009 - What the hell is a business entity? And Do I Need One as a Drag Queen?
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On this episode of the podcast I dive into business entities which is lesson 4 of my tax basics and legal fundamentals framework for drag professionals and LGBTQ+ entertainers. If you missed my intro episode, Part 1, Part 2, or Part 3 of the series, take a pause and go back and check those out.
A business entity is how we structure our business. Your structure is really the way that you're setting up your business in terms of how you want to collect money and pay taxes and also how you are protected from liability. This might look like an LLC, S Corp or corporation. You don’t want to be personally liable for your business.
Today we’re focusing on sole props, LLCs and S Corps which is all that’s really relevant for US drag professionals and entertainers unless you have a business partner.
Sole prop – The default business entity. Think of it as a lack of entity. When you have a profit motive (aka not a hobby) you have a business in the eyes of the IRS, even if you haven’t formed anything like an LLC. This does not mean you’re off the hook when filing taxes.
LLC – The proactive step beyond a sole prop. Like Glinda the Good Witch’s magic bubble in The Wizard of Oz. Inside the bubble is your business – your wigs, your outfits, everything you have for your business. Anything you own on the outside like a home or retirement account is protected by your magical bubble, the LLC. The LLC is there to protect everything you own on the outside of the business from any kind of liability that can happen inside of the business. Even if you don’t have any assets now, if you get sued a judgement from the court is good for a decade and they can come for any assets you gain over the next 10 years. There is a cost to filing an LLC, which varies by state, but think of it as insurance for your business.
Disregarded entities – An entity not recognized by the IRS. Much like Mariah Carey responding, “I don’t know her,” when asked if she was friends with J Lo, when you form an LLC the IRS is like “I don’t know her,” meaning you get liability protection from the LLC but from the IRS point of view it’s not there meaning it doesn’t impact your taxes. On the flip side, partnerships, S Corps and C Corps are not disregarded and they have to file business taxes by March 15th of each year and the IRS sends you a personal tax return.
Pass-through entities – The income or profit from the business passes through to you personally, there’s no corporate taxes. All entities other than C Corporations are pass-through entities, to make this simple.
C Corporations – You pay a corporate-level tax, the corporation pays you a salary, you then pay taxes on the money you get from the corporation. This only makes senses when you have dozens of employees with benefits or you keep a lot of money in the business, for example if you want to buy a building. Entertainment and service-based businesses don’t do C Corps. Instead we can have an S Corp.
S Corporation – They’re not actually an entity, they’re just a tax status. You form an LLC or a corporation and then you file Form 2553 which is an additional election with the IRS that says you would like your LLC to get the benefits of sub chapter S of the US tax code. All this means is you get sort of preferential tax treatment. In our previous episode we discussed the 15.3% self-employment tax on our net business income to cover our share of Medicare and social security.
Assume your business brings in $100,000 and you are really profitable and have $20,000 in expenses and $80,000 profit. If we have a regular LLC or Sole Prop, 15.3% of $80,000 is $12,240 in self-employment tax (this does not include income tax). In an S Corp, you put yourself on a salary the way you would get if you were working full time at a company. Say you put yourself on a $60,000 salary. You’re going to pay self-employment tax and income tax on the $60,000. After the expenses and salary we have $20,000 left which is net income after salary (our profit in an S Corp) and we don’t pay self-employment tax on the $20,000 meaning the S Corp is saving us 15.3% of $20,000 which is $3,060. The lower a salary in an S Corp the more you save on taxes, but you must pay yourself what the IRS calls a “reasonable salary” based on what someone in your industry in your geographic market would make which is difficult for entertainers to estimate. You can also assess all the mini hats you wear in your business.
I don’t encourage people to file S Corps on their own, I always want people to know the options available to them to know if they are ready right now or have it in their mind for if and when they are ready and will consult a professional (I can help you). Typically I tell people you want your net income after salary to be at least $20,000 and you probably aren’t going to be really ready until you’re profiting at least $60,000 because we typically aren’t paying a salary less than $40,000.
To learn more about LLCs, S Corps, DBAs, etc. snag a copy of my book.
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