What’s Best for Your Business?

Posted on April 1, 2014 by

The pros and cons of different legal structures for your studio

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When Jilissa Cotten decided to open her Corpus Christi, Texas–based studio in a community already saturated with dance schools, she didn’t question her attorney’s advice to establish the business as a limited liability company, or LLC—once he’d explained what an LLC was. “Being a small business, the first two years are really critical—that’s when most businesses fail,” Cotten says. “If I’d gone bankrupt, as a sole proprietor I could have lost my car and my house. Being an LLC protects owners from that.”

It sounds dramatic, but knowing the ins and outs of the various legal structures for businesses—and choosing the right one—can make or break your studio. It will determine how much you’ll end up paying in taxes; whether you’ll be held personally liable if things go wrong; and how much paperwork you’ll need to take on. Prepare to get cozy with an attorney—the legalities can be daunting—but start by educating yourself on the basic breakdowns of the most popular business structures for studios. Know, too, that your business structure is not cast in stone. “You can always change the way you organize your business later on,” says attorney Margarita Smirnova, should that be to your advantage.

 

Sole Proprietorship

A sole proprietorship is run entirely by one owner, with no distinction between you and the business itself. This gives you complete control over the way your studio operates, and you get to keep all of its profits. However, you are also personally liable for all your business’ losses and debts.

GOOD FOR: 

A single owner who doesn’t have much start-up cash You’re in charge of all business decisions, and it’s the cheapest and easiest business structure to set up.

Easy-breezy tax prep You’ll only be taxed once (your business isn’t taxed separately; you report income and expenses on a Schedule C on your personal tax return). And sole proprietorships have the lowest tax rates, on average.

THINK TWICE IF:

Liability is a concern You and your business are considered the same entity, so you are held personally responsible for your studio’s liabilities—putting your personal assets at risk. When Iacono Ballroom Center owner Paula Iacono opened her Amherst, New York, studio, she established a sole proprietorship, imagining that the business would operate as her part-time job. But as her studio grew, Iacono was forced to reconsider her liability issues—and her business structure. “If somebody trips and falls in your studio, they can take everything you have,” she explains. In order to secure her assets, Iacono eventually switched to an S Corp structure (see below).

C Corporation 

With this structure, your business is a separate legal entity, independent from you. Though this means you’ll have to file two tax returns, pay two tax bills and organize much more paperwork, your personal assets will never be seized if the studio goes into debt or fails.

GOOD FOR:

Limited liability Your personal assets are protected from business debts, much like they would be in an LLC (see below).

THINK TWICE IF: 

You’re low on funds It’s expensive to establish a corporation: You have to pay start-up, operating and tax costs exclusive to C corporations.

You don’t want to be taxed twice You are taxed once on the studio’s profits reported on your corporate tax return and again on your personal income tax return—on the salary the studio pays you.

 

S Corporation

This type of corporation allows you to avoid being taxed twice while offering you reassuring liability protection. But it still comes with the increased paperwork, tax prep and legal costs typical of a corporation.

GOOD FOR:

The studio franchise If your studio has grown considerably, with multiple locations, it makes sense to reap the best benefits possible within a business structure meant for established, larger companies. Smirnova warns, however, that you cannot have more than 75 shareholders total for these benefits to be viable.

Fewer taxes All income and losses are included on your individual tax return, meaning there’s only one level of federal tax to pay on your business.

THINK TWICE IF:

You don’t like playing secretary You need to file articles of incorporation and hold business-status meetings with recorded minutes.

 

Limited Liability Company

The most important aspect of this structure is in its name: You can’t be held personally liable if the LLC incurs debt or is sued. The LLC is a hybrid of the corporation structure: Your personal assets are safe, but you won’t be taxed twice.

GOOD FOR:

The new studio owner or owners who want a safety net With this business structure, you can’t be held personally liable for debt or business decisions. As Cotten learned, if your studio fails, your personal assets will be protected.

Smooth operating You won’t have to do the extensive recordkeeping of a C corporation, and your registration paperwork will be minimal.

THINK TWICE IF:

You don’t want to pay self-employment taxes Because you’re considered self-employed, you need to pay the self-employment tax amounts for Medicare and Social Security—based on your LLC’s net income.

 

Nonprofit Corporation

When you hear “nonprofit,” don’t think “no profit.” “Nonprofit is just a tax designation, not a statement of your business,” explains Shira Greenberg, artistic director of the nonprofit Keshet Dance Company and accompanying Center for the Arts, based in Albuquerque. “It doesn’t change the fact that we’re running a functioning and profitable business.” Once you’ve documented an educational purpose for your nonprofit corporation and become a 501(c)(3) organization (named for the IRS article governing this tax status), you’ll enjoy various tax exemptions. You’ll also have the liability protections—and many of the responsibilities—of operating a corporation.

GOOD FOR:

Alternative avenues of funding You can supplement your studio’s tuition income with government arts grants and solicited donations (which can be tax-deductible for the donor) for your programs. Keshet maintains an extensive outreach program—including bringing dance to kids in juvenile prison—which allows Greenberg to apply for grants that fund her studio’s sizeable tuition scholarship program.

Tax exemptions Nonprofits don’t pay income taxes, so you will only pay taxes once, on the salary you take. Depending on the state you’re in, you may also be exempt from various sales taxes.

THINK TWICE IF:

Paperwork isn’t your thing You’ll need to undertake the complex 501(c)(3) application to become tax-exempt and then comply with the strict regulations and procedures of a nonprofit. Nonprofits need to operate through a board of directors and have regular corporate meetings.

You want to be a millionaire Although you can, of course, collect a salary as the head of a nonprofit, you must redistribute any surplus money (once bills and salaries have been paid) back into the organization. DT

 Photo by Goodshoot/Thinkstock

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