Limit your liability: Choose your business format wisely

Art Business News, Jan, 2005 by Joshua Kaufman

Running a gallery, publishing business, art agency or simply being an artist, requires that you choose a form of business entity. Each form of entity has its pros and cons. Some are based on legal issues, but many of them are tax generated. In order to properly evaluate what type of business entity you should use in structuring your business, it is imperative that you check with a lawyer and an accountant.

The nature and requirements of a business entity are locally generated. Each state has its own laws. You will usually find that there are also county and local laws specifically dealing with business licenses with which you must comply. Simply hanging out a shingle without proper planning can cause you to lose thousands and thousands of dollars in taxes; to be responsible for things that you might not normally be liable for; and subject to fines and penalties. This is certainly a circumstance where the old adage of "penny wise and pound foolish" is true. If you get proper advice when initially structuring your business entity, you can prevent many legal and financial problems down the road. Of course, if you want to pay twice as much in taxes and be personally liable for any actions that you or any of your employees take, ignore my advice. On the other hand, if you wish to limit your tax liability as well as your personal liability, read on.

There are seven basic formats in which you can do business: sole proprietorship, general partnership, joint venture (JV), limited partnership, C corporation, S corporation and a limited liability company (LLC).

The limited partnership, corporations and limited liability companies are created by filing documents with the state. The sole proprietorship, the general partnership and a joint venture are generally created by the actions of the parties without the necessity of an official governmental filing. However, most states do allow for the registration of these type of entities as well, but it is not usually required.

The sole proprietorship--the simplest form of doing business--occurs when you simply do business by yourself. When you start working as an artist, an artist agent, a publisher or gallery, and you are working by yourself by default, you are a sole proprietorship. The sole proprietorship can have employees and hire independent contractors, but as long as there is only one decision-maker, it remains a sole proprietorship. It is a business entity that is virtually indistinguishable from its owner. If you are operating under a name that is different from your own, many states require the "fictitious business name" to be registered. Also, you will likely be required by your local jurisdiction to obtain some kind of license to operate either out of your own home or at a business premises. There is not much additional paperwork required by the state. Your tax return for your business is the same as the tax return you file for yourself--you simply add additional schedules. You are taxed at the same rate as an individual with the same deductions. You are also personally liable for all the debts of the entity, as well as for any liabilities that arise when you or your employees are acting in the scope of your business.

A general partnership is formed when two or more individuals or business entities come together and work in furtherance of a common business goal. Partnerships do not necessarily have documentation that give rise to their creation or the management of their operations. It is, of course, highly recommended that when you go into business with another person or another entity that you draft partnership documents, which spell out the obligations, liabilities, transferability, responsibilities of each of the partners, as well as any buyout rights and post termination issues that might arise. Generally, the paperwork required by the state in regard to general partnerships is the same as that of a sole proprietor. For tax purposes, the partnership is not a taxable entity as such profits and losses of a partnership flow directly to the partners. The tax burden (profits and losses) generally follows the same percentage as the ownership interests in the partnership. One of the greatest risks in forming a partnership deals with liability. Each partner is not only liable for their own actions and those of the partnership employees, but they are liable for the acts of their partners. Even if you weren't aware that your partner obligated the partnership on a contract or lease, or committed some act that created a liability, you are liable for your partner's actions. It is not uncommon for the "innocent" partner to be straddled with the debts and obligations incurred by the "irresponsible" partner. Your partnership agreement can shift the burden of liability between the partners to the responsible partner, but as to third parties all the partners are liable. The lesson to be learned is to choose your partners very carefully and keep close tabs on their activities.

The joint venture is very similar to a general partnership, but it is usually for a specific project or projects. It is considered a partnership in the eyes of the law with the same tax and liability consequences. It is simply much narrower in scope. But even though it is limited in duration and scope, the prudent business person will have a joint venture agreement in writing, outlining all of the responsibilities, obligations, and limitations of the agreement.