Music Business Entities
The way dollars flow and into what type of entity has a very large effect on the tax bill along with providing in some cases a layer of protection or "corporate veil" from lawsuits. Before we go into the different options available for running your business it should be understood that if you are forming a Limited Liability Company or Corporation simply to provide the corporate veil I wish you the best of luck. Everything must be perfect in an actual lawsuit with something real to loose. Place one penny from your company into the wrong slot, and you have pierced the corporate veil. Now you know why there is always a CFO (Chief Financial Officer) in a successful corporation to assure everything is compliant all the time.You have a large and complicated array of choices when it comes to the business entity that you pick. In many cases in the music business it takes several of them working in concert to make the money flow properly. Don't despair as you read through all these options. All you need is a basic understanding of the ground rules and a trusted tax and legal advisory team to keep you compliant.

Sole Proprietorship

This is the most basic form of business entity and is formed on the spot by simply accepting dollars in exchange for goods or services. The owner is an individual and is financially and legally responsible for everything the business does. The owner pays tax on all the profits from a sole proprietorship in addition to self employment tax (self employed version of social security and medicare otherwise known as FICA). It is often best to begin your career with this type of entity and most independent musicians and sidemen use it very effectively well into their careers.

A few advantages:

1 Easy and inexpensive to form
2 Little regulation and paperwork
3 Owner has complete control of the business
4 Owner keeps all the profit (or loss for tax purposes)
5 Losses can offset taxable income for other sources

A few disadvantages:

1 All the owners assets are at risk personal and business
2 Owner pays self employment, federal and state income tax on all profits
3 Owner may be subject to quarterly estimated tax payments
4 If the owner dies, so does the business
5 Difficult to raise investment capital

At the least I suggest you get a federal tax id number for a sole proprietorship, a separate business checking account and credit card for use exclusively for business purposes. Doing these things provides you with cleaner accounting and some financial discipline. This helps a bunch with hobby loss rules that may impact your tax bill if no profit is made in the earlier years of your career. The owner files a special schedule on his or her personal tax return to account for the business activities.

Partnerships

Partnerships come in many forms and are the vehicle used when more than one individual or company desires to do business with and share in the profits of another. Commonly in the music industry a partnership needs to be formed if a label wishes to sign a band as a complete entity. Songwriters sometimes use them for their publishing interests. There are many reasons to form a partnership but be warned that the accounting becomes much more complex with a complete balance sheet and capital accounts. Without proper accounting from the very start, the partners in the firm will have a very difficult time breaking the company up later, and in many cases the attorney and accountant end up with most of the cash assets through fees to determine the true value of a partners stake in a company before it can be sold or liquidated. Get good tax and legal advice before forming a partnership. Partnerships do not pay tax but rather "pass through" profits and losses to the individuals or companies that own the partnership in ratio with their ownership share. The partnership does file its own tax return.

There are three basic forms of a partnership

General Partnerships
In this type of partnership all partners share in the tax and legal responsibilities. Each partner may enter into contracts and all partners are accountable for the actions of the other partners concerning the business. Bands tend to use general partnerships to some effectiveness. The profits or losses flow to the bandmembers once the partnership tax return is completed.

Limited Partnerships
In this type of partnership there are two different kinds of partners. At least one partner acts as a general partner and has control over management of the business while the limited partners can be thought of as passive investors. This type of arrangement can work well for small labels that have raised investment dollars to record and release a project. It is a must to consult both an attorney and accountant before attempting to form a limited partnership. Security and other laws can come into play and even sending an email across state lines asking for an investment could trigger trouble with the securities exchange.

Joint Ventures
These are tricky little entities which show up quite a bit in the film industry. A joint venture operates just like a general partnership but it is formed for a specific project after which the joint venture comes to an end. It could be used for a CD project or other project as well.

A few advantages of partnerships:

1 Cost less than a corporation to form
2 More flexibility with management and less required meetings
3 Owners share in profits or losses for tax purposes
4 Capital can be raised by inviting more partners in
5 The business can continue if one or more of the owners die or leave the business

A few disadvantages of partnerships:

1 Owners are responsible for legal and tax responsibilities including self employment tax
2 Complicated accounting and an additional business tax return to do annually
3 Each partner binds the others with business decisions
4 Interests are not easily sold or transferred
5 The partnership will break up at some point

Corporations

Corporations are separate legal and taxable(sometimes) entities from the owners otherwise known as shareholders. Corporations have a life of their own and can last perpetually. The shareholders are not financially responsible for the actions of the business (sometimes). State regulations govern how a corporation is to be formed and operated. Generally they must have a Board of Directors and Corporate Officers to manage the affairs of the business. All corporations must have at least one employee which means if you choose to form one, you must pay yourself or someone a salary to operate it. This is especially important in an S Corporation. Owners buy shares of the company and cast votes to elect the Board of Directors who then appoint the Officers. Corporations come in different sizes and flavors.

C Corporations
These corporations are the only truly separate legal and taxable entity on the menu. They are also the most difficult to form, manage, operate and stay compliant with. Even with all the paperwork and regulation I tend to choose this entity in many cases when the business is showing some financial success. All those tax breaks that the federal government gives out apply most to the C Corporation. They pay their own taxes and can choose their own fiscal year (ending month when the accounting and tax return is due) thus delaying tax payments and accounting for strategic timing with the owners personal return. Raising capital is simply a matter of selling shares of the company. Also, the company lives on perpetually if you want it to making it perfect for passing musical assets (copyrights)to your heirs by transfer of your shares.

S Corporations
If a corporation meets certain requirements it can apply to be treated as an S Corporation. This treatment makes it operate for tax purposes much like a general partnership passing the profit and loss to the shareholders. It provides deeper liability protection in lawsuits (sometimes). There are many dangers in this type of corporation which many professionals are not aware of. On the surface they seem like the right entity, but in many cases the IRS has overturned management decisions concerning owner compensation making all profit payments to owner/employees subject to employment taxes. S Corporations are used in the music industry but I tend to use them for individuals who own rental real estate instead creating a type of personal mutual fund for them that can easily be passed through their estate to their heirs. They also have the benefit of using real estate depreciation rules to offset personal tax liabilities as well.

A few advantages of corporations:

1 Owners are not personally liable (in theory) for legal and financial business
2 The business lives forever if you choose
3 The company can own, lend, borrow, and do other business completely on its own
4 Shares in the company can easily be sold or transferred
5 They tend to enjoy many more tax breaks and pay less overall income tax

A few disadvantages of corporations:

1 Plenty of government regulation
2 Not easily formed and cumbersome to operate
3 They begin life with zero credit and no assets
4 Employment laws and regulations apply
5 Complicated annual accounting and legal work must be done

Limited Liability Companies

These are handy entities because of their flexibility. I use them very often for bands, songwriters, producers, and many other music applications. The attraction to a Limited Liability Company is it can be seen by the IRS as any one of the entity choices. Put another way, it can grow with the business. An example would be a guitarist who is a sideman and a sole proprietor. We convert his business to a limited liability company is the early years and nothing changes for tax purposes. Later he forms a duo with a friend and we change the LLC to partnership status. Later that duo has a top ten hit and we convert that partnership LLC to C Corporation status for tax purposes. Handy!

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