Legal & Tax Structure for Interior Designers

Did you know that how you structure your business now could have long-lasting legal & tax benefits or disadvantages?

These are basic and simplified descriptions of the business structures.  This article is not a substitute for professional legal & tax advice.  If you have not set up/chosen a structure for your interior business yet OR you could benefit from a possible change in structure find a professional to discuss your specific situation.  You create an entirely new business (in the eyes of the government) when you change business structures.   It's best (so much easier) to start with the business structure that fits your thriving business rather than have to get new bank accounts and start new records later.

Each structure comes with its own legal & tax consequences and benefits so you will want to choose the one that fits your business best.  Talking to a professional about your specific situation will give you a full picture of your possibilities.  They can let you know of options that you wouldn't otherwise consider (legally LLC, but taxed as an S-corp).

The important thing is to be educated and know your options, don't just go for a sole proprietor because it is the easiest.  

Sole Proprietor

Sole proprietor is the most basic business structure.  You and your business are the same entity.  All assets, profits, debts and liabilities are the sole responsibility of the single business owner. Most interior designers take this route because it is the simplest to set up.  In the eyes of the IRS, as soon as you start business activities you are considered a sole proprietor.  If you get paid for your neighbor's small powder room remodel you are automatically a sole proprietor.  Despite this automatic designation by the IRS, you may still need to obtain licenses and permits for your area to run a business.  It is your responsibility to pay withholding taxes (income taxes & self-employment taxes) and any sales taxes from client purchases.

The benefit of this structure is that it is the simplest and easiest.  The disadvantage of this structure is that you and your business are the same entity, which opens you up to personal liability.   If your business is sued or you have business debt, your personal assets (home, car, bank accounts) could be on the line.  This is why I never recommend this structure.

Limited Liability Company

Creating a Limited Liability Company (LLC) puts separation between business and personal.  LLCs are a state classification and therefore for federal taxes must file a corporation, partnership, or sole proprietorship tax return.  As a single owner, federal taxes will likely be just like a sole proprietor.   The owners of the LLC are taxed (not the business) and simply report profits and losses on their personal tax returns.  The point of all this tax talk?  With a single-owner LLC you have the ease and simplicity of a sole prop, but with a giant benefit: limited liability.

Limited liability means that if you treat your business as a separate entity the government will treat it that way as well.  If your business is sued your personal assets will be protected under a LLC.  The key here is to not "pierce the corporate veil".  The most common way to pierce the corporate veil is to not keep separate bank accounts.  This is why it is so important to keep your business separate from your personal.

Creating a LLC is more work than becoming a sole proprietor and does cost a little bit of money.  But paying a few hundred dollars for the liability protection is worth it.

Partnership

If you will be owning and operating a business with several owners you could create a partnership.  You can create a general partnership or if you have several investor-only partners you could create a limited partnership.  Each general partner is responsible for all aspects of the partnership, including assets, profits, debts and liabilities.  Though not required, be sure to create a legal partnership agreement if you are starting a business with anyone.  Like a sole proprietorship or LLC profits & losses are "passed through" to the business owners and are reported on their federal income taxes.

Corporation

A corporation is much more complex to structure than the previous options.  A corporation is independent of its owners and subject to many more legal & tax regulations and requirements.  Because of this, I am only going to talk about an S-corporation, which is more appealing to small business owners.  An S corp avoids the double taxation (business & owners) of a corporation but retains the legal liability protection.  There are a lot more formalities required for a corporation, like regular shareholder meetings, keeping minutes and records, having officers, etc.  You will have to pay yourself "reasonable compensation" i.e. a regular salary.  There have to be less than 100 shareholders and all must be US citizens or permanent residents.  If your business is making good profits, it could be beneficial to speak to your accountant about restructuring as an S corp for tax benefits.

Read more about business structures and for help determining the right one for you: Small Business Administration

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