You may have heard the saying “small businesses are the backbone of America,” and while it’s a nice sentiment, it’s really all talk. In fact, Bethany Swartwood cringes every time she hears a politician utter those words. “If that was true,” she says, “they wouldn’t make it so hard for the self-employed to exist.” Bethany is the Head of Member Services at Collective, which is an online behind-the-scenes financial platform for people running their own business. Collective is all about helping individuals navigate the twists and turns that come with being your own boss. We partnered with Collective to help creators tackle those challenges and invited Bethany to lead a workshop on everything you need to know about running an S corp, which is her favorite type of small business for creatives. You can watch it in full here.
Let’s talk business structure
There comes a time in many creators’ careers when they have to start thinking about going legit — AKA officially incorporating themselves as a small business. We know making things official can be scary, but it might do you some good in the long run. Whether you’re a full-time or part-time creator, there are some real benefits to making yourself a business. Aside from saving you a good chunk of change, it can also cap the amount of damage you’re exposed to as a business. If the time is right for you to take the plunge, keep reading to learn the ins and outs of each type of business.
A corporation is really good for two things: raising money and retaining money. These are the Googles and Facebooks of the world, and basically anything that has an Inc. at the end of its name. Legally, corporations limit the liability of owners, which is a fancy way of saying that it helps separate the business side of things from the personal. So, if you find your business in debt, you don’t have to worry about anybody coming after your personal assets.
The main issue with corporations is that their default taxation has a double-tax problem, which means they pay corporate income tax on everything they earn and then the shareholder pays again on the dividends they receive from the corporation.
An LLC or limited liability company is great if you’re a business-of-one or sole owner with just a couple employees. They’re easier to maintain than corporations and generally way more flexible. Plus, they’re the best choice if you own property for your business.
By default, an LLC is a “flow-through” entity, which means it pays taxes through an individual income tax code rather than through a corporate tax code. If you’re the sole owner of your LLC, you’ll automatically be a “disregarded entity” — which means your company doesn’t exist for tax purposes. But, (and this is where things get interesting), as an LLC you can choose to be taxed many different ways, and one of them is as an S corp.
What’s an S corp?
If you ask Bethany, she’ll tell you that her go-to for creator businesses is an S corp. Remember: in this case, an S corp is not a type of business. It’s a tax status, which is why you can technically be an LLC and an S corp.
S corps are a less common type of corporation than a C corp but it has some major upsides for small, creative business. One of the reasons Bethany (and Collective) loves S corps is because of a little thing called social taxes. In most countries, including the U.S., we get charged social taxes on “earned wages.” (In the US, we call social taxes by many different names: FICA, payroll taxes, self-employment tax, social security and medicare, etc.) But, remember that when you’re a single-member LLC, your business, by default, doesn’t exist for tax purposes. That means that the IRS deems every dollar you make to be an “earned wage,” so you’re going to get that 15% social tax on everything. Choosing to be taxed as an S corp is your way of saying hold on, my business is more than just the hours I work. You’re telling the government that there are intangible assets associated with your business, like your knowledge, artistic signature, and brand. So, it’s not fair to say everything you earned is an “earned wage” because some of it is more like a return on investment.
What does this mean? If you have two identical businesses but one chooses to be taxed as an S corp and one chooses to stay an LLC, the LLC is paying the 15% social tax on all business profits and the S corp is pocketing most of that money. And that’s what generates the cash savings. In this scenario, “for every $100,000 your business earns, expect to save $12,000 to $15,000 on just social taxes alone,” Bethany says.
The Pros and Cons of an S corp
You already get major savings on social taxes but there’s also nothing forcing you to take your wages in cash. As the employee and employer, you get to decide your own benefits and because you’re technically a corporation, you can get corporate style benefits. You can choose how much goes into your 401(k), you can set up a dependent care plan for your kids, and you can even put your premiums for health insurance through the business. It’s all up to you.
Unfortunately, there’s always going to be a downside. In exchange for all the benefits we just talked about, you will have to run an entire business. For example, you have to maintain and run payroll, and clearly separate payroll from your business or personal expenses.
What about the C corps?
Ah, the other type of corporation. Good question! We haven’t talked too much about C corps until now, but that’s because they’re probably not the best choice for creators. C corps could be the right move for you if you’re trying to get outside investors, but there are some major drawbacks (remember the double layer of tax we talked about earlier?). Here’s the breakdown:
Let’s say you have two identical businesses making $150,000 but one is taxed as a C Corp and one as an S corp. The C corp pays a flat federal income tax of 21% on everything (regardless of what state you live in), which leaves them with about $118,000 left over after taxes. It then distributes that $118,000 to the owners and the government slaps another tax on top of that, too. That adds up. If you’re the S corp in this case, you don’t have to deal with this double taxation debacle, which means you can put a good amount of cash back in your pocket and don’t have to be worried about getting taxed on it twice.
Where do I go from here?
The truth is, It’s not really that hard to set up an S corp and the good really does outweigh the bad. If you’re thinking about starting an official business, this workshop is a great first step. Reviewing different business types and tax structures is the best place to start so you can understand your options and make the best decision for the future of your small business. Once you’ve made the choice, you can go ahead and start getting set up with a tax ID, business bank account and payroll. It may feel daunting at first, and that’s ok! Nobody said finances are easy. But once you get past all the legal jargon, you’ll see that setting up an official business can be pretty simple.
That being said, everyone is at different stages with their business and everyone has different goals. It’s totally fine if you’re not ready to start a small business or even think about all this stuff. You don’t want to over-engineer things if you’re just getting started. But, if you’re reaching a stage where your day-to-day is getting a bit more complex, then it’s worth looking into your options based on your current needs.
If you want more information on starting an S corps or need some help taking the leap, Collective services are right in Patreon’s app directory to walk you through it.