Marketing agencies are different from traditional brick and mortar businesses. In fact, agencies are unique from the way most companies do business (and tax planning).
A few of these unique aspects include:
- Different products and services
- Unique expenses
- Various pricing models
- An unorthodox labor force
- Fluctuating profitability
These attributes mean your tax planning situation (as an agency) is also a bit different. So, what variables can impact your tax burden? What can you do to ensure you’re not overpaying? And how can you best set your business up for success?
In this article, you’ll find a bit more information regarding these questions.
Structuring Your Marketing Agency for Tax Purposes
For many agencies, you’ll consider three different entity structure classifications for your business. And they are:
- Sole proprietorship
- Limited liability companies (LLC)
- S-Corporation
There are a number of factors that go into determining which classification is right for your company. Think of them as levels to achieve as your revenue and profit grow. Here is a brief explanation of each, as it relates to agencies.
Sole Proprietorship
Pro: Inexpensive and easy to set up
Con: No individual liability protection, meaning legal action will directly affect you personally, not simply your business
If you’re very early in the process, going the sole proprietor route is possibly the way to begin operations. Do some research and file a “doing business as” or DBA in your state. It’s the fastest, and often least expensive way to begin doing business.
However, sole proprietorship doesn’t offer any liability protection. If you already have a few clients, ready to use your services, it’s best to skip the DBA and head to an LLC.
Limited Liability Company (LLC)
Pro: Relatively easy and inexpensive
Con: Pass through income is subject to self-employment taxes, which becomes a higher tax burden over a certain amount of profit
As in the name, this classification reduces (but does not eliminate) legal liability of the individual who owns and operates the business. Both sole proprietors and LLCs allow owners to have “pass through income.” This means all profit from the business “passes through” to the owner.
Example: If company revenue was $200,000, with $75,000 being profit, all profits would be classified as your self-employment income. (Unless you are also classified as an S-corp, covered in the next section.)
A simple LLC is a great option for agencies under $100,000 in profit. After that, the self-employment tax often becomes an undue burden.
S-Corporation
Pro: Often reduces tax burden by cutting out self-employment tax while keeping pass through income status
Con: Can be difficult to set up without assistance and has the highest cost of the three options
Once your marketing agency is established and making a good amount of income, it’s possibly time to think about adding that S-Corp classification to your business. The primary benefit is the ability to avoid the self-employment tax.
If you’re making greater than $100,000, that tax is a bit more than 15%. Under 100k, the pass through deduction and your personal deductions often help with this tax rate. Over that level of profit, and you’re going to start feeling the IRS’ presence.
Tracking Expenses Matters More than Searching for Deductions
At the end of the year, you’re taxed for the profit in your business. Some agency owners wait till the end and search out how to spend money in order to increase the amount they deduct from the taxable income.
Doing this often leads to unnecessary spending and reduced operating cash flow. Spending on legitimate business expenses is a great idea, but spending for the sole purpose of deductions is not.
Example: If you’re paying monthly for a software product (i.e. Ahrefs, SEMRush, and so on), and you know:
- It’s critical to your business
- Cash on hand is solid
- You’ll absolutely use it all year
Purchasing an annual license for those products will reduce that year’s tax burden and save you a bit of money off of the monthly subscription fees. It’s a win-win.
Compare that to spending a ton of money on WordPress themes or arbitrarily upping your ad spend, without knowing if they’ll be a return on investment.
What’s better than looking for ways to spend before you file?
Detailed tracking of expenses all year long. Track every penny, including personal expenses (to claim a home office, if you use one).
Then, take those records to an accounting partner who understands your unique business model. A skilled accountant will pore through your financial records and find you every qualifying deduction — even those you didn’t know you could deduct.
Example: The Augusta Rule (or Augusta Loophole)
The Augusta Rule is named for Augusta, Georgia. During the Master’s Tournament, people would rent out their homes. The tax code allowed income from this short-term rental to go on tax returns.
Now, small business owners have the ability to rent out their home, in a short-term capacity, and avoid paying taxes on the income that passes from the company to the business owner.
For instance, if you have a remote team at your agency and want to have an in-person meeting, you would hold the meeting at your home (instead of, say, a hotel conference room). If you charge your business a reasonable amount (according to the rates in your area) that income moves from taxable to non-taxable (or sole proprietors, LLCs, and S-corps). There are specific rules so make sure to contact your CPA.
This is one example that intermingles personal and business finances, but illustrates the point to track all expenses meticulously.
Work with an Accounting Firm that Understands Marketing Agencies
Many accounting firms understand traditional business models. But with the rapid development of digital marketing techniques and agencies, some of those firms don’t fully understand just how different your financial situation is, compared to their typical client.
At Pasquesi Partners, we work with startup founders, digital marketing agencies, and traditional businesses. We understand the tax code and unique business models. Multiple revenue streams, pricing strategies, complex contractor and employee arrangements — we’re ready to help you plan for the best tax outcome. Get in touch with us today.