable for the actions of the other partners.
  • Profits must be shared with others.
• Since decisions are shared, disagreements can occur.
  • Some employee benefits are not deductible from business income on tax returns.
  • The partnership may have a limited life; it may end upon the withdrawal or death of a partner.

Types of Partnerships that should be considered:

1. General Partnership

Partners divide responsibility for management and liability, as well as the shares of profit or loss according to their internal agreement. Equal shares are assumed unless there is a written agreement that states differently.

2. Limited Partnership and Partnership with limited liability

“Limited” means that most of the partners have limited liability (to the extent of their investment) as well as very limited input regarding management decision, which generally encourages investors for short term projects, or for investing in capital assets. There must be one or more general partners who assume unlimited liability for the liabilities of the partnership. This form of ownership is not often used for operating retail or service businesses. Forming a limited partnership is more complex and formal than that of a general partnership.

3. Joint Venture

Acts like a general partnership, but is clearly for a limited period of time or a single project. If the artists in a joint venture repeat the activity, they will be recognized as an ongoing partnership and will have to file as such, and distribute accumulated partnership assets upon dissolution of the entity.

4. Partnership Taxation

The sole proprietorship files its taxes as part of the owners Form 1040, whereas the partnership files its own separate income tax return, on federal Form 1065, that reports the total income and expenses of the business. The partnership than then passes the net income (bottom line) or loss directly the personal income tax returns of the partners via the federal Form K-1.

The partnership (as compared to an “S Corp”) has the unique and important tax advantage of special allocations. That is, special allocations which allow the partnership to customize the distribution of income and loss by mutual consent through the use of the partnership agreement. For instance, partners may own the business 50%/50%, but choose to split and losses 80%/20% if that yields a better tax result for them. Partnerships can also, if properly structured, have possible tax advantages relating to film and sound recording activities.


A Corporation, either domestic (incorporated in the state where it is headquartered) or foreign (incorporated in a state in in which it is not headquartered), is considered by law to be a unique entity, separate and apart from those who own it. A Corporation can be taxed; it can be sued; it can enter into contractual agreements. The owners of a corporation are its shareholders. The shareholders elect a board of directors to oversee the major policies and decisions. The corporation has a life of its own and does not dissolve when ownership changes.

Advantages of a Corporation

  • Shareholders have limited liability for the corporation’s debts or judgments against the corporation.
• Generally, shareholders can only be held accountable for their investment in stock of the company.  (Note however, that officers can be held personally liable for their actions, such as the failure to withhold and pay employment taxes.)
  • Corporations can raise additional funds through the sale of stock.
  • A Corporation may generally deduct the cost of benefits it provides to officers and employees.
  • Can elect S Corporation status if certain requirements are met. This election enables company to be taxed similar to a partnership.Disadvantages of a Corporation
  • The process of incorporation may require more time and money than other forms of organization.
  • Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations.
  • Incorporating may result in higher overall taxes if not all income is distributed as salary and wages, expenses, or pension plan contributions. Dividends paid to shareholders are not deductible from business income; thus this income can be taxed twice

Subchapter S Corporation

A tax election only; this election enables the shareholder to treat the earnings and profits as distributions, and have them pass through directly to their personal tax return.  The catch here is that the shareholder, if working for the company, and if there is a profit, must pay his/herself wages, and it must meet standards of “reasonable compensation”.  This can vary by geographical region as well as occupation, but the basic rule is to pay yourself what you would have to pay someone to do your job, as long as there is enough profit.  If you do not do this, the IRS can reclassify all of the earnings and profit as wages, and you will be liable for all of the payroll taxes on the total amount.

Although “S” corps are taxed similar to partnerships in that each shareholder receives a K-1 for their share of the income or loss for the tax year, please be aware that “S” corporations are not allowed the special allocations of the partnership. If two shareholders own the corporation 50%/50%, the profits or losses have to be split 50%/50% too.

Limited Liability Company (LLC)

The LLC is a relatively new type of hybrid business structure that is now permissible in most states.  It is designed to provide limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. If you are considering setting up your business as a partnership, take a long, hard look at the LLC, which is generally preferable to the standard partnership.

Federal Tax Forms for LLC

The LLC combines many of the features of a partnership with those of an “S” corporation, without the restrictions that applies to S corporations. It allows the reporting of income or loss directly on the personal income tax returns of the “partners” (or members in an LLC) but provides some of the liability protection of a corporation. The LLC is also a “flow-through” entity that generally files the same federal income tax forms as a partnership, Form 1065, with each member receiving a federal form K-1. It does allow for the use of “special allocations” discussed in the section on partnerships. Normal partnership organization requires that you do need two individuals to set up and LLC though some state (including California and New York) do allow the “single-person” LLC.


In reality artists have basically three choices of business entity, the sole proprietorship, partnership/LLC and corporations. The sole proprietorship is the least costly and requires the least amount of cost to establish and maintain. Unless there is a clear need or reason to set up a more formal and costly entity, you probably shouldn’t consider it. If you do decide to go the more formal route or you are unclear as to what course of action you should take, your deliberations should involve both an attorney and tax professional.

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