The creator economy has 200 million content creators, according to a Linktree report, 10 percent of whom make more than $100,000 annually. But the new industry has minimal infrastructure to educate creators about how they are supposed to pay taxes, or if they need to pay them at all.
That’s an opportunity for Karat, a financial services company for creators.
The Observer previously featured Karat in its list of people and companies powering the creator economy, published in September. At the time, Karat was focusing on developing its credit card for creators that takes social statistics into account when setting the terms, limits, and rewards. Karat has since transitioned to bookkeeping and doing taxes for creators.
Eric Wei, 31, Karat’s co-founder, previously worked as a product manager at Instagram and Facebook and as a consultant at McKinsey & Company. In 2019, he founded Karat alongside Will Kim, formerly an investor with Lucky Capital, a seed fund.
With U.S. federal tax returns due April 18, Rachyl Jones of the Observer spoke with Wei on what creators should know about doing their taxes.
What are the things creators get wrong when they do taxes?
There’s three high-level ones. Many of them don’t even know that they should be paying quarterly taxes. Some of them don’t even pay taxes, but most of them don’t do quarterly. I didn’t necessarily know this either, so many creators don’t. You’re supposed to pay your taxes throughout the year. When April comes, that’s just the government checking—‘Did you pay what we think you owe?’ If you paid too much, you get a refund. Refunds aren’t really great. They’re just interest-free loans to Uncle Sam. You pay too little, you get penalties. If you work for a company, they are supposed to withhold a portion of your paycheck to cover the tax burden. When you’re working for yourself as a creator, no one’s withholding anything. You’re supposed to do it yourself four times a year.
The second thing is many creators are making six or seven figure incomes and they’re not “incorporated.” Or even if they’re incorporated as an “LLC,” they’re not set up properly to get tax savings. You have to do an additional step of saying you want to be taxed as an “S corp,” where you can now get savings. Even when you designate yourself an S corp, you still don’t magically save money.
An S corp saves money by allowing (them) to avoid paying about 15.3 percent self employment tax on whatever income their business generates that’s not payroll and salary. The reason that matters is creators can still transfer (that income) to themselves via personal distribution to avoid paying that self-employment tax. So, if you had $100 and you’re supposed to pay 15.3 percent self-employment tax, with an S corp, you can designate $40 of that as salary. You pay 15.3 percent on the $40 salary but not the other $60, and you can still transfer that to yourself whenever. It’s just considered business income.
This is a lot of work, and you have to figure out how to set the right level of salary and payroll for yourself. Presumably, you want to minimize it so you can transfer more to yourself while skipping self-employment tax, except No. 1, the IRS will go after you if you set your salary too low, and No. 2, there are other, more complicated tax reasons that sometimes you want to increase your payroll. For some retirement plans, you can only contribute a percentage of your salary, which might be a reason to increase it.
What’s the third thing?
The third one is there’s a number of write-offs available for small businesses that creators are eligible for and they just don’t know. They can be very meaningful—even hundreds of thousands of dollars for some clients. There’s a deduction called QBI, the Qualified Business Income writeoff. It’s actually up to 20 percent of their qualified business income. If I made $100, I can write off 20 percent of it. That’s insanely high. There’s a number of rules and stipulations regarding if you qualify—if you are below a certain income threshold around $160,000 for a single filer. If you are above that threshold, you qualify depending on the nature of your business and amount of your payroll. And typically, creators’ brand deal income doesn’t count. Other types of income—AdSense, merch—could still count.
The other bonus fact I’ll share is it’s actually really tricky to know as a creator what you can write off as a business and what you can’t. You might assume if something is in a video, you can write it off. Actually, no. This is something most creators get wrong. You can only write off clothing if it is specific enough it could only be used for that shoot and not for things after.
Are there other, non-tax perks to being considered incorporated or a small business?
When you’re a small business, you can set up your own retirement plan, and you have a lot more flexibility over how you contribute to it. It’s way more versatile and powerful than following one that your employer set up for you. There are other reasons to incorporate from a legal perspective in not being personally liable for things your business has done.
Have you had to hire more people since starting bookkeeping and taxes?
Since August, we have tripled or quadrupled the number of staff.
In what kind of roles?
Mix of CPAs (certified public accountants) and bookkeepers. CPAs have more expertise across taxes, tax filing and financial strategy, and bookkeepers don’t actually need to have CPA designations. They just need to know how to be good bookkeepers.
How many people are you servicing through your tax and bookkeeping operations?
We don’t share that number publicly, but since August, we’re already double. And we could be more so but we stopped taking on clients.
How is doing taxes for creators different from doing taxes for other freelancers?
You have to explain things and be on call more when working with a creator. It’s not specific to the nature of the business per se. They’re just really, really busy, and they’ve grown up in an entirely new industry that didn’t have any stuff in place. It’s kind of wild. Our average client makes over $300,000 a year, and less than a third of them are incorporated. That’s a bizarre statistic.
I saw that you charge on a per-client basis. How do you determine the cost of your services?
It’s based on how much money we think we can save you. If you’re not making more than $80,000 to $100,000, just do your own taxes. Don’t worry about getting incorporated. It’s also based on how much time and work we think it’ll take on our side. The baseline for our service, which involves an actual human being coming in, is typically $500 a month, up.
For that group of creators making less than $100,000 that should do their own taxes, what hurdles would you advise them of?
Just keep track of your business expenses. Even if you’re not incorporated, you can put business expenses on your Schedule C—it’s just a form where you list out what your business expenses were, and guess what? You can now still write them off. If you write off “X” dollars, you’re saving money because you’re not paying tax on “X” dollars. That can be meaningful.
Try to separate things out as much as possible. This is an obligatory plug for the Karat business (credit) card, but frankly, any business card would be helpful.
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