Choosing Your Business Structure: Sole Proprietorship, Corporation, LLC

Recently, a peer and friend of mine changed her business entity from sole proprietorship to an LLC. This was a very smart move. Why? – it protects herself, her personal life, personal assets, and her family from any obligations and financial liabilities that arise out of the course of her business. If she were to default on a loan or face legal proceedings, her LLC status means that the lender or any other party seeking monies can go after her business’s assets, while she can feel safe that her house, her family bank account, her belongings, etc., are protected.

Mary Lee Herrington, Esq.

It made sense, though, that when she started out, she chose the easiest business entity: sole proprietorship. As a sole proprietor, she did not have to register her business with the state, pay fees, or open up a separate business bank account. It was easy to start business right away and accept payments. But once her business began to grow and she was working on projects that included subcontractors, vendors, planners as well as more demanding and higher-paying clients, it was crucial that she change her business entity.

Choosing the best type of business entity for your business will turn on certain facts such as the service/product you offer, how much money you can outlay for the business registration process, tax obligations, ongoing reporting obligations, whether you are a professional (i.e., lawyers, architects, engineers, doctors), among others.

I should mention that it is a very good idea to talk to your accountant or lawyer about which type(s) of business entity would work best for your business (and I should note that, YES, I also advise and help business owners with choosing and registering their business structure too).

Here are some of the most common types of business entities that creative entrepreneurs choose for their businesses (IMPORTANT NOTE: rules may vary state to state):

Sole Proprietor:

As mentioned above, this is the simplest type of business organization and the most cost-effective. In essence, your business is an extension of yourself – i.e., you can use your personal accounts to write and receive payments and there is no requirement to formally register yourself or your business with the state. However, many sole proprietors will not want to use their personal name and will file a very simple “Doing Business As” certificate under an assumed name with the local county clerk’s office (this does NOT create a separate legal entity). Doing taxes is also simple: business income is reported and taxed on a personal tax return. Once the business gets going, you really should switch to another business structure – one of the ones listed below are the most common among creative small businesses.

Corporation:

Discussing corporations can be extensive, so I’m only going to stick to main points here. When you form a corporation, your business becomes a separate legal and tax entity from yourself as the owner (or any of its shareholders). This protects the small business owner because the corporation is responsible for all liabilities and debts. All shareholders have limited liability, where the liability is capped at the amount the shareholder has invested.

The “C” status is the standard type of corporation. The “S” status (“s-corp”) is common among creative small businesses and essentially provides that owners are treated by the IRS as if they are sole proprietors or a partnership (i.e., the “pass-through” tax treatment whereby business income may be reported and taxed on a personal return).

S-corporations must have fewer than 100 shareholders, each shareholder must be either an individual or certain trusts & estates (but never a corporation or partnership), none of the shareholders may be a non-resident alien, and the corporation must only have one class of stock. To apply for S-corp status, fill out a Form 2553 with the IRS (and a Form CT-6 with the New York Department of Taxation and Finance). But, please also speak to an accountant first!

Both C-corporations and S-corporations must follow ongoing regulations for corporations. This includes certain record-keeping requirements at the federal, state and local levels, and periodic board meetings and annual shareholder meetings.

LLC:

A limited liability company (LLC) structure is now permissible in most states (including New York) and is a very common business structure for creatives because it offers the limited liability protections that you would get as a corporation and certain other beneficial tax efficiencies (particular tax classifications depend on the number of members in the LLC). Note that tax and liability treatment may vary from state to state. Operationally, this is also the most flexible of business structures. Notably, they do not have the same formalities (i.e., paperwork) that corporations are required to follow. Most creative small businesses are single-member LLCs (owners are called “members”), but there is no limit to the number of members and members do not necessarily have to manage the business.

Note that in New York state, registering for LLC status entails a publication requirement with newspapers and this part of the business structure formation can set you back a couple thousand dollars.

Professionals:

Those who want to hang up a shingle as one of the traditional categories of professionals – i.e., lawyers, doctors, architects, engineers – must check with their state to see what type of business structure applies to their profession as well as any other requirements from their professional, governing body. For example, in New York state, lawyers may either structure their business of legal services as a PLLC (professional LLC), PC (professional service corporation), or LLP (limited liability partnership, the most common type among lawyers banded together in business). It’s important to check with your state because, for example in California, lawyers are not permitted to structure their business as an LLC (and neither can any business which requires a professional license).

Interestingly, the business structure and requirements for legal professionals came up in conversation recently, a topic which a friend of mine and I remembered from the bar exam. To prevent the unlawful practice of law, any ol’ company cannot simply decide to add legal services as one of its business services. Legal services may only be offered by an organization that is formed specifically and only for the purpose of providing legal services and the owners of the business providing legal services must all be licensed lawyers. It cannot and may not conflate its services with another type of business service – for example, non-lawyer business owners may not tack on a legal services division to their company with the view to offer legal services to clients/customers, and any lawyer who associates him or herself with a non-lawyer in providing such legal services to clients can face disciplinary action; similarly, a lawyer who has formed a PLLC, PC or LLP also cannot then tack on another type of service (such as, real estate brokerage) to its existing business, but rather should form a wholly separate business entity for the non-legal service. A point of distinction: a company that has hired an in-house attorney is hiring the attorney to represent and act on behalf of the company, not offer legal services to clients (such as, draft the client’s contracts, provide advice on the client’s issues).

More info:

I’ve only provided a cursory overview of these types of business structures. To decide what’s best for your business, it’s a good idea to talk to an attorney. This journal entry only presents basic, general information and does not constitute legal advice and is not a substitute for legal advice. I myself am pleased to offer legal advisory services in choosing business structures and assisting with the registration process. For tax-specific questions, it’s always good to speak to your accountant or financial advisor.

As mentioned at the outset, switching from one business structure to another is possible and sometimes should be done.

{ Images by Aneta Mak }

Best Practice Tip: Adding Protections Into Your Contracts

For my inaugural newsletter, I thought I’d talk about my own experience as a solo business owner in the wedding industry and what I’ve learned along the way about adding protections into your contracts.

Mary Lee Herrington, Esq.

Like many new entrepreneurs, I started my event planning business with rose-tinted glasses and hit the pavement running. In many ways, it was so busy just getting the business off the ground and then figuring things out on the fly that sometimes it felt impossible to stop and make sure all the ducks – legal ducks, I should say – were in a row.

My experience showed me that you can’t predict everything when it comes to weddings – after all, every couple is unique and, especially these days when couples want their weddings to be bespoke, a form contract may not cover everything that is eventually demanded of you.  I found that my contracts would always have to be reviewed, tweaked and tailored to each client after I had learned something new or experienced a different unforeseen incident from the last wedding that I had wrapped.

And as time went on and each client wedding brought new challenges and predicaments, I always went back to my agreements and reviewed them in light of the new experiences and tightened the language to protect me in the future. It wasn’t necessarily “bad” things that would prompt me to do this – rather, and often, it was due to things I realized from just doing the work.  It was things like realizing that the massive quantities of wedding favors needed extra days to assemble (ergo, a proviso for additional fees and staffing), or noting that clients must inform us of guests in wheelchairs and seniors who needed separate transportation options (adding additional liability language in addition to the existing indemnity clause); or just making sure that all the time leading up to the wedding day was correctly spelled out and covered in the contract.

I also spoke to many of my peers who told me they had similar issues but weren’t sure how to reflect it in their contracts. Sometimes they just didn’t know what to do and instead of sticking to their guns, they would forfeit a deposit, lose a wedding date during high season, work many hours for free because they had not set out clearly with the client what the expectations would be, or absorb the cost for rush jobs or printed mistakes when the clients had already signed off. Sometimes, perhaps unfairly, a situation can even result in bad word of mouth or a demand for refunds.

It is so easy to think that because weddings and events are about parties and celebrations that business will always be fun and people will be lovely to work with. And we hope always true!  But realistically, even if you are the type of person who actually does get teary-eyed at every “You may kiss the bride” moment, the fact remains that this is and should be regarded as a business, not a hobby or a personal favor, and a business whose interests you should protect. After all, if you are a sole proprietor in an unlucky situation, your personal assets – not just your business – could be vulnerable.  Albeit an egregious example, the fact that couples like this one actually decide to sue is a scary reality and you never want to find yourself on the receiving end!

So here is my best practice tip: after every wedding, jot down notes on where you think things could have gone wrong (and of course those things that actually did go wrong, however minor or major) while it is fresh in your mind.  Then go back to your client contract and see if it covers you on all of those points.  If your contract is lacking those provisions, then think about getting a lawyer to help you with revisions.  Because every client is so different and there are so many chefs in the kitchen on a wedding day (the parents/in-laws who may be footing the bill and think of themselves as the client rather than the couple, a demanding bridal party, the guests who may view you as their personal valet), you will find that a very generic form contract is not enough and that you need to add more protections.  Just having these protections in your contract not only covers you in future contractual work, but it also offers that lovely thing called “scope” – meaning, your next client will read it and, at the time of booking you, understand that these are your terms and your boundaries.

{ Photo credits: left image, Aneta Mak // right image, Judy Pak }