What's the difference between SP, LLC, S-Corp, C-Corp, and Holding Co.
· corporations,legal entities,llc,business
While the coronavirus pandemic has disrupted the hospitality and events industries leaving many out of work, this has created an opportunity for DJs and other entertainers to do some housekeeping. This is a good time for them to review finances, straighten up business operations, and if necessary, change their legal entities. It would be worthwhile to determine what type of business structure would be most advantageous to them: a sole proprietorship, limited liability company (LLC), or corporation. This is not an exhaustive list and there are other business structures (for example, partnerships), but these are the ones that are most applicable to DJs and entertainers.
What is at stake?
There are two primary considerations when comparing business structures: tax liability and personal liability. A business owner wants to minimize their tax liability (pay less taxes) and protect their personal assets from creditors (lawsuits).
This is the simplest structure and generally the default for many independent contractors. It means that the business is owned and managed by an individual. This is a pass-through entity—income tax is levied only at the individual level. Income is subject to the 15.3% self-employment tax rate, which covers Social Security and Medicare taxes.
Under this structure, the owner is personally liable for all debts, lawsuits, and taxes that the company accrues. This means that their personal property and assets may be used to satisfy outstanding debts.
For example: suppose that while setting up speakers for a corporate event at a private venue, Joe accidentally knocks over and breaks a valuable piece of art. If Joe is operating as a sole proprietor, the venue could go after the Joe's personal assets (home, car, bank account, etc.) to recover the cost of the artwork.
An LLC is the most-commonly used business structure by entertainment companies. It is a separate legal entity from its owners or “members.” An LLC can have one owner and it’s formed by registering with the state where it’s located and paying the requisite fees. Similarly to a sole proprietorship, it is a pass-through entity, and the profits/losses are passed through to the individual owners. Therefore, this income is subject to the self-employment tax rate.
Unlike a sole proprietorship, “members” are not personally liable for the company’s debts. Of course, there are limitations to this protection: there must be real separation between the company and its owners (no commingling of finances) and it does not extend to wrongful or fraudulent actions (this is referred to as "piercing the corporate veil").
C-Corporations are less common among DJs and smaller entertainment companies, as they are more administratively complex. A corporation is owned by shareholders, who are not personally liable for its obligations. However, corporate income is taxed twice: at the corporate level and at the shareholder level.
S-Corporation is a corporate structure that is a hybrid between a C-corporation and a sole proprietorship: it is a pass-through entity. It allows shareholders to split company income between wages (subject to the self-employment tax) and dividends.
For example: Joe has set-up his DJ business as an S-Corp. In 2019, the company generated $100,000. As an employee of the company, Joe paid himself a salary of $50,000. This salary is a business expense, bringing the company’s net profit to $50,000. Therefore, Joe would pay the self-employment tax rate (15.3%) on the $50,000 he received as wages, and he would treat the other $50,000 as dividends, which is subject to his individual tax rate.
Consequently, with careful planning, this could reduce the overall tax liability for the owner. However, the key requirement is that the owner-employee is paid a reasonable salary based on the market rate.
LLC S-Corporation Hybrid
It is worth mentioning that LLC’s can elect to be treated as an association taxable as a corporation. Thus, they can enjoy the flexibility of an LLC structure, while receiving the tax-benefits of an S-Corporation.
A holding company is a business entity which does not have operations; rather it owns assets. This is typically used by big conglomerates with different subsidiaries, but can be advantageous to industrial individuals who own multiple companies. There are two main benefits of this structure. First, it protects each subsidiary from being liable for the debts of the other subsidiaries. Second, it may reduce the overall liability for the owner of the holding company: the holding company can file a consolidated tax return whereby the losses incurred by one subsidiary can offset the profits by another subsidiary.
For Example: Joe has a DJ business, a photobooth business, and a graphic design business. Instead of setting up one LLC which controls all three operations, Joe decides to make each one its own separate LLC. Joe then forms the Joe Holdings LLC, which owns the three companies. In 2019, Joe’s DJ company is sued by a venue for property damage (see example above). The venue is limited only to the DJ company’s assets in recovering the damages; it cannot go after the photobooth or graphic design companies. Further, that same year, the DJ company reported a net loss, while the photobooth company and the graphic design company made a profit. Therefore, Joe Holdings LLC can file a tax return where the losses incurred by the DJ company offset the profits by the other two companies, thereby reducing the overall tax liability.
Now is an opportune time for DJs and other small business owners to reconsider what business structure would best meet their needs: which one would reduce their overall tax liability and personal liability. While this article discussed some of the most common structures, there are several others, and business owners should consult their accountant and/or attorney.
This article is provided for general informational purposes only and should not be construed as legal advice. This article shall not be construed as creating an attorney-client relationship, and an attorney or other professional specializing in the field should be consulted.