What You Need to Know about Starting Your Own Company
I recently was working with an author on a project to refresh her brand and organize her business. In addition to a fresh start, she wanted to separate her business from her personal assets for the rebranding. Sure, she could have done all this within her existing Kindle Direct Publishing account, but she wanted to take her business to the next level.
After some discussion, we decided it was time for her to create a limited liability company (LLC) for her work.
After incorporating the LLC, the author I worked with began relaunching books under a new pen name within the company. This new company has its own tax ID, bank account, and publishing accounts on all the major platforms.
You’re not alone if legal jargon and filing fees make creating an LLC sound complicated. Plenty of authors debate the need for a separate company when they already publish their work as an individual. But the decision to create one can have financial and tax implications, especially if you already have an established author business. Maybe that’s you, or maybe it’s still early. But if your writing is more than a hobby, you need to understand the process and the pros and cons behind it nonetheless.
What is an LLC?
An LLC is a charter from a state that identifies certain assets, liabilities, and activities as separate from you and your personal assets and liabilities. An LLC also has a special agreement called an operating agreement that sets a company’s rules. The operating agreement is flexible and can outline ownership, various rules and responsibilities, and how succession works. The federal government has legally established that companies are separate legal individuals for all intents and purposes. So the agreement explains to everyone how this company operates on its own.
This designation and separation provide you with protection. In the worst case of some legal trouble, including a bankruptcy filing, your personal assets are separate and won’t have any claims made against them—only the business assets will be at risk.
Why form an LLC?
Before I answer that question, it’s essential to understand that my advice to authors is based on the premise that you want to build a successful full-time career selling your content while working with limited resources. These authors should take steps in the correct order to make the most of the resources they’re investing in their business.
Your writing is a career, not a hobby. You may not be making any money, but you’re going to spend money to get this enterprise going, and your journey will ideally result in a profitable business built around the content you create. Over the course of writing and publishing your work, you might pay for courses and subscriptions, hire cover designers, or purchase software to write or edit—and in the process, according to the Internal Revenue Service, you are accumulating expenses as a sole proprietor.
Now, this article isn’t about taxes nor is this tax advice. I’m establishing the ground rules of entrepreneurship in the United States, but as you earn more profits, companies—when set up correctly—provide some tax advantages over a sole proprietorship.
As far as the IRS is concerned, you can operate as a sole proprietor, accumulating expenses and charging them against your gross profits to determine your net profit. But the IRS expects you to pay federal income and self-employment taxes on that net profit.
In the beginning, when you’re not profitable, you can claim those expenses against other income to lower your tax liability. In essence, you get to charge the business loss during start-up against the income you earn elsewhere, like at your day job. Even if you set up an LLC, nothing changes from a tax perspective without a special tax election. A standard LLC is called a pass-through entity, and it’s treated just like a sole proprietor.
However, as a sole proprietor, your business activities, assets, and liabilities are connected. If you could not pay your bills and creditors sought repayment, including state and federal tax authorities, they could make claims against your existing personal assets to get paid. Simply put, if you were sued and lost the case, the court could put a lien against your home and other personal assets. But a company creates a different legal bucket of assets and liabilities. The creation of a company sets up a separate entity that the state and the federal government see as assets and liabilities distinct from your personal ones. It’s in the name—limited liability.
When should I set up an LLC or incorporate a company?
For some, setting up a company and separating personal and business assets is one of the first steps of any start-up business, including a publishing house.
My approach with authors is a little different. Instead of focusing on the trappings of a business, I consider its success. Paying to incorporate your company before you even write your first book creates a legally recognized company, but it does nothing to help that business succeed. If you’re strapped for cash, paying to set up the business could even harm your chances of success. Starting fees for LLCs can range from 50 to 150 dollars, according to entrepreneurial information service Start Filing (https://start-filing.com/llc-fees) with some states requiring several hundred dollars annually in additional fees. If you spend that money at the beginning of your author journey, you can’t use it on something that could instead help bring your product to market.
Setting up a company also creates additional paperwork and fees. You may have to file a separate tax return, and in most states, you will need to pay an annual fee and file a registration form. This is why I suggest looking at setting up your company only after your business has cleared the hurdle of earning ten thousand dollars a year in profit. Doing so before earning that much means you are spending a large percentage of your expenses on accounting and state fees just to maintain the company’s standing, and none of that work or money ever contributes to selling a single book.
Of course, there are exceptions to waiting. If you plan to collaborate with others or are going to be writing controversial content or content that comes with an added risk, you could benefit from setting up a company and separating your assets, even from another company you may have, or for an operating agreement and separate investment.
So when should you set up an LLC? I think if you earn more than ten thousand dollars in net profit, are in a partnership with another author, or are involved in higher-risk activities, then it’s time to get your LLC chartered.
Which do I need: an LLC or a corporation?
Once you decide it’s time to create an LLC, visit the website of the Secretary of State in the state where you reside. Here, you can find information as to the different types of companies that you can charter and the associated costs. There are usually two main types: an LLC and a corporation. Both create a separate legal entity from you personally. The difference is how the entities are managed and how equity is structured.
For an LLC, you create an operating agreement, or the rules of operation, which can be very flexible. In that agreement, capital is also defined, which allows you to form different types of membership for your LLC, with different rules as to other individuals’ ownership in the company and how they receive profits.
A corporation is much more rigid in its structure. Stockholders have ownership in the company, and each share translates to equal claim on assets as any other. Most states require you to have a named board member or board members who manage the business. The board is elected by shareholders, though shareholders typically don’t manage the business. This structure is designed for joint ownership by non-operating partners.
In some states, such as Massachusetts, sole operators choose to set up corporations because they come with fewer fees. However, in most states, an LLC is the most cost-effective and easiest company to create.
What’s this S-Corp thing?
You may hear people say they have an S-Corp. This isn’t an entity like an LLC or a corporation, but it is a tax designation for those entities. An LLC is considered a pass-through entity, which means its profits flow through to your personal tax return and are taxed at your nominal tax rate. A corporation, on the other hand, currently has a federal corporate income tax, and the dividends you take out are taxed at your personal tax rate, resulting in double taxation.
The IRS allows you to get permission for special tax treatment, called a Subchapter S tax election, which is a hybrid tax treatment and gives you the best tax treatment in most cases. Create an LLC and ask the IRS to treat it as an S-Corporation, and you might save money when it comes to your company’s tax bills each year.
Types of Organizing Structures
|Sole Proprietor||Limited Liability Company||Corporation||S-Corp Election|
|What is it?||How the IRS designates earning a profit outside of a wage on a W-2 tax form||A legal entity that holds assets and liabilities and becomes a vehicle for conducting business||A legal entity that holds assets and liabilities and becomes a vehicle for conducting business. This type of company has alternative management and equity structure with a joint stock basis and a board for control.||A special tax designation that is applied to small private LLCs or corporations and creates a tax advantage over pass-through taxation|
|When to use it?||You are automatically considered a sole proprietor if you are earning income that is not wages.||When you earn more than $10,000 in net profit, are in a partnership with another author, or are involved in high-risk activities||If you live in a state where LLCs don’t exist or are more expensive||When you set up your LLC, it might be more cost-efficient to be treated as an S-Corp. Consult with a tax consultant in your jurisdiction.|