If you’re a digital content creator, chances are you’ve seen something online about the potential tax savings of switching from an LLC to an S Corporation. However, most of these articles and videos gloss over the most important input of this decision – your reasonable salary or reasonable compensation. This figure, along with your total net profit, are the most important numbers to look at when determining the most advantageous entity for your business.
Myths surrounding reasonable salary for content creators
There are several myths floating around about how to determine reasonable compensation. Some say to take 50% of your profits as reasonable compensation and 50% as distributions. Some say to set your reasonable compensation at the Social Security maximum. And there’s plenty of other wild advice that’s not rooted in any fact, such as ‘just take $40,000 or $75,000’.
The courts have been reliable in debunking these myths, although many accounting professionals and business owners still aren’t aware of the rules the IRS has established.
How to determine reasonable compensation for content creators
The reality is, the IRS has determined three approaches that it deems acceptable to determine reasonable compensation. By nature of your business, most content creators will be best suited to use the Cost Approach, aka the Many Hats Approach, – you perform several different functions for your business.
In addition to choosing the correct approach, you’ll want to document your reasonable compensation calculations and make sure you’re using unbiased data in those calculations. If you don’t have reliable data to back up your calculations, you’re putting yourself at risk of a lengthy reasonable compensation challenge with the IRS.
While these calculations can be done by hand if you can find the data the easiest way to determine an accurate and defensible reasonable compensation figure is to have your accounting professional run a reasonable compensation report in RCReports.
So, LLC or S Corp?
Once you have determined your reasonable compensation figure, you can calculate whether it’s more advantageous for you to be taxed as a pass-through entity (LLC or Sole Proprietorship) or as an S Corporation. Make sure that you consider the additional fees associated with being an S Corp, such as payroll fees, bookkeeping fees, any state fees/taxes, etc. If your accountant used RCReports to calculate your reasonable compensation, ask them to do an entity selection analysis for you using the RCReports Entity Selection Planning tool. It will take all these factors into account, plus show you potential savings over a 10-year span. Plus, it’s a great way to start a conversation with your accountant about other tax saving strategies that might work for your business.
The bottom line—while filing as an S Corp has potential to save you thousands of dollars on your taxes, you need to fully understand what your reasonable compensation should be (and document that figure!) so you can protect yourself and your business should the IRS come knocking.
Check out our What is Reasonable Compensation? brochure here.