The Business End of Fun

Daniel YergerFinancial Planning Leave a Comment

There’s a funny thing about entrepreneurship: many people who have successful businesses never thought of themselves as, and to this day may not think of themselves as, entrepreneurs. While this can apply to many common examples, such as those working in the trades as independent contractors, the same thing can often happen to those in more creative businesses. What might start as a fun group activity or a personal hobby can quietly transform from a personal interest to a thriving business generating real money. The problem, of course, is that no creative deed goes unpunished in the view of the government, and consequently, there can come a time at which even the most innocuous of interests turns into a business activity with bookkeeping, taxes, and all the bits and bobs of a real business. So today, we’re discussing what to think about when converting a hobby or passion into a business, and some of the immediate and important elements that can arise.

Business Formation

At the point that you realize you might have a business on your hands, it’s important to take care of the legal elements first. While advice in this area is going to vary by country, state, and county, there are a couple of immediate principles and steps to consider. For our purposes, I’m going to talk about a creative business in Boulder County, Colorado, and for your purposes, if you’re reading this as a “how to,” my first and only piece of personalized advice is “talk to a lawyer about your personal circumstances.” This is educational, not instructional.

Now, with that in mind, in Colorado, the first step many people will take is to rush to the Secretary of State’s website and register an LLC. After all, all the kids on TikTok say you should! While registering an LLC is incredibly easy, it’s not actually the first thing you should do. First and foremost, you need to determine your business structure. If this business is just a business of one, e.g. you’re the only person involved, the most appropriate choice at this time is likely to be a Sole Proprietorship. This means you own 100% of the business, and everything the business does will ultimately flow back to you. Now, in this particular case, registering an LLC has nothing to do with the activities of the business itself, but will provide you with some legal protection around your business and any liabilities that could arise with it. Yet, there can be some traps to look out for here, but we’ll discuss that in the next part.

If you have partners, then either a partnership or a corporate structure could be more appropriate. However, a couple of things to keep in mind. First, if this is a “mom & pop” operation, e.g. your business partner is a spouse, then you probably shouldn’t utilize a partnership structure. Under marital law and tax law, the business is going to be jointly owned regardless of how you title the business, and the taxes are going to pass through to your marital tax return anyway, so it’s not really beneficial to divvy up ownership as a formalized partnership. However, there are two common cases in which a partnership or a corporate election might make sense.

The first case is one in which you share your business with a non-spouse, e.g., a friend or friends. In these instances, a partnership is probably an appropriate way to divvy up a share of the control of the business, as well as allocate income and expenses for tax purposes. This makes the most sense in cases where everyone’s work and involvement in the business is more or less equal to the others. But in cases where there’s a separation of the work in the business from the ownership, e.g. one partner does far more work than the others, then a structure such as an S-Corp may make sense because you can pay the more involved partner or partners of the business for their actual work, and then divide profits of the business separate from the actual work going into the business. This makes the most sense in cases where perhaps one member of the group has invested a lot of money into the business but doesn’t do much work in the day-to-day, while another member of the group hasn’t invested much but does most of the heavy lifting.

The second case can be one wherein there is a genuine difference in ownership. Many partnerships are established with even shares between all parties, but not all members of a group may bring the same value to the business, whether that be in terms of capital or talent, so different divisions of ownership can make sense in those cases. Just remember that in a partnership, both expenses and profits of the business are allocated based on ownership, so even if you’ve put more money or more effort into the business than others, your ownership share is fundamentally what’s going to matter.

A final note on the formation of your business, though there is much we’re not covering here: good agreements make for good partnerships. All too often, a creative or hobby-based business starts between partners with little more than a handshake and the assumption that everyone involved is going to act in good faith. Unfortunately, the creative business today is rife with stories of good friends turned foes, and the history of creative enterprises is one of lawsuits and litigation over everything from profits to intellectual property. Taking the time to engage legal counsel in establishing your business is absolutely essential, no matter how small of a matter you may think it is at the outset.

A last administrative note: while you must register your business with the secretary of state and keep it in good standing, another obligation exists under the Financial Crimes Enforcement Network, which is Beneficial Ownership Information Reporting. When you establish your business entity, you must also report that entity’s ownership to FinCEN, or you will end up paying some extraordinarily hefty fines.


Let’s get this out of the way now: bookkeeping software is not the same thing as bookkeeping. All too often, because a hobby starts out as a personal activity, there’s no tracking of expenses, inventory and materials, or anything else going on. Yet, when a business emerges out of a passion, a necessity arises that the business keeps appropriate records. At this stage, many people will rush out to either find a “bookkeeping spreadsheet” in Excel or buy a software subscription for Quicken or Quickbooks to track their finances. While this is all well-intended, bookkeeping is its own skillset and art form, so if you do not have a formal education or significant experience with bookkeeping, do not confuse writing down your transactions or categorizing expenses for keeping accurate financial records. With that in mind, let’s talk about a few fundamental things of consideration in managing your business’ finances.

First things first: separate your personal finances from your business finances. While many people will pay for their hobbies out of pocket, if you’ve gotten to the point that you’re going to have a business, you need to completely separate your business capital from your personal capital. This means that if you want to invest new money into the business, you should be writing checks to the business, and if you’re looking to get paid out of the business, you should be taking distributions out of the business or paying yourself as an employee, depending on your business structure. This is particularly critical for those who operate a sole proprietorship (though it matters in all forms of business), because as mentioned earlier, many people will run to the Secretary of State to establish an LLC, but fail to separate their business and personal finances. If you do not adequately establish a healthy boundary between your personal and business finances and find yourself being sued for whatever reason, a sufficiently talented plaintiff’s attorney will rip your limited liability company to shreds, and you could end up on the hook personally for the business’s liabilities.

Secondly, beyond separating the business and personal financial accounts, you must also carefully track the ordinary and necessary nature of your business expenses. While dubious sources of information might lead you to believe that you can expense just about anything as a business and write it off as a deductible expense, the fact of the matter is that only ordinary and necessary business expenses are deductible. So, while you might think that printing your business’ name on a jacket means you can deduct the jacket, the fact of the matter is that many common business expenses are not actually deductible. This is an excellent area in which you should consult a small business tax specialist, who can not only help you with your business’ bookkeeping but also advise you as to whether expenses are deductible or not.

Third, while you may be tempted to be poor on paper, e.g., simply spend all the money the business makes so that there’s no tax impact or ramifications, be careful with this. As noted previously, not all expenses are deductible or can be deducted immediately. This is of particular concern if your hobby involves expensive property such as a printing press, high-quality musical instruments, or tools that can run in the thousands of dollars. Simply put, if you spend all the money in your business, that is not synonymous with not having taxable income in the business. Once again, a small business tax specialist is more than worth their fee if you have expensive property or are unclear about what is or isn’t deductible in your business.


As the old adage goes, there is no greater certainty in life than death and taxes. If your business shows any degree of profitability, you are going to end up sharing some of the spoils with Uncle Sam. It doesn’t matter if you don’t “pay yourself” from the business; if there is profit in the business at the end of any given fiscal year, you are going to end up paying some amount of taxes. So, being aware of the “amount” of taxes and what you might owe is important.

First, for a sole proprietor, whether you’ve established an LLC or not is irrelevant. All net profits of the business will be passed through to your personal income tax return as a “disregarded entity.” This means you will pay any federal and state income tax as if you’d simply worked a regular W2 job. However, when it comes to social security and medicare taxes, you will end up paying double. While your share of this as an employee is normally 7.65% up to a certain threshold and 1.45% thereafter, when you’re self-employed, you get to pay both the employee half and the employer’s half of this tax, which can add up to 15.3% and 2.9% respectively. These are known as self-employment taxes.

If you are a partnership, the business’s income will be divided based on the proportion of ownership you have in the business. Thus, if you and your friend are equal owners of a business that shows $10,000 in profit, you will each be reporting $5,000 of income on your personal tax return. Now, if you’ve been at this for a while, and in previous years you lost money, you might be able to use prior year losses to offset your newly taxable income, but that gets into a more advanced area than we’re going to cover today. This same offset rule does apply to sole proprietors as well, but as with most things tax, there are some other factors to consider.

Now, whether you are a sole proprietor or a business with partners, it’s not all that uncommon for folks to establish an S-Corporation to attempt to help mitigate the self-employment taxes. This is because, as an S-Corp, you must pay yourself reasonable compensation as an employee of the business, wherein you will pay self-employment taxes on the W2 income as an employee (the full 15.3% mentioned earlier), but you do not have to pay self-employment taxes on any profit of the S-Corp. However, you should be cautious here for a number of reasons. First, an S-Corp does require that you pay reasonable compensation for the type of work you’re doing, and if you’re a sole-member business with no other employees, it’s hard to make an argument that your “wages” should not be equal to the “profit” of the business, since it’s just you doing all the work. Secondly, while an S-Corp does help you account for who is doing the work and who owns the business, allowing you to divvy up some of the business income on the basis of work versus ownership, this can lead to a tricky dynamic in which much of the business’ income is being paid out for effort, thus as wages, and consequently, is not really helping much with the self-employment tax issue. Finally, an S-Corp is a formally recognized business entity. This means its legal compliance costs are higher, including needing formal articles of incorporation, filing notice with the IRS of the S-Corp election and having it be accepted, maintaining rigorous books and thorough meeting minutes, and paying experts for the privilege of ensuring compliance.

All Work and No Play?

Worry not. Everything I’ve shared here today might make it feel like all the fun can be sucked out of a creative hobby or endeavoring enterprise. There is a simple solution for this: take money out of the equation. If you have a hobby or interest that you passionately enjoy, there is nothing wrong with pursuing it and enjoying it thoroughly. If you do not bother to try to make money from the endeavor, much of what I’ve discussed today is thoroughly moot. It’s only when your creative interests lead you to engage in entrepreneurship, whether it be selling your crafted goods or being paid to perform, that the business end tends to kick into consideration. So, while it’s carefree and money-disregarding, enjoy your hobbies and passions with joy. Just remember to be cautious when cash enters the equation because the costs and efforts of being compliant in your business can become quite the hassle!

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