Whether you're selling your works of art or craft creations on Etsy, Facebook Marketplace, Amazon, or another online platform, making sound business decisions is crucial. Besides figuring out ways to manage costs, fulfill orders, and handle other operational details, choosing the ideal business structure for your company is imperative.
Could you benefit from forming an LLC or incorporating your online art business? Let’s take a look at what each entity type offers.
Advantages of Forming an LLC
An LLC (Limited Liability Company) is a separate entity from its owners (known as members). It’s the simplest business structure (aside from a sole proprietorship), with minimal startup and compliance requirements. Several other possible benefits of the LLC structure for your business include:
Personal Liability Protection
An LLC is considered a separate legal entity from its members. Under most circumstances, the business owner's personal assets are protected in the event of a lawsuit against the company or if the LLC runs into financial problems and cannot pay its debts.
The IRS and most other tax authorities consider an LLC a "disregarded entity" for tax purposes. In other words, the LLC does not report and pay tax, but rather business income and losses pass through to the LLC members' personal tax returns (subject to members' individual tax rates). This is akin to how sole proprietorships are handled. And, as with sole proprietorships, all business profits are subject to self-employment taxes.
Unlike sole proprietorships, LLCs have the option of electing to be taxed as a corporation instead. Members can choose to have the LLC taxed as a C Corporation (with the business paying tax at the corporate tax rate). Or they can select S Corporation election. As an S Corp, owners maintain pass-through taxation but only pay Social Security and Medicare taxes on income paid as members' salaries and wages. Any business profits paid to members as distributions are not subject to self-employment taxes.
Business Name Protection
Forming an LLC protects a business's name from being used by other companies that offer similar products in the same state. By registering your business as an LLC, you lessen the risk that some other company that's creating art or producing work similar to yours will use the same (or a very similar) name in your state. Applying for trademark protection can further safeguard a business name by protecting it in all 50 states.
LLCs may have an unlimited number of members, which allows for growth if a business owner wants to bring on additional partners to expand the business. Your art business may be solely operated by you now. However, if the demand for your work takes off, you may consider adding members to extend your production capabilities.
Advantages of Incorporating
A C Corporation is a separate tax and legal entity from its owners (shareholders). Incorporating is more involved and costs more than forming an LLC. However, it offers the highest degree of personal liability protection for its owners and other stakeholders (such as managers, directors, employees, etc.). Here are some key benefits of the C Corp structure to consider as you evaluate your options:
Personal Liability Protection
Shareholders’ personal liability for the legal and financial debts of the corporation is limited to the amount they individually invested in the company.
By default, a C Corp reports and pays tax at the corporate rate. You may have heard the term "double taxation" when people refer to how C Corporations are taxed. That's because the company pays taxes on its profits. Then the individual shareholders pay taxes on the dividend income they receive from the corporation. A C Corp cannot use the dividend payouts to its shareholders as a tax deduction. So, those funds are taxed twice: once at the corporate level and then again at the individual level.
There are two methods some corporation owners use to avoid the sting of double taxation.
- One is paying themselves a bonus at the end of the year, rather than receiving profits as dividends. Bonuses are considered supplemental wages (and therefore deductible for the business).
- Another way is electing to be taxed as an S Corporation. As an S Corp, all profits and losses flow directly to the company’s shareholders’ personal income tax returns. Owners’ salaries and wages are subject to self-employment tax, but profits given as distributions are not.
Business Name Protection
As does forming an LLC, incorporating a company protects its name from being used by another business in the state. By registering your art business as a corporation, you minimize the risk that a competitor in the same state will use the same name. As I mentioned earlier, having a registered trademark can further protect a business name across all 50 states.
C Corporations can grow by issuing shares of stock to new shareholders. The C Corp structure may have an unlimited number of shareholders, and an S Corp may have a maximum of 100. Another growth-related advantage is that, typically, investors are more receptive to requests for funding from companies that have incorporated. So, if you set your sights on getting financing to build a warehouse or fund another initiative to expand your business, this is food for thought.
How to Decide
Forming an LLC or incorporating has legal and tax effects, so I encourage you to speak with your attorney and accountant or tax advisor for guidance. After you've decided on the best business entity type for your situation, you must complete various filings and applications to establish your business structure officially. These depend on which entity type you've chosen and your state's requirements. Several examples include:
- File business registration paperwork with the state (Articles of Organization to form an LLC or Articles of Incorporation to form a corporation).
- Obtain an Employer Identification Number (EIN).
- Submit IRS Form 8832 and/or IRS Form 2553 for tax election.
- Create an operating agreement or bylaws.
- Hold a member or shareholder meeting.
- Open a business bank account.
- File an initial report.
Without a doubt, there is much to think about when deciding on the ideal business structure for your online art business. As you consider your options, also talk with your SCORE mentor, who can help you weigh the pros and cons and assess your unique situation.