Maximizing Tax Savings for Performers: S-Corp vs Sole proprietorship in NYC

Recently, I had a conversation with a client who performs in New York City and internationally. This discussion raised an important consideration for artists and performers who work across multiple jurisdictions: the potential tax advantages of making an S-Corporation (S-Corp) election.

Understanding the NYC Tax Landscape

A previous accountant had advised my client against forming an S-Corp due to New York City's 8.85% General Corporation Tax (GCT). While it’s true that NYC does not recognize the federal S-Corporation election and treats S-Corps similarly to traditional C-Corporations, there’s more nuance to consider when income is primarily earned outside of the city.

NYC’s GCT only applies to corporations that do business, employ capital, or maintain an office within the city. For an S-Corp, this tax is limited to income generated from activities conducted within NYC. If the corporation does not meet these criteria, the GCT may not apply to its earnings at all. For performers who work in various states and countries, this can open up significant opportunities for tax savings.

The Power of S-Corporations

One of the biggest advantages of electing to form an S-Corporation is its potential to reduce self-employment taxes. For self-employed performers, income from multiple jurisdictions can result in hefty self-employment tax bills, which can be mitigated by the S-Corp structure.

Here’s why:

Self-Employment Tax Savings: Without an S-Corp, performers must report all their earnings as self-employment income, which is subject to a 15.3% tax rate (covering Social Security and Medicare). By setting up an S-Corp, performers can split their earnings into two categories: salary and distributions. Salary is subject to self-employment taxes, but distributions are not. This strategy can significantly lower the amount of income subject to self-employment taxes. For my client, the savings could reach an estimated $25,000 annually.
Limited NYC Tax Exposure: Since my client primarily performs outside NYC, a large portion of his income falls outside the scope of the GCT. Income generated in other states or countries isn’t subject to NYC’s corporate tax, allowing for additional tax savings. Although he may still owe taxes in the states or countries where he performs, the exclusion of non-NYC income from NYC taxation is a major advantage.
UBIT vs. GCT: While UBIT may seem more attractive due to its lower rate (4% compared to 8.85% for GCT), it's essential to recognize the full scope of savings available through an S-Corp structure. The potential to exclude non-NYC income from GCT and save on self-employment taxes often outweighs the UBIT’s simplicity for high-earning performers. Sole proprietors, although benefiting from lower UBIT, face higher self-employment taxes on all earnings. For clients earning significantly outside NYC, the savings from the S-Corp structure, even with GCT applied to city-sourced income, can be substantial.

Maximizing Out-of-State and Foreign Income Benefits

Given that my client performs internationally and across the U.S., understanding how to classify and tax his income is critical. Here’s how the S-Corp election plays into his strategy:

Out-of-State Earnings: Income earned in other states or countries is exempt from NYC’s General Corporation Tax. While this income will still be taxed by the relevant jurisdictions, avoiding the NYC tax means my client retains more of his earnings.
Reducing Self-Employment Tax Liability: With the S-Corp, only the portion of income classified as salary is subject to self-employment taxes, while distributions remain untaxed for Social Security and Medicare purposes. This can be a game-changer for high-earning performers.
Filing in Multiple Jurisdictions: It's essential to note that although my client’s S-Corp will reduce NYC and federal tax burdens, he will still need to file state income tax returns where he performs and comply with foreign tax laws if earning income abroad. Proper withholding is crucial to avoid penalties.

Additional Considerations for an S-Corp Election

While the potential tax savings are significant, there are other factors to weigh when considering an S-Corp election:

Reasonable Compensation: The IRS requires that business owners pay themselves a “reasonable” salary. Performers will need to determine a fair wage for their services while balancing distributions to optimize tax savings.
Increased Administrative Responsibilities: Running an S-Corp comes with additional administrative duties, including payroll, separate tax filings, and bookkeeping. However, these can be managed with the help of a qualified accountant and are often outweighed by the potential tax savings.
State-Specific Tax Rules: Some states, like California, impose a minimum tax or franchise tax on S-Corps, regardless of profitability. Performers should be aware of these rules to accurately project tax savings.

Conclusion: A Smart Move for Performers

For artists and performers who work across different locations, setting up an S-Corporation can be a smart financial move. By leveraging the S-Corp structure, performers may significantly reduce self-employment taxes and mitigate NYC’s General Corporation Tax for income earned outside of the city.

My client’s case highlights the importance of tailoring financial strategies to individual circumstances, especially for those earning in multiple jurisdictions. Whether you’re a performer, artist, or freelancer, the benefits of an S-Corp election could be substantial.

Schedule an Appointment

If you’re interested in exploring whether an S-Corporation election could work for your unique situation, don’t hesitate to schedule an appointment. Contact Stella Sanchez, CPA for more information. Let’s work together to create a tax strategy that maximizes your income while minimizing your tax burden.

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Jun 9, 2020

Main Street Lending Program: Worth a 2nd Look!

The Main Street Lending Program has been largely dismissed by many businesses as the terms of the program were not attractive enough to get them off the sidelines. The FED, however, announced some noteworthy changes to the program yesterday, which include:

Minimum loan size has been decreased from $500,000 to $250,000
- This brings many more businesses into the fold. Even if a small business wanted a $500K loan, they very well may not have qualified for it because of the 4x Adjusted EBITDA limitation
Maximum loan size has been increased
- New loans: max $35M (previously $25M)
- Priority loans: max $50M (previously $25M)
- Expanded loans: max $300M (previously $200M)
The loan term has been extended from 4 years to 5 years
The repayment term has been pushed back to Year 3 though Year 5
- No payments are due during Year 1. Interest payments begin during Year 2. 15% of principal must be repaid (with interest) during Year 2, another 15% must be repaid during Year 3 and the remaining 70% is due in Year 5.

So, if you originally thought you couldn't qualify for the Main Street Lending Program or that they weren't attractive enough for you, it's time for a second look.

In this second look, you'll need to understand what loan amount you would qualify for. The formula is as follows:

Adjusted EBITDA x4 = Max Loan Amount

Your maximum loan amount will then be reduced by any outstanding or undrawn available debt (think: line of credit), unless that available debt is used to finance receivables or inventory (which many businesses could substantiate).

Example: Company has Adjusted EBITDA of $200K and outstanding debt of $100K. Their max loan amount would be $700K ($200K x 4 = $800K - $100K).

In terms of how you arrive at Adjusted EBITDA, there are no hard and fast rules, but rather the guidance from the Fed states that the bank must use the same criteria it has used for the borrower most recently, and if the borrower is new, the criteria used for similarly situated borrowers. Many banks will look at a 3-year average of your prior 3 tax returns, removing the impacts of capital expenditures (and related depreciation), as well as adding back one-time expenses and the salary of any majority owner. Obviously, the "ITA" (Interest, Taxes, Amortization) of EBITDA will also be added back to the ordinary income of the business as well.

There very well could be additional modifications to the terms of the Main Street Lending Program, which will all depend on the demand for the loans. If demand is low, expect further favorable modifications to the terms. The Fed created this program to put up to $600 Billion in liquidity into the economy, so if the demand is low, there will be incentive to make the loans more attractive to accomplish this objective. Keep abreast on the program details directly from the Fed here.

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Mar 22, 2022

Retirement Contribution Madness!

Well, it certainly is that time of year again. Where there WAS sleep, there IS coffee, and without the latter, the former is inevitable. Suffice to say that we are looking forward to reuniting with our families after April 17th! In the meantime, there is work to be done!

Each tax season, we field countless questions on retirement contributions, whether it is, “how much can I contribute?” or “how much can I deduct?” or “when is the deadline for contributions?” or “when is the deadline to establish the account?” or some other variant of the aforementioned. As is the case with most tax questions, the answers are many and often nuanced.

Take, for example, a husband and wife, who want to max out their 401k and IRA. How much can they contribute? Well, it depends. If both have a 401k sponsored by their employer, then they can both max those suckers out with $18K in contributions in 2017 ($18,500 in 2018). When it comes to the IRA? Well, that’s going to depend on their income level. If their MAGI (Modified Adjusted Gross Income) is less than $99K in 2017 ($101K in 2018), then they can each contribute and deduct $5,500. If they earn between $99K-$119K, then they can contribute the full amount, but their deduction will be limited. If they are above $119K, then they can contribute the full amount but can deduct none of it. Why would you contribute into an IRA if you couldn’t deduct the contributions? So you can backdoor it into a Roth IRA, duh! Granted, you’d only do that if, as a Married Filing Joint Couple, your MAGI was greater than $196K, which prevented you from contributing straight to the Roth in the first place.

There are many twists to the above example, such as when one spouse isn’t covered by a 401k plan, or if both aren’t, or if you’re single, etc.

What about when it comes to a SEP-IRA? Well, you can establish those up to the date you file your tax return, including extensions. The same timeline holds true for contributions to the account. This means that you can get a tax deduction for 2017 with a contribution made as late as October 15th, 2018 (September 15th for Partnerships and S-Corps). Pretty wild huh? How much can you contribute? This depends on your entity type. If you’re an S-Corp, then you can make a contribution of up to 25% of the W-2 wages you paid yourself up to $54K for 2017 ($55K for 2018). If you have an LLC or sole proprietorship, then you can contribute up to 20% of your net taxable income (without respect to the contribution itself), once again to the same maximums as that of S-Corps.

But what about a Solo 401k? Ah yes, this typically allows for higher contributions than a SEP. This is because you are not bottle-necked as greatly by the company’s profitability. Under a Solo K, you can contribute on the employee side up to $18K in the same way as the very first example above. This is true even if the company has no taxable net income. On the employer side, you can contribute 25% of W-2 wages (or 20% of taxable income for LLCs/Sole Props) in the same way you do for a SEP-IRA. You are still capped at $54K between EE and ER, but a quick example will illustrate the advantage.

An S-Corp pays its shareholder $100K in W-2 wages. In a SEP, the maximum contribution is $25K. In a Solo K, it is $43K ($18K on the employee side PLUS $25K on the employer side).

The point here is that so much of how much you can contribute is situational and not a simple black and white rule. If you need help in this area, we are here to help!