Congratulations! You’ve decided to start a business as a freelance composer or sound designer. One of the things you need to figure out is how you want to set up your business. How you set things up will affect how you sign contracts, determine your liability, deal with taxes and present yourself.
One important note: In this article, we’ll cover some of the basics on how businesses can be set up. However, laws regarding corporation formation differ from state to state. What’s true in California might not be true in Rhode Island. Therefore, it’s important that you consult an attorney and/or account who is familiar with the laws affecting small businesses in the state where you live.
The primary factors in determining how you'll set up your freelance composing business are usually liability and taxes. Below are the three most common ways freelance composers and sound designers set up their businesses and their role in determining how these are affected.
A Sole Proprietorship is the simplest and easiest way run a business. In fact, it’s so simple, there’s nothing you need to do. You just start providing services and getting paid. Doing business as a sole proprietor means that the “business you” is the same as the “person you.” All the financial, legal and other transactions you do as a freelance composer or sound designer are between you, a person, and the company hiring you (or whom you are hiring).
Many sole proprietorships simply use their own legal name to do business. However, as a sole proprietor, you may decide you don’t want to do business under your own name. For example, maybe you want to be known as “All Things Music” instead of “Jennifer Davidson.” In that case, you will need to file a “Doing Business As” (DBA) with the state. Exactly what that entails will vary by state; some states will require posting of a public notice in addition to filing forms with the state; others have fewer requirements.
Dealing with taxes in a sole proprietorship is quite straightforward. You list your business income and expenses on your personal tax return (1040) using “Schedule C: Profit or Loss from Business.” Depending on how much you make, you may also need to file quarterly estimated tax payments to the IRS and/or your local state.
Although sole proprietorships are easy, they have one large downside: Liability. In a sole proprietorship, the owner is personally responsible for any and all debts created as a result of operating the business. For example, if you were to be sued over anything related to your business, you would be personally on the hook to pay if you lost. And lawsuits can come for many unforeseen reasons such as…
A session guitarist trips and falls during a recording session and breaks their hand (or worse) and sues for loss of income & medical expenses
Copyright infringement (even if inadvertent)
You are late providing SFX (say due to illness) and a developer has to delay shipping their game and sues
You accidentally violate an NDA by accidentally forwarding a confidential email
Lose a large lawsuit and they can go after your personal assets: your house, car, savings, etc.
If you own enough where that’s a frightening thought, you may want to consider separating your “business you” from your “personal you.”
Limited Liability Company (LLC)
If you want to operate a composing business, but don’t want to be personally liable for any business loss, one of the easiest ways to protect yourself is to form your business as a Limited Liability Company (LLC). The most important characteristic of an LLC is that it is a legally separate entity from you. When you create or own an LLC, you are called a “member” of that LLC. When you enter into contracts, you do it as a member on behalf of your LLC, not as you personally. And if the worst were to happen, since your clients do business with your LLC, not you, the person, they can sue the LLC, but they can’t sue you. Therefore, you are generally protected from losing your personal assets over things done in the name of your business. This is often referred to as the corporate veil. The corporation shields you from being personally liable for something that the business did or didn’t do. [note that the corporate shield doesn’t protect you from things like fraud or other wrongful acts]
Liability protection is probably the single biggest reason most companies form LLC’s.
Tax-wise, by default an LLC is what’s known as a “pass through” entity. That means that from a tax perspective, it’s no different from a sole proprietorship. You file pretty much exactly as you would if you were a sole proprietor, entering your business income and expenses on “Schedule C” of your personal 1040 form.
Show me the Money---but keep it Separate: Co-mingling
Since the whole purpose of an LLC is to separate the “business you” from the “person you” it is important that you keep the two separate. You will need to create a separate bank account(s) for your LLC. Deposit all business income into the LLC’s account, NOT your personal bank account. Likewise, pay business expenses from your LLC’s account. You may find it very helpful to open a credit card in your LLC’s name for business purchases.
It is important to not pay personal expenses (groceries, the rent, gas for the car, etc) directly out of your business account. Doing so weakens the separation of the “business you” from the “person you” and is called co-mingling. Co-mingling can result in the government determining that the “business you” (your LLC) isn’t really separate from the “person you.” If that happens, there’s a good chance you will lose any liability protection, and if you’re sued, they’ll come after your personal assets as well as business assets. This is known as piercing the corporate veil.
So if you can’t co-mingle, how do you actually get your money from an LLC? When you’re a member of an LLC, the company can give you some of its profits throughout the year. You can also hire yourself as an independent contractor. You can then pay yourself by writing a check or transferring money to your personal account from your business account.
But make sure the that business incomes goes into the business account, and that you pay yourself from that account:
Business income -> Business Account -> You (the person) -> Your personal bills
LLC's were created in the 70's as a kind of 'corporation lite'. They have the liability protections of a corporation (see below), but without as much paperwork or overhead as a standard corporation. However, they may not have quite as many benefits as a corporation...
“S-corp” (Subchapter S Corporation)
A third way to set up your composing or sound design business is to form a corporation. There are two types of corporations “S” Corporations and “C” corporations. [We won’t discuss C corps here, since it would be very unusual for a composer or sound designer to set themselves up as a C Corp.]
A subchapter S corporation is similar to an LLC in that it is a separate legal entity from its owner. And therefore, it provides the same liability protection. And as with an LLC, you must treat your business as separate from you: create separate bank accounts, and maintain a crisp delineation between the “business you” and the “person you.”
Like an LLC, an S-Corporation is also considered a “pass through” entity. The profits (or losses) of the company flow to the owners (shareholders) of the company. However, an S Corporation has a bit more paperwork to go through.
The biggest difference you’ll likely see as an S Corporation will be around taxes. Unlike a sole proprietorship or normal LLC, where you list business income and expenses on your personal tax return, an S-corporation must file its own tax return (form 1120-S). This is completely independent from your personal return, and is the place you enter business income and expenses (and is typically due a month earlier!).
In addition to filing its own tax return, an S-Corp generally needs to file a quarterly Employment Tax form. In an S-corp, you typically set up yourself as an employee of the company, and pay yourself what looks like a more conventional, regular paycheck. At any time during the year (I used to do it at the end) you can opt pay yourself a distribution from what's in the business, or leave it in the business for various business expenses (day to day, new equipment, etc.)
What is the tax advantage of an S-Corporation?
The biggest advantage to organizing as an S-Corp has to do with how you are taxed on profits you (the person) receive from your company. Although we won’t get into the details here, the gist is that you may be able to avoid having to pay certain federal taxes (FICA) on a portion of your income. There may also be some additional tax benefits if your S-Corp provides health insurance.
And just to make things more confusing, it is possible to have your business set up as an LLC, but to elect to file taxes as an S-Corporation. This is known as an S-corp. election and gives some of the benefits of an LLC (less corporate paperwork) with the tax advantages of an S Corporation.
Thinking about the form your music composing or sound design business takes may not be as exciting as studying a the game score for Call of Duty or exploring a new sound library, but it can have a significant impact on your business and finances.
This is a case where talking to a qualified account is essential; everyone’s situation is unique, and this is one place where you don’t want to decide what to do based on one article you read online, but to get professional assistance.
Although it is possible these days for to create LLC’s or S-Corps online, without ever talking to a human being, this is one area where you want to make sure all the I’s are dotted and t’s are crossed correctly. If you’re serious enough to think about creating an LLC or S-Corp, it’s probably well worth a few hundred dollars to talk to an attorney, let them know your specific situation and have them handle the papework; if you get it wrong, you may lose your liability protection, which is probably the main reason you went to the trouble of creating an LLC or S-Corp in the first place.
Summary of Business types and their impact on taxes and liablity
Brian Schmidt has been a full-time, self-employed composer, sound designer and game audio consultant for 21 of his 32 working years. He has operated businesses as S-Corporations and LLCs (as well as a tiny stint early on as a sole proprietor). This article is informational only and should not be considered advice; Brian is neither an accountant nor a lawyer, and highly recommends that if you are serious about starting a music composing business or sound design company that you find a local attorney and accountant you feel comfortable with who can guide you through the process and tailor your business for your particular circumstances.