Business Structure

Before we get started, the disclaimer. Remember that I am not qualified to give tax or legal advice, but am only sharing my interpretation of the advice I have received.

The big thing is that you do not have to "set up a business" to get started. Nobody expects an artist to set up a business to sell a painting. In fact, there are good reasons to NOT set up a business - do not incorporate, create a LLC, or file a DBA (Doing Business AS...). Report what you sell on Schedule C of your 1040. Schedule C is really simple... if you sell something (even as a kid with a hobby), you should always have recorded the revenue there. You can deduct the cost of materials used to make what you sell on schedule C as well. Your parents gave you the business name - "John Doe" or in my case, "Charles Plesums." I am not doing business under an assumed name.

Should you incorporate? I decided not for me. If I had a big business with many employees and a product failed, it would be hard or impossible to determine who was at fault. The most a customer can do is sue the company, so a corporate structure would be good to isolate the business. As an individual craftsman, if a product fails, the lawyers know who they can blame, so a corporate structure doesn't provide much protection. It does help support your friendly lawyer and accountant.

Are you a business or a hobby? The usual federal test to distinguish between a business and a hobby is that a business tries to make a profit, and is actually profitable at least once every 7 years. If it is a hobby, you can deduct the portion of the machinery related to the "business" (if half the time you make things for yourself, and the other half of the time you make things to sell, then half of the cost of the equipment can be deducted). If you are a business, you can deduct all of the cost of the equipment, and can also carry your losses forward - deduct your losses in one year from your profits in a future year.

If the business owns machinery or inventory, it is often subject to additional taxes such as property tax. Therefore I avoid keeping any inventory... I order just the materials I need for a specific project. I even own the machines personally (yes, I paid sales tax on them).

You do have to keep careful financial records. Since I do not have inventory, I can choose to operate on a "cash basis" rather than "accrual." I use the basic Quicken, not the more expensive and complex Quicken for business or Quick Books. (They can help you if you have complex billing, inventory, etc., but they are not necessary for a solo craftsman.) I believe Microsoft Money is similar. If you keep precise financial records, you don't even need a special bank account - but if you aren't certain about your bookkeeping precision, set up a separate bank account to help track business income and expenses.

Do you have to "do" sales tax? In Texas, yes. You even have to do it if you have more than two days of garage sales in a year. You have to do it if you sell your work at a craft fair. If you don't collect it, and are caught, you have to pay the sales tax (and probably a fortune in penalties and interest), and you can bet your customer isn't going to volunteer to pay later.