There comes a moment in every creator’s career when it’s time to level up their business and, with that, their business entity. Most creators hold onto sole proprietorship longer than they should, which can cost them big time in taxes.
There is a better way: Enter the S Corp. And while S Corps might be intimidating at first, this business setup is the MVP of growing creator businesses. Here’s a complete breakdown of S Corps for creators.
What’s an S Corp?
Technically, an S Corp isn’t a legal entity but a tax election.
Wait...what? It’s confusing, so bear with us.
The IRS assigns every business structure a default tax treatment…which is just a fancy way of saying that the IRS decides how each business structure is taxed.
Both single-member LLCs and sole proprietors are automatically taxed like sole proprietors. LLCs can ask the IRS to tax them differently, while sole proprietors can’t change how they’re taxed unless they form an LLC.
Now let’s talk about the S Corp tax election.
You can ask the IRS to tax your single-member LLC as an S Corp, which means that the IRS won’t tax you under the rules of a sole proprietorship. They’ll tax you under the rules of an S Corp (which we’ll talk about later). Again, if you’re a sole proprietor, you can’t change your tax structure unless you form an LLC.
How you’re taxed when you’re self-employed
As a sole proprietor or single-member LLC, you pay taxes on your business’s profits.
Regardless of if you keep the profits in your business or use them personally if your business makes money, you pay taxes on it.
There are two taxes you pay as a sole proprietor: Income tax and self-employment tax.
Everyone pays income tax based on their tax bracket, and being a sole proprietor doesn’t impact your income tax. But then there’s self-employment tax.
Self-employment tax, which goes towards your Social Security and Medicare, is 15.3% on 92.35% of your profits.
When you’re an employee, you only pay half of these taxes (7.65% of your wages) and your employer foots the rest of the bill. As a sole proprietor, you’re on the hook for the full 15.3%.
As your business grows and profits increase, so does your tax liability.
To give you an idea of how much self-employment tax can cost, here’s an example.
Your business profit is $100,000. $92,350 is subject to self-employment tax. Your total self-employment tax is $14,130.
Whoa! That much?
Yes, that much. Plus, you’ll be paying income tax.
How S Corps save on taxes
Many creators switch from a sole proprietor to an S Corp to decrease their tax liability.
S Corp profits are not subject to self-employment tax, which can save you some serious money.
The tradeoff is that you need to pay yourself as an employee of your business.
Every time you run payroll, you pay 15.3% in taxes on your employee wages. Half is paid for by your business through employer payroll taxes, and the other half is deducted from your paycheck.
How do I save money if I’m still paying payroll taxes?
Payroll taxes only apply to employee wages, and you don’t have to pay yourself all of your profits, just what’s reasonable for your industry. The rest of your earnings are exempt from self-employment tax. That’s where the tax savings come in.
Tax savings: S Corp vs Sole proprietor
Let’s do an example to compare the taxes a creator would pay as a sole proprietor or single-member LLC versus an S Corp. We’re basing this example on a creator who earns $150,000 annually in profit and, who as an S Corp, pays themselves a $50,000 salary.
In this example, the creator could save $15,350 by switching to an S Corp! Keep in mind that these tax numbers don’t include income taxes or state taxes, which will vary based on your tax situation.
Check out Collective’s tax savings calculator if you want a personalized comparison of how much you could save with an S Corp.
S Corp costs
If you’ve already started to swipe right for an S Corp, hold up. Because even though an S Corp’s Tinder profile looks great, there’s some stuff you should know before committing.
S Corps cost more money to run than an LLC or sole proprietorship. These are some of the additional costs associated with an S Corp.
Payroll service fees
Payroll involves many percentages, tax calculations, quarterly and annual forms, and ongoing payments to the IRS. It’s a lot to manage as a creator!
We recommend you use a payroll service that runs payroll for you and takes care of all your tax payments and paperwork. Our favorite payroll service is Gusto, which is perfect for S Corp owners.
But like most magical things that do all the work for you, Gusto isn’t free. For an S Corp owner, Gusto will cost you $45 a month to run payroll.
S Corps are under more scrutiny by the IRS, which means you’ll have to start taking your bookkeeping and accounting seriously.
Using an accounting program like QuickBooks Online will ensure that your books are clean and up to date. The most basic QuickBooks Online subscription will cost you $20 per month.
Tax preparation fees
When you’re a sole proprietor, you report your business’s income and expenses on your personal tax return and you only file one tax return.
As an S Corp, you’ll file your personal tax return plus a corporate return. Filing this extra return will set you back several hundred dollars.
Annual state registration fees
Depending on where you live, you might have to pay a yearly registration fee for your LLC and S Corp. Fees range from $20- $800 per year.
S Corps: Worth it in the end?
Just because an S Corp costs a little more to maintain doesn’t mean they aren’t worth considering, especially for creators earning more than $80,000 a year. The tax savings could outweigh the extra costs, and then some. The key is making an informed decision for your business.
If you’re still deciding if an S Corp is right for you, check out Collective’s tax savings calculator and see how much you could save with an S Corp.
Lumanu members can enjoy one month of Collective Membership at 50% off with this exclusive sign-up link and the code LUMANU.
Collective is on a mission to redefine the way self-employed people work by giving creator’s the tools and team they need to focus on their passion, not their paperwork. Collective handles company formation, taxes, accounting, bookkeeping and more. Collective members save an average of $9,000 per year.