Business Entities

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General Partnerships

A partnership is the simplest business to form. You will need to
draft a partnership agreement, make up a partnership name and open
a bank account. If you need help drafting a partnership agreement
there is a great book by Rich Stim called Music Law: How to run
your Band’s Business. There is a link to it in the Barely
Legal Library. The book comes with a CD that has a partnership agreement
that you can fill in the blanks and either use it in its entirety
or you can modify it to suit your band’s needs. If you want
to do it yourself, you may want to include the following topics:

  • Ownership of the band name and songs
  • How assets and debts will be divided
  • How decisions will be made
  • Band Rules
  • What to do when band members leave or join

This list is not exhaustive; there are many other possible topics
to include in your agreement. Also, you will want to create a name
for the partnership and file for a Fictitious Business Name. You
will also want to open a bank account in the partnership’s
name, which will be used for band purposes only. That’s all
you have to do until tax season rolls around. The partnership’s
income, gains, losses or credits will be allocated to each partner
individually in proportion to their holdings in the partnership.
That means if you give someone in the band a bigger stake, maybe
because they handle all the business, get all the chicks and write
all the songs, then the debts and assets will be allocated to that
person in a larger amount.

The amount allocated is then added to the individual’s personal
tax return and taxes are paid or returned accordingly. This is referred
to as a pass-trough tax status because the business’ taxable
income is passed through to the individual partners. The partnership
doesn’t pay tax as a business, but an informational tax return
must be filed. You need to get help from an accountant or tax preparer;
not optional in my opinion.

The drawback to being a partnership is the exposure to liability.
Each member is responsible for the debts of the partnership. If
you charge a bunch of equipment for the band, the members are responsible
even if the band has broken up. If one member moves to Siberia,
the remaining members are still responsible for the debt. The members
will also be responsible for any action or omission, of one or all
members, that harms a third party. To solve this problem, the partnership
purchases a general liability insurance policy for protection. Simple

Partnerships are required to have an office in the state where
they operate and they are required to maintain certain records in
that office. Don’t worry! Your parent’s basement where
you live and practice will suffice. The minimal records you’re
required to keep are a list of all current partners and their last
know addresses, a copy of the agreement and any additional forms
you filled out, tax returns for the past six years and any financial
records you have for the past six years.
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Limited Partnership

There is a business entity know as the Limited Partnership. This
is very similar to a general partnership, so I’ll only point
out the differences. (see the chart for additional requirements).
Members are designated as general partners or limited partners.
General partners control the business and are liable for all obligations
of the business. Limited partners may not participate in controlling
the business. Doing so will automatically convert them into a general
partner. General partners must provide limited partners with tax
information so they can file their state and federal taxes. Additionally,
the business is required to pay a minimum annual franchise tax which
is currently $800.00.
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Limited Liability Company (LLC)

This is a relatively new way to form a business. It has the protection
of a corporation, but the simplicity of a partnership. The LLC must
have an operating agreement which is similar to the partnership
agreement described above. In addition, the band will need to file
an articles of organization form (LLC-1) and designate an agent
for service of process with the Office of the Secretary of State.
California Secretary of State – Business Portal. Designating an
agent for service of process just requires that you supply the name
and address of an individual who will be handed paperwork by that
guy who personally delivers lawsuits in the event the LLC is sued.

The agent does not become liable for the lawsuit, they are merely
being handed the lawsuit and will be expected to make sure the members
get it so they or their attorney can respond timely. You will also
need to file for a fictitious business name which must include the
word “limited” or the initials LLC. If your band name
is The Pencil Necks, the name of your LLC can be The Pencil Necks,
LLC. Much cooler. None of the LLC members are personally liable
for the obligations of the business. Just like the partnership,
members of a LLC will be responsible for any action or omission
of one or all members that harms a third party so the LLC needs
to purchase a general liability insurance policy for protection.
The LLC can file tax either as a corporation or as a pass-through
(see above).

Corporations get certain tax breaks and shareholders of corporations
can take certain write-offs. However, sometimes being taxed as a
corporation is not a benefit because you can end up getting taxed
twice. It is vital to consult an accountant or tax preparer to determine
what is best for you. Additionally, the business is required to
pay a minimum annual franchise tax which is currently $800.00. If
the band is making more than $250,000.00 per year, there is an additional
tax that increases as your income increases. The LLC is required
to maintain the same records as a partnership (see above).
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Close Corporation (C-Corp)

It is usually more expensive to form a corporation than any other
type of business because there is a lot more paperwork to file (see
chart). The shareholders’ (the band members’) liability
for the debt of the business is limited as a C-Corp. As a corporation,
there is a chance that the shareholders are shielded from some acts
or omissions that harm third parties. However, the protections that
corporations once enjoyed are quickly eroding thanks to Enron. A
liability insurance policy is still recommended if you are forming
a corporation.

Shareholders are taxed as a corporation which may or may not be
beneficial depending on your circumstances. Corporations get certain
tax breaks and shareholders of corporations can take certain write-offs.
Sometimes being taxed as a corporation is not a benefit because
you can end up getting taxed twice. It is vital to consult an accountant
or tax preparer to determine what is best for you. Additionally,
a C-Corp is required to pay a minimum annual franchise tax which
is currently $800.00. A C-Corp need only maintain the minimum required
records and may dispense with the corporate formalities such as
holding meetings with shareholders or directors.
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Small Business Corporation (S-Corp)

This type of corporation is designated for small businesses. The
business must form a general corporation and then file its taxes
as an S-Corp. It allows the corporation to file taxes as a pass-through
(see above), but requires it to maintain formal corporate records
such as: minutes of board meetings, bylaws, and a complete set of
books, records and accounts. In addition, the S-Corp is required
to designate officers and a board of directors, who are required
to hold regular meetings. Otherwise it is essentially the same as
the C-Corp.

It would be impossible to tell you what type of business form is
best for you. As you can see it depends on your specific circumstances.
Generally, if you are a small band starting out and the members
have few or no personal assets, then a general partnership and liability
insurance would work fine for you. Though you are not personally
shielded from the debts of the band, you will not have to pay the
annual $800.00 minimum franchise tax. In addition, the cost of formation
and tax preparation will be fairly simple and cheap.

If, I mean, when your band gets big and starts going on major tours,
you can think about converting the partnership into an LLC. Then
any debts incurred on tour or while recording cannot be collected
against you personally. That doesn’t mean you can burn people
intentionally, but if the band breaks up and the business dissolves,
if there is no money left to pay your creditors they probably can’t
take your house. One thing to keep in mind however is that most
creditors are going to seek personal guarantees from someone anyway
or they wont extend credit to you in the first place. If this is
the case, being a corp or an LLC is not going to prevent you from
being liable for these debts personally.

The LLC appears to be a great way to reduce your risk of liability
while maintain the simplicity of a partnership. If you are willing
to pay at minimum $800.00 per year, or if you are going to pay that
anyway because you are making money, then this is a great way to
organize a business. I can’t really see any benefits of a
limited partnership. If you decide to incorporate, you might benefit
from the tax breaks, but you also have this option with the LLC.
I can’t stress enough that you need a good tax consultant
that is experienced with the entertainment field or you are playing
with fire.
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Summary Table

Partnership Limited Partnership Limited Liability Company C-Corp S-Corp
Advantages Simple and inexpensive to create and operate

Partners report their share of profit or
loss on their personal tax returns
Limited partners have limited personal liability
for business debts as long as they don’t participate in management.
Owners have limited personal liability for
business debts even if they participate in management.
IRS rules now allow LLCs to choose between
being taxed as partnership or corporation.
Owners have limited personal liability for
business debts.
Fringe benefits can be deducted as business
expense
Owners can split corporate profit among owners
and corporation, paying lower overall tax rates.
Owners have limited personal liability for
business debts.
Owners report their share of corporate profit
or loss on their personal tax returns.
Owners can use corporate loss to offset income
from other sources.
Disadvantages Partners personally liable for business debts General partners personally liable for business
debts
More expensive to create than general partnership.
Suitable mainly for companies that invest
in real estate.
Annual Minimum Franchise Tax $800.00.
More expensive to create than partnership
or sole proprietorship.
Annual Minimum Franchise Tax $800.00.
More expensive to create than partnership
or sole proprietorship.
Paperwork can be burdensome
Separate taxable entity
Annual Minimum Franchise Tax $800.00.
More expensive to create than partnership
or sole proprietorship.
More paperwork than for a limited liability
company which offers similar advantages.
Income must be allocated to owners according
to their ownership interests.
S Corporation election can only be made after
a General Corporation is formed first.
Annual Minimum Franchise Tax $800.00.
Agreement Partnership
Agreement
Partnership
Agreement
Operating
Agreement
Pre-incorporation
Agreement
By laws.
Organizational Board Resolutions or a Shareholders
Agreement in lieu of a board of directors.
Pre-incorporation
Agreement
By laws
Organizational Board Resolutions
Forms to file with the Secretary of State Fictitious Business Name. Fictitious Business Name. Fictitious Business Name. The name must include the word limited or the initials
LLC. Register and Agent for Process
Articles of Incorporation must contain the
phrase ”This corporation is a close corporation.” The name must include the word corporation,
incorporated or limited.
Liabilities Partners
personally liable for business debts.
General
Partner(s) are Liable for all Obligations.
Owners
are protected from personal liability for business debts and
claims
This protection can be lost when the owners
act illegally, unethically, or irresponsibly.
Shareholders
are protected from personal liability for business debts and
claims
This protection can be lost when the owners
act illegally, unethically, or irresponsibly.
Shareholders
are protected from personal liability for business debts and
claims.
This protection can be lost when the owners
act illegally, unethically, or irresponsibly.
Tax Requirements Annual
Informational Return
“Pass-through” tax entity, which
means that all of the profits and losses pass through the
business to the owners, who report their share of the profits
(or deduct their share of the losses) on their personal income
tax returns.
Pass-through
tax.
Annual Informational Return.
General Partners must provide limited members
with tax information for filing Income Tax within 90 days
after the taxable year.
Annual Minimum Franchise Tax $800.00.
Pass-through
tax.
Annual Informational Return.
Annual Minimum Franchise Tax $800.00.

Graduated Tax on Income over $250,000.

The
owners pay taxes only on profits paid out to them in the form
of salaries, bonuses, and dividends.
The corporation itself pays taxes, at special
corporate tax rates, on any profits that aren’t deductible.
Annual Minimum Franchise Tax $800.00.
Pass-through
tax status.
Annual Informational Return.
Annual Minimum Franchise Tax $800.00.
Records and Formalities Must Maintain the Minimum Required Records
and keep them in the Office.
Must Maintain the Minimum Required Records
and keep them in the Office.
Must Maintain the Minimum Required Records
and keep them in the Office.
Must Maintain the Minimum Required Records
and keep them in the Office.
Formal corporate recordkeeping is not necessary
for a close corporation and may even be considered burdensome.
May dispense with corporate formalities such
as holding meetings of shareholders or directors and the conduct
of their affairs by other arrangements made in the shareholders’
agreement.
Must maintain formal corporate records. Minutes of board meetings, bylaws, complete
set of books, records, and accounts. Failure to do so will results in fines of $25.00 per
day.

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