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This chapter is from the book

Forming a Production Company

Setting up a production company as a separate business entity is a good idea. Each business structure has advantages and disadvantages. Although federal rules apply across the board, states, counties, and cities may have additional regulations you have to follow. Talk with an attorney or accountant to make sure you understand the advantages and disadvantages, and what you'll need to set up your business.

Generally, these are the three most common business structures for production companies:

  • Sole proprietorship

  • Partnership

  • Corporation

More general business information on business structures can be found on smallbiz.biz.findlaw.com/, http://www.nolo.com, and the IRS Web site at http://www.IRS.gov. See Resources for more listings.

Sole Proprietorship

A sole proprietorship is the simplest form and with it you and the business are the same. Business income and business losses are reported on your federal income tax return.

Establishing a sole proprietorship is inexpensive and relatively uncomplicated. In all likelihood, you'll have to get a business license, but be sure to check. If you're going to conduct business under a trade name, you may need to file an assumed name or fictitious name certificate. You can operate as a sole proprietor as long as you're the only owner.

The biggest disadvantage of a sole proprietorship is that you have unlimited personal liability. This means that someone can sue you and go after not only your business assets, but your personal property as well, such as your car, bank account, and house.

Advantages

Disadvantages

Easy and (c)(3) Corporation inexpensive to create.

Owner is liable for debts. Liability is not limited to the value of the business.

You have total ownership and control of the business.

More difficult to borrow money or obtain outside investment.

All the profits of the business belong to you, the owner.

All management responsibility is with the owner. You've got no one to share the burden.

No additional federal taxation on business profits.

 

No periodic business reporting to the IRS or other government agency.

 

Report business profits on your personal income tax form.

 


Partnership

If two or more people are going to own and operate the production company, you need to choose between establishing a partnership or corporation.

In a partnership, business ownership is divided between two (or more) partners. There are two types of partnerships.

The general partnership is the most common. In a general partnership two or more partners are fully involved in the operation of the business and all partners share both profits and liabilities.

A limited partnership provides for limited liability of the limited partners, meaning that their liability is no greater than the partner's investment in the partnership. Basically a limited partner provides all the capital and shares in any profits or losses, but is not actively involved in the management of the company. At least one general partner handles running the business and remains liable for all the debts of the partnership.

If you decide to form a partnership, write a partnership agreement. You can have a partnership without one, in which case you'd be governed entirely by either the Uniform Partnership Act or the Revised Uniform Partnership Act. But you want your partners to know exactly how they fit into the project and to stick to those roles.

Beyond the written agreement, the paperwork is minimal. You may have to file a partnership certificate to register your partnership name, and you may have to obtain a business license.

A partnership doesn't pay income taxes, but you must file an informational return that tells the government how much money the partnership made or lost during the tax year and how much belongs to each partner.

Limited partnerships have advantages. Limited partners can't interfere with the moviemaking process managed by the general partners. They also have disadvantages. SEC regulations are complicated, whether it's a public or private offering, and require research and expert advice from an attorney or accountant. In addition to federal filing, each state has its own regulations.

Advantages

Disadvantages

Easier and less expensive to create than other structures.

More expensive to create than a sole proprietorship or general partnership.

The partnership does not pay federal income tax. An informational tax return(IRS Form 1065) must be filed which shows income/loss to each partner.

Partners are personally liable for debts.

Liability may be spread among the partners.

Formation and subsequent changes in structure are complex.

Investment can come from the partners in the form of a loan. That creates interest income for the partners and a business deduction for the partnership.

Misunderstandings, different goals, and so on can weaken or destroy the partnership.

Partners report their share of profit or loss on their personal income tax returns.

If limited partners become actively involved in running the business, they lose liability protection.

Limited partners can't meddle.

Unless written into the partnership agreement, the partnership will dissolve on the death of a partner.

 

General partners have unlimited liability. You may also be liable for the commitments of your partners.


Limited Liability Corporation

The Limited Liability Corporation (LLC) blends the tax advantages of a partnership and the limited liability advantages of a corporation. State laws control how an LLC is created and the federal tax regulations control how an LLC is taxed. Owners of an LLC are referred to as members.

Members of an LLC have limited personal liability. The members risk only the individual member's share of capital paid into the business and any business debts that the individual personally guaranteed. That means any debts accumulated by the partnership are not the responsibility of a single member, unless that member guaranteed repayment of the debt himself or herself.

Nearly all states allow an LLC to be formed by just one person, although the LLC will not be taxed as a separate entity, like a regular corporation, unless you choose to have it taxed this way. Normally, you won't choose corporate-style taxation, but will have your single-member LLC report its profits (or losses) on your personal return.

If you have an LLC with two or more members, it will be treated as a partnership for tax purposes, with partners reporting and paying income tax on their shares of LLC profits. Unless you elect to have the LLC taxed as a corporation, the LLC reports its profit or loss on an informational return that notifies the IRS of how much each member earned or lost. Members will then report their individual shares of profits or losses on their personal income tax forms.

Advantages

Disadvantages

Owners have limited personal liability for debts even if they participate in management.

More expensive to create than a sole proprietorship or general partnership.

Profit and loss can be allocated differently than ownership shares.

Legal assistance is required to set up and the paperwork is complex.

 

State laws may not match federal tax changes.

LLCs can choose to be taxed as a partnership or corporation.

The LLC dissolves if one of the owners dies or otherwise leaves.

No federal taxes, just like a partnership.

 

No limit on the number of stockholders.

Some states require that an LLC have more than one member.

More than one class of stock is permitted.

 

Business losses may be deducted on your personal tax return.

 


C Corporation

If you're concerned about limiting your personal liability for business debts, you may want to set up your business as a corporation. Limited liability protects you from corporate debts that you haven't personally guaranteed, as well as from claims by people who are injured by business activities not covered by insurance.

A C Corporation requires that you file papers with the state and pay an incorporation fee. The corporation's assets and liabilities are separate from those of the owners. Because the assets are separate, some people retain copyrights to certain assets (screenplays, motion pictures, and so on) in their own names. If the corporation goes bust, the owner still owns the copyrighted material.

Federal taxation of corporations is complicated. Basically, a regular corporation is treated as a taxpayer separate from its investors and must pay corporate income tax. But a regular corporation may not have to pay any corporate income tax at all. In most incorporated small businesses, the owners are also employees. They receive salaries and bonuses that eat up all potential profits, so there's no taxable income left.

Structuring your business as a corporation is essential if you need to attract investors through a public offering. It's easier than it used to be. A small corporation can raise from $1 million to $10 million annually through a limited public offering.

Advantages

Disadvantages

Owners have limited personal liability for debts.

More expensive to create than partnership or sole proprietorship.

Shareholders (the owners) enjoy personal limited liability.

Tax returns require the help of an accountant.

Easier to obtain business capital than with other legal structures.

Double taxation on profits paid to owners.

Profits may be divided among owners and the corporation in order to reduce taxes by taking advantage of lower tax rates.

Recurring annual corporate fees.

The corporation does not dissolve upon the death of a stockholder or if ownership changes.

Business losses are not deductible by the corporation.

Owners can split potential profit among themselves, leaving none for the corporation to pay taxes on.

Paperwork can be a burden.


S Corporation

An S Corporation is owned by one person. It's easy to start, has little regulation, and the paperwork is fairly light. Electing to do business as an S Corporation gives you the limited liability of a corporate shareholder, but you pay income taxes on the same basis as a sole proprietor. As long as you actively participate in the S Corporation, business losses can be used as an offset against your other income.

Most states tax S Corporations the way the feds do: They don't impose a corporate tax, choosing instead to tax the shareholders for corporate profits. Some states do tax an S Corporation the same as a regular corporation.

Advantages

Disadvantages

Owners have limited personal liability for debts.

More expensive to create than a sole proprietorship or general partnership.

Owners report corporate profit or loss on their personal income tax returns. No federal income tax, and in most cases, no state income tax.

Legal assistance is required to set up.

Owners can use corporate loss to offset income from other sources.

Income must be distributed according to ownership share.

The S corporation does not dissolve if one of the owners dies or leaves.

More paperwork than an LLC having similar advantages.

Wholly owned subsidiaries are permitted.

Maximum of 75 shareholders.

Only one class of common stock is permitted(no preferred stock).

 


501(c)(3) Corporation

Approaching some foundations, government institutions, and other grantors for funding requires nonprofit status, or at least a fiscal sponsor that has nonprofit status. Getting grants, however, is not the only reason to incorporate as a nonprofit. The organization is also tax-exempt and has personal liability protection.

The most common federal tax exemption for nonprofits comes from Section 501(c)(3) of the Internal Revenue Code, which is why nonprofits are called 501(c)(3). If your production company obtains tax-exempt status, not only is it free from paying taxes on all income from activities related to its nonprofit purpose, but people and organizations that donate to the nonprofit can write off their contributions.

Forming a nonprofit corporation usually protects the directors, officers, and members of the nonprofit from personal liability for the corporation's debts and other obligations. You can lose that protection if you or another corporate officer personally guarantees a bank loan or other debt the corporation defaults on, fails to deposit taxes or file returns, does something intentionally fraudulent, illegal, or stupid that causes harm, or mixes corporate and personal funds.

Unlike for-profit corporations, a nonprofit corporation cannot distribute any profits to its members, contribute money to political campaigns, or lobby. Many documentary moviemakers decide to form a nonprofit " corporation to be eligible for certain types of grants.

Forming a nonprofit corporation is similar to forming a regular corporation. The difference is that you must also file federal and state applications for tax exemptions.

Advantages

Disadvantages

Corporation doesn't pay income taxes.

IRS can say no to tax-exempt status.

Contributions to charitable corporation are tax-deductible.

Full tax advantages available only to certain groups.


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