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Introduction
However you envision your future in photography, if you're going to make
money at it, you're likely to start your own business. That's right,
you're going to be an independent entrepreneur, where you set your own
hours, are your own boss, and watch TV late into the night as you clip your
toenails. And if you thought that was fun, just wait, because now comes
the fun part: doing your taxes, writing contracts, collecting money from
clients, paying your bills, and dealing with attorneys (yours and others).
The good news is that I'm not going to get into any of that here. Volumes
have been written on the subject, and it's beyond the scope of this
book. However, where I can be of service is to help you understand the
principles behind these aspects of the business in order to clear up
common misunderstandings and put you on the right track for talking to
your accountant. On the bright side, this isn't all that hard. Running
a business is sort of like riding a bike: once you learn, you wonder
what the fuss was about.
De-Myth-ifying the Photo Business
First things first: despite many internet rumors, you do not need a permit
or license of any kind to qualify as a "professional photographer." Selling
photographs or photography services requires nothing more than your desire
to do so. The only thing that really matters is how you intend to have your
income and expenses affect your tax returns. And that's where the IRS
comes in. The agency has only one interest: whether you are properly
paying (or not paying) your taxes.
IRS and other legal entities use certain metrics to determine whether
you're a bona fide business, or just an enthusiastic hobbyist, or
possibly even a criminal trying to evade taxes. Assuming you're not
a criminal, the greatest concern you should have about the IRS is that
it determines that you only have a hobby, not a business. Difficult as
it may be to believe, there are those who spend a lot of money on
photography, call it a business, and use their expenses as deductions
against other income. There's nothing wrong with having a photography
business while you have other income, the IRS just wants to make sure
you're not lying about your motives and inappropriately deducting
expenses that are not business-related. After all, people gain extra
income selling stuff on eBay all the time, even photos, and many of them
do not have businesses. Whether or not the IRS thinks you really just have
a hobby (where you aren't allowed to deduct expenses), is by both specific
and ambiguous means. In general, the IRS looks for the following:
Receipts.
This almost goes without saying, but it's important to know that
it's not just having receipts that matter. They look for patterns of
behavior. Are you consistent in what you deduct? Are you thorough in
your accounting? Is there a consistent correlation between the kind of
things you deduct and the kind of income you declare? For example,
if you're deducting expenses associated with trips to Hawaii, but your
"photo-related income" is only from wedding assignments in your home
town of Tulsa, Oklahoma, the IRS might send some people over to ask you
a few questions.
Separate personal and business expenses and activities.
Again, it's all about patterns of behavior. Car receipts are always what
people hate (and the IRS loves). If you're going to deduct your car and
its expenses, you need to log mileage when you drive on business-related
activities to demonstrate a correlation between expense activity and
income activity.
Filing the right tax returns, and doing them properly.
When you collect your receipts for the year, and total up your income, you
need to summarize all this to the IRS. Depending on the type of business
you have, you attach an appropriate schedule to your personal tax returns.
Many photographers consider themselves "sole proprietors," which requires
filing a "Schedule C" along with tax returns. This does not change your
tax obligations in any way—you still pay taxes on income (and deduct
expenses). It's just that this formality separates your business dealings
from your personal ones.
Consider Incorporating
You might consider incorporating your business to further establish
it as a separate entity. This is the most secure way of protecting
yourself from the IRS ruling your activities as a hobby, though it's
not foolproof (since cheaters are known to use this method as well).
Incorporation involves more paperwork and other administration overhead,
but there are many other benefits to incorporation, which may include
tax savings and legal protections. So, there's a tradeoff, and although
incorporating is not for everyone, it's worth looking into if you feel
strongly about aggressively pursuing your business.
So, myths aside, let's start the discussion with some preliminary framework.
Are you a "Pro," or just a Hobbyist?
Regardless of what you claim to be, the IRS and other legal entities
use different metrics to determine whether you're a bona fide business,
or just an enthusiastic hobbyist, or possibly even a criminal trying to
evade taxes by masquerading as a professional for the purpose of deducting
expensive vacations to offset income that would otherwise be taxed.
So, the first decision you need to make is, which one of these are you?
The main risk with having a photography business is having the IRS
determine that it is really just a hobby. That is, many people spend a
lot of money on photography, call it a business, and offset expenses
against their otherwise taxable income. So, if you're losing money in
your photo business, you have a lot more to worry about than just the
fact that you have less. The IRS might want to come and take more
in the form of penalties, back taxes and interest on the taxes you
should have been paying against your other income. Yes, you may be
stunned to learn that there are actually people out there, living it up
on vacations and fancy dinners, not really taking pictures, but writing
off all those costs as "business expenses" (wink, wink!).
This all serves as another reminder that forming a business requires a
concerted and intentional effort to take it seriously, and while that
may be vague and/or ambiguous at times, especially in the beginning,
the business is perceived to be more legitimate when you follow
established guidelines sanctioned by the IRS. I will cover many of
them here, but you are encouraged to do additional research, since there
are state-by-state laws that you may need to know. A great resource for
more information (which include necessary forms for filing a corporate
papers and tax election status), see Books on Incorporating,
published by Nolo Press (www.nolopress.com).
All that said, you are certainly allowed to treat your photo hobby like
a business and still not actually form a business entity. For example,
if you're selling prints on eBay, then you can do this in your spare
time and just file a Schedule C with your normal tax returns. (This
is the form that declares "other" income.) If you sell something that
requires "sales tax," you may need to do a few things with your state's
local franchise tax board. But these don't necessarily require you to
"start a business."
Deciding Your Business Type
Assuming you are not going to be a fulltime employee of another company,
and you are going to start your own business, pay taxes, pay yourself,
and be responsible for the day-to-day running of your new enterprise,
you now need to make the next decision about your business type. Here,
you have several choices: a Sole Proprietor or one of the various
types of a Corporation.
Important note here: The first mistake people make is thinking that there
is a single "correct" way to establish your business type or file tax
returns, and there isn't. There are many ways to do this correctly—which
method you choose should be the one that is most advantageous to you based
on your particular circumstances. Some people are better off incorporating
because of personal details, not because one way is "better" or even
"correct." Those details may involve how you financed your company,
whether you have an angry ex-spouse, or if you want to prevent your
evil step-children from inheriting your business when you die. Unmarried
hobbyists who spend most of their time in caves may do just fine filing as
an individual using a schedule C. There are pros and cons to each choice.
Lastly, the type of business entity you choose has legal and tax
consequences, as will be discussed. Let me re-emphasize that there is no
"correct" way, so you should not follow the advice of single-solution
individuals who may say "all photographers should be sole-proprietors."
Regardless of whatever decision you make, you will get in trouble if you
don't know exactly why you've made the decision you've made. Accordingly,
when you're done with this, if you still have questions for your tax
preparer, you should not be asking "what" you should do, but instead,
ask, "what are the advantages of choosing method X over method Y?"
Most freelance photographers typically consider themselves "self-employed"
or "Sole Proprietors," and file a Schedule C on their tax returns to
reflect business expenses and income. Anyone, doing any kind of business,
can be a Sole Proprietor, including bookkeepers, construction contractors,
videographers, journalists, independent cooks, contractors, or web
designers. One can even form a partnership with one or more people
and still maintain Sole Proprietorship status on his personal tax
returns. However, such relationships are better managed through another
vehicle, the Limited Liability Corporation, which is discussed later.
The Sole Proprietor method is preferred mostly because it has the lowest
administrative overhead, and the tax filings are not much different
procedurally from how individuals normally do them. If your photography
business is profitable, or if you don't plan on selling the business in
the future, this may be the simplest form of business. There are caveats
(listed later), but if you are willing to live with them, and don't need
the added protection of a corporation, then this may be your best option.
Corporations: Three Choices
When you form a corporation, you assume a new paradigm for how you run
your business. In essence, you have given birth to a new entity, at least
in the IRS's eyes. While they won't send you any congratulatory cards,
your new child will be given a new social security number, otherwise
known as the Corporate Tax ID. This is your hint that this new business
is going to have a virtual life of its own.
While you may have already picked a name for your new offspring, you also
get to make a choice that you can't do with human babies: you get to choose
its sex. In IRS lingo, that's called the "tax status." And, thanks
to creative legislators, you don't have only two to choose from, you
now have three! The traditional C-corp, which is what most people
are familiar with; the S-corp, which is used for "Small" businesses
owned by one person (or a small set of people); and the LLC—Limited
Liability Company, which is kind of a hybrid between an "S" corporation
and a Sole Proprietorship. Let's get into each of these as briefly as
possible. (I know, you're getting woozy.)
We'll start with the C-corp, because non-business people are most familiar
with this one making it easier to establish the concepts. Most companies
you know are C-corps: Coke, Gillette, McDonalds, ATT, Microsoft, and
even Enron. ("even Enron?" you ask! I point this out because, although
it is bankrupt, it hasn't changed its corporate status.) Briefly, in
the C-corp, the company makes money and pays tax on it, less expenses
it pays. As it happens with most companies, they pay their employees,
and in so doing, this becomes one of its many expenses. After all
expenses are paid, whatever money is left over from the revenue earned
that year is profit from which taxes are paid. Those taxes are paid
at the "corporate rate," which is based on a sliding scale of income.
The lower the amount earned, the lower the percentage of it that's paid
in taxes. The higher the amount, the higher the percentage. Although the
personal income tax rate is designed similarly to the corporate rate,
the schedules are different. And that presents a problem for small
companies at many levels—especially for those companies where the owner
is also the only employee.
Since most photographers are usually like this, let's examine what happens.
First, the simple case: if the owner takes all the profit out of the company
for himself (so he can live), the company itself pays no tax, because
it has no profit. The owner, however, pays income tax on that money
because, obviously, that's his personal income. For this simple case,
the money is taxed as a single rate: the personal income tax rate for
the owner of the company. If, however, the owner decides to keep money
in the company—say, so it can buy more equipment, pay expenses yet to
come, prepay for advertising, or for general operations—then we run into
a problem: by having kept some money in the company, it now has a profit
that it needs to pay taxes on. And, because the owner took some money for
himself, he needs to pay taxes, too. The same money is taxed, but at
different rates, depending on whether it's the company paying the tax,
or the individual.
If you thought that was complicated, consider how much more so it is
when you factor in all sorts of other things, like real estate and
other property and depreciation schedules. Things really get insane for
those who have other income as well, such as pensions, dividends from
stocks, capital gains from home sales, and all sorts of other accounting
lingo that can make your head... well, go to sleep. For so many reasons,
the IRS designed a special kind of corporation to simplify the whole thing
as if it were one tax-paying entity. For individuals who own and run their
own companies, but don't need or want the complicated overhead, they need:
Here's how it works: whatever money an "S" corp. earns or loses, it is
declared on the shareholder's tax return. That's it. That individual
prepares his tax return like he always did before, only he now has one
more line-item: the profit or loss from the company. It's just as if
he got a normal paycheck, or had other deductions. So, let's review
some scenarios about how this tax consideration unfolds for both an "S"
and a "C" corp.:
Company loses money:
-
You personally earn $50K/year from various sources (a job, stocks, etc.).
-
Your company loses $10K in operating income.
If you were a C-corp
-
You personally pay taxes on $50K.
-
The company has a "tax loss carry-forward" of $10K that it can deduct
against any earnings it may have in the future.
If were an S-corp
-
You personally pay taxes on $40K (your normal $50K, minus the $10K loss).
Company earns money:
-
You personally earn $50K/year from various sources (a job, stocks, etc.).
-
Your company earns $20K in operating income.
If you were a C-corp
-
You personally pay taxes on $50K.
-
The company pays a corporate tax on $20K, but the money stays in the company.
-
If the profits are paid to the shareholders (you), you pay taxes on $70K,
but the payment of that "dividend" is an expense to the company, which would
reduce its profit to zero, eliminating its tax obligation.
If you were an S-corp
-
You personally pay taxes on $70K.
For those reading outside the box, there are several things to notice:
First, your out-of-pocket tax payments are less if you personally have any
income at all, your company is an S-corp, and your business is losing
money. Second, your out-of-pocket tax payments are higher if you have the
same conditions, but your company is a C-corp, and it's making money.
Anyone reading this can quickly do the math to see that those with lots
of losses can offset personal income with an S-corp One way the IRS
helps to deter cheaters is by requiring a minimum tax payment for "S"
companies, regardless of profitability. Specifically, S-corps are
required to pay $800 a year, profit or loss. (This amount varies on the
first year, and it seems that tax codes may be changing again with the
volatile political landscape of the 21st century). You have to do the
math for your own circumstances to see how much money your company has
to make for this $800 to be a wash, loss or benefit, since it depends
on your personal income tax bracket.
One aspect to this that shouldn't be overlooked is that, like the
C-corp, "S" companies can have multiple owners (shareholders) up
to thirty-five. If you start a business with one or more partner, you
can all participate in the S-corp. Here, the distribution of profits
(or declaration of losses) is passed through to the shareholders in
accordance with their percentage of ownership. There's nothing magic
about this, it just means that each person's tax returns needs to slice
up the company's returns correctly.
Obviously, the advantage between forming an "S" or "C" company requires
planning wisely. This is where it's important to review these features
with your accountant.
The Limited Liability Company (LLC)
To wrap up the different corporation types, we come to the LLC—or,
the Limited Liability Company. Technically, this is not a corporation
because it does not issue shares. But, it provides many of the advantages
of a corporation in many ways, to be discussed. So, it's sort of like
a combination of an "S" Corp. and a "partnership" in that it can have more
than one partner or investor, but the company participants don't have to
be involved or employees. (But, they "can" be.) An LLC is identical
to the S-corp where profits and losses flow through to the shareholders'
tax returns, but unlike the S-corp, the distribution of those funds
does not have to reflect the percentage of ownership in the company.
Furthermore, the distribution of the funds do not necessarily have to be
considered as "wages." That's important because social security taxes have
to be paid on wages. If there's only one owner of the LLC—like you, a
photographer—then any money you do take out is considered wages, and
are subject to social security taxes, but the single-owner LLC can be
considered a special case by the IRS in that you don't have to file a W2,
file many other forms. You just pay social security taxes at the end of
the year based on how much money you withdrew from the company.
Also, the legal system for LLCs is, as the name implies, designed to
give the shareholders "limited liability." This is attractive for those
who want to protect their personal assets from any liabilities the company
may have, such as if you were sued because someone tripped and broke his
leg in your photo studio at the mall. By extension, this same protection
extends to other investors that may not be employees of the company.
If your uncle Bob invests $10K in your new business, then he won't be
sued either because of the LLC status. Likewise, if Bob gets sued for
some reason, his claimants can't go after the company's assets.
The "liability" concern for a photo business doesn't apply the same as
other, more risky businesses (like medicine and law), where litigation
is more common. However, if you're thinking of starting a collective
"agency" of many photographers, it might be just the thing. For example,
if you were going to do "adult entertainment," where the nature of the
models is such that someone could sue because she wasn't really 18,
then the other shareholders might want protection from such risks.
Acquiring a Business License
Many local governments (in the USA) require businesses to register
for a business license. Business licenses are revenue generators
for governments. The general rule of thumb is that any business with
walk-in customers require a license, and those who don't do not require
a license. Hence, online-only business generally do not require
business licenses. If you ever have customers come to your place
of business on any sort of regularity, or it appears you do (like if
you have studio lights set up for portraiture), then you're going to
have to get a business license.
These laws are regimented on a city-by-city basis (or on a county-wide basis),
and, for the most part, they are mostly used as revenue-generators for
local municipalities. Despite the rule of thumb noted above, which most
people will find to be true for their local market, you should check for
yourself on whether you need one. However, it's not that simple because
online-only business are rare, and most desk clerks either don't know,
or don't think to really do the research to find out. In one case, I
had a reader tell me that his city (Santa Clara, California) had someone
on the phone tell him that if your home address is your mailing address,
you need a business license. Talk about obscure and, frankly, dubious.
What isn't clear is whether the requirement still applies if customers do
not visit you at your place of business. No one asked, so the person
at the city probably assumed as such. This underscores the importance
of being precise when interviewing people in government. Don't just
assume they know what you're doing.
Also note that you should rarely take a bureaucrat's word as gospel,
especially when dealing with more obscure questions/issues they don't
deal with on a day-by-day basis. That, plus the fact that because it's
a revenue generator, it's probably all they've been trained to say:
"yes, it's required." In any event, all requirements such as these have
to be documented in city codes, and many states require all such codes
to be online by now (or soon, perhaps, for some cities). Either way,
you can certainly ask the person you speak with for the code section
and paragraph that stipulates the article of law, and you should check
it out for yourself. Even if they quote you the appropriate text, it's
often more vague than their biased interpretation of it. (This is why
Tax Court is constantly busy, for example.)
Why the big fuss? It's not that business licenses are all that
expensive (although that's a relative term). And while there is very
little that a business license really gives you, one thing I assure
you'll get that explains why I'm giving it all this attention: you'll
be hounded by solicitors of every walk of life to buy everything
from business cards to company insurance. Worse, you can't protect
yourself by delisting your number. A business license requires a
phone number, and all business licenses are part of public record.
Telemarketers have access to these records, as do chambers of commerce,
which provide their members such lists so they can solicit each other
for new business. (Business-to-business economics is very big.)
Anti-telemarketing laws only apply to residential phone numbers,
not businesses.
If you have to have a business license, it might be a good idea to get an
extra phone number (perhaps one of those dirt-cheap numbers you get when
you sign up for a voice-over-IP calling plan) that never gets answered. If
you never use or publish that number to your real clients, you can ignore
the plethora of solicitations that will surely come your way.
Caveats to Business Types
When faced with the decision on whether to be a Sole Proprietor,
or one of the corporation types, the issues become complex,
especially when you consider factors beyond just taxes. There are
matters of legal liabilities, protections, and other financial
concerns as well. So, let's compare each of these as they pertain
to photography businesses.
For Sole Proprietors, one caveat with filing a Schedule C with your
tax return is that it is also a commonly used method of tax evasion.
The IRS usually finds high-income wage earners or those with significant
investment income (dividends, bond interest, etc.) using Schedule C
filings to offset that income that they would otherwise have to pay
tax on. A "photography business" with very ambiguous deductions and
very little income (or sales) clearly looks suspicious, and it a common
way for people to avoid taxes. In fact, Schedule C filers are 50%
more likely to be audited than those who use alternate reporting methods.
(Put in absolute numbers, the IRS tends to audit 1% of the population;
those filing Schedule C's have about a 1-½% chance of getting
audited.)
If the IRS audits you and finds you really just have an expensive hobby,
and not a "real business," it may impose hefty penalties, require a
revision of all tax returns for the years where the Schedule C was used,
reverse those deductions, and charge interest along with the back taxes
you owe. Worse, they may even critique your photographs. It's not pretty.
The IRS web site (www.irs.gov) is full of complete information on all
this stuff, and it's surprisingly well organized. Don't forget to use the
"search" feature to find relevant documents and IRS codes. For example,
if you search for "hobby," you will learn quite a bit.
You may have a legitimate business with nothing to fear, so you may
not need to worry about getting audited. Also, if your non-photo
income is minimal, then it's even less likely that an audit would
find you've done anything wrong. Still, audits are time-consuming
and bothersome (not to mention risky, if you have an overly zealous IRS
auditor), so consider this along with the other factors below when
deciding on your business type.
The intent of a Sole Proprietorship is to provide the simplest
method possible for filing a legitimate tax return. However, it
doesn't address other factors, such as property, assets, liabilities,
or partnerships. What all of these have in common is the principle
of "assets"—property owned by an entity. As a Sole Proprietor, you
are that entity. You own your property, such as camera equipment, photos,
computers, or anything else related to your business. Thus, anything
associated with you can stake claims to it. If you owe money, your
creditors can tap into your assets: money, house, photo equipment, etc.
If you're married, then this may also apply to your spouse, too. That
is, if your spouse owes money, then those creditors can come after the
same things, even though those items are "yours." Then again, this
may not be a problem, depending on if you live in a "community property"
state, like California, and you set things up properly.
In states that have community property, a spouse owns 50% of your
assets, unless (1) they were excluded in a pre-nuptial agreement, or
(2) you owned them before you got married. So, if you started your
business before you got married, anything you had then remains
yours. Anything new you acquire is 50% owned by you and your spouse.
What's more, any growth is also split with your spouse, whether cash
(from salary or dividends, etc.), or appreciated assets that weren't
excluded in the pre-nup. Say you started your company when you were
single and it appreciated in value to $50K on the date you were
married. That's yours. From that date forward, however, any cash (salary
or dividends) you earn is split between you and your beloved, 50/50. All's
well if you remain married. But if you get divorced, things can take a
very different course, depending on if you are a Sole Proprietor or if
you formed a Corporation.
If you're a Sole Proprietor, then all your personal assets that you
acquired since your marriage are divided, including any camera
equipment, or anything else associated with your company. Of course, you
can mutually agree to swap items so as to preserve the photo business,
but you're negotiating for items that you might not have had to if you'd
incorporated. In that case, the corporation is an entity in and of
itself. Your beloved can make no claims to its assets individually and it
can operate unimpeded.) Whatever horse-trading you may negotiate at this
point is limited to that set of assets that do not include company assets.
Also note that whatever money you earned from the company is still up
for grabs, which is true of any money you obtain from any source after
your marriage, regardless of whether you're a Sole Proprietor, or a
Corporation. However, unlike salary you earn from an external employer,
if you own a corporation, you can refrain from taking a salary,
thereby having it remain within the company. Here, the cash remains
an asset of the corporation, and it is not part of the community
property. You may still owe income tax on the money you didn't take,
but that's irrelevant to the issue at hand. Compare again to the Sole
Proprietorship, where there is no separate entity at all, so the company
money is also your money, and is immediately available to outside entities
upon any triggering event.
While you may love and trust your spouse, that's not the only risk with
community property: debts and other credit problems can be tapped into
by creditors, like school loans, car loans, or other debts that come to
haunt you later. This applies whether you're married or not; but if you
are married, you inherit your spouses debts as well. Even your spouse's
distant relatives could make claims against all your assets in the event
of a death (where they may claim "inheritance"). Ask any lawyer for a
running list of possible ways that someone can affect your business in
a community property state, and you may end up staying for the weekend.
Caveat #3: Legal Liability
Because a Sole Proprietorship is not a separate entity, it does
not provide the same legal protections that may be more applicable to
your business. For example, insurance companies may cover your home
but not your business interests, unless you are incorporated. Others
may give you worse rates or coverage terms depending on how you
characterize your business. You may also find the best rates are those
who only insure incorporated businesses, and no personal assets at all.
This problem gets even more complicated if you ever hire people, or have
clients come to your home or office, or travel, or do anything that may
require liability insurance. This is often one of those considerations
that cause more serious-minded business people to decide to incorporate.
And if you ever want to borrow money, banks look far more favorably
on incorporated businesses than Sole Proprietorships, especially when
it comes to an emerging photo business.
As for legal protection, the laws protecting individuals that have sole
proprietorships are no different than if the individual didn't even have
a business. In contrast, when it comes to protecting an individual's
assets, incorporating can provide some protection in many (but not all)
circumstances. That is, if you used a photo of someone without a release,
and that person sued you, he would most likely be limited to assets
within the company alone, not your personal assets. This is called a
corporate veil. Similarly, if your company ran up debts, and you
failed to pay them when the creditors demand it, they could sue your
company, but the courts would limit their claims to assets held within
the company—not your personal assets.
On the other hand, if you form a company and do not transfer ownership
of appropriate assets (including your photo copyrights), then it could
appear to the legal or tax system that your corporation is merely a
"shell" with no actual business assets. In this case, a judge would
allow a claimant to go after your personal assets to settle the charges.
This is called piercing the corporate veil. And it's not just the
protection you have against your creditors; your legal ability to
pursue others may be hampered as well.
Exceptions include gross negligence or other matters that involve
civil rights or felonies, like whacking someone over the head with your
tripod. Also included are intentional or malicious intents, such as using
a non-released photo in a way that clearly was beyond the normal course
of business, like placing a nude photo of an ex-lover on a billboard in
your downtown area with text that says, "Do Not Date This Person!"
These are cases where the corporate veil won't help you protect your
assets.
Lastly, consider the possibility that, one day, you may choose to sell
your company. If you do stock photography, chances are, you have a great
number of assets that act like annuities: they continue to generate
income year over year, even though you may have taken the picture years
ago. If you sell a corporation, if the assets are properly declared,
there is little worry or dispute about who owns the copyrights on the
images. All the company's assets are transferred free and clear to
the new owner. While it can be made just as easy for a Sole
Proprietorship as well, it's not as clearly defined in the law about
who owns what, possibly raising concern for a potential buyer.
Valuing Your Company
If you're a Sole Proprietor, you do not need to "value" your company
because it is not a separate entity to own. So, this section is
only for those who choose to incorporate. Filing incorporation papers
varies from state to state, so you need to look into what local
requirements may apply. In general, however, the parts that apply to
anyone follow.
The first thing you'll need to do (besides naming your company, which
we'll discuss later) is determine the company's initial value. You will
issue shares (doesn't matter how many; it's largely irrelevant at this
point) to the shareholders in proportion to their contribution. This is
important if and when any of these scenarios occur:
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You are starting the company with a partner.
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You sell the company.
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You can't sell the company, and need to write it off.
Your company's value is not unlike any other on the stock exchange in
this regard: if you paid $10K for 1000 shares of stock, your cost
basis is $10K. If you later sell the stock for $12K, your profit is
the sale price, minus your cost basis. In this case, you have a gain of
$2K. You pay a capital gains tax on that money at the end of the year.
On the other hand, if you bought a stock whose value goes down, you
declare that loss on your tax return to offset other gains.
When you form and own your own company, it's the same thing. The initial
money you put into it is your cost basis, and whenever you sell the company,
your capital gain (or loss) is determined by the difference between the
sale price and the cost basis.
If you think it's unlikely you'll sell the company, you still need
to know this value. For example, you may die someday. I don't want to
predict when, but my guess is that you're not going to take anything with
you. So, when your estate has to pay taxes, your kids or beneficiaries
will have to know this value for tax and inheritance reasons.
Another reason you need to know the value of the company is if you
don't like the business and want to quit. Let's assume you decide to
get out, but you can't find a buyer for all your dreadful pictures.
In this case, you would sell whatever assets you have (cameras, computers,
or anything you can/want to sell), and "write off" the difference between
that sum and your initial cost basis.
Establishing the initial "value" of your company relies on one variable:
Physical Assets. These can take several forms, the first being the
obvious: cash. The money you put into the bank account to pay for initial
expenses and equipment is the easy calculation. The other kind of asset
includes your equipment: cameras, computers, scanners, software, and anything
at all associated with your photography business that you already own
that will be used by the business, and only the business. Those calculations
can be a little more tricky, but here are some guidelines.
 Equipment you purchase before the founding of the company is
calculated as fair market value, and that contribution is considered
a capital contribution. It's not an "expense" because you already bought
it. You're using it as part of the "cost basis" of the company. If your
equipment values at $10K, and you add $15K in cash, your "cost basis"
for the company is $25K.
Equipment you buy after the founding of the company is just an expense.
It is not part of initial capitalization.
Equipment or expenses you share between the company and your personal
life is usually a deductible expense as a proportion to its use in the
business. For example, if you're going to share your car with your
personal life, then it becomes a depreciable asset. If you drive 50% of
the time for the business, and the other 50% for personal life, you simply
divide the car's expenses (gas, insurance, etc.) by two at the end of the
year, and those are business expenses. The same is true for a home office
(as a percentage of your house) and so on.
If the equipment you turn over to the company is less than a year old, you
can use your purchase price as its value. Otherwise, you have to use a
"fair market value" formula, either by getting it appraised, or getting
an independent source to verify its cost. A reliable and accepted method
for doing this is eBay. There are almost always similar products to yours
available in the open market, and you can use a proven sale price as a
"current value" of your stuff. (Note: it can't be something that's "for
sale" but unsold. It has to have been sold because that establishes what
someone will pay for it. Hence, a "fair market value.")
Once you invest the cash and contribute your equipment, this adds up
to the "value" of the company.
But, what about your photographs? They have value, too, right? This
especially important for stock photographers, since they derive their
income from the sale of their images, and they presumable start the
company with a sizable base. Surely, must have value. Well, they do,
and they don't. Unlike listing computers and camera equipment on
eBay, you cannot objectively ascertain the value of photos because they
are all different and unique. In other words, their value is a matter of
speculation, which the IRS deems as "zero." However, you can use the
cost of the film itself, as well as the cost of processing as part
of your capital investment. Those are known payments (provided you have
receipts), which makes them verifiable. What's more, any expenses paid
that allowed you to get the images in the first place (such as travel,
etc.) can also be part of your cost basis in the company. Note that there
is no tax benefit here; these are not deductions. They are simply
calculated into what you've invested to form the company.
Spinning the magic time dial, we fast-forward in time to that event where
you now want to exit the business. (Either that, or let it dissolve into
nothingness.) Whenever that time comes, you have to value the company
again so you can file the final tax return and realize whatever gains
or losses from your investment. The valuation process is no different
from before, but now comes the moment of reckoning for whether you did
it right the first time. For example, if you claimed as a cost basis
all those pictures and trips to Hawaii, but never sold any, the IRS
could deem those investments as inapplicable. That is, they could;
it doesn't mean they will. What they are looking for is a pattern
of business that's consistent with your spending and capitalization.
If something doesn't fit a pattern, the IRS may disqualify it, in which
case, you're starting down a class five rapid, you have no paddle, and
there's a waterfall not far down river. Once the IRS sees smoke, they
are going to find the fire, so my suggestion is to be very conservative
on your calculations for initial valuations.
Assuming everything is on the up and up, and you've grown the business,
your assets may amount to a great deal more than what you started with.
Assuming you sell the company at a profit, you now deduct your initial
investment into the business from what you get in the sale. So, if your
assets total $100K, and your initial investment is $10K, then you made
$90K. Timeframe isn't important (so long as it's longer than one year),
your tax obligations are whatever the capital gains tax rate is for $90K.
Over the course of the past ten years, it's gone from 28% to 20%, with
rumors of it going down further.
But one more thing needs to be considered. To illustrate this, consider
the following: if someone wants to buy your company, and your assets total
$100K, but you can also show that the company earns $20K/year in profit,
you could say that the company is worth more than the $100K of assets
that it owns. That is, if the buyer is going to get a return of $20K in
the first year from his investment, you would expect that his return on
investment would pay for itself in five years. It is pretty common for
this benefit to be factored into the sale price of the company. I mean,
how often is it you can find an investment that pays for itself in a
short period of time? After that, you've got a money machine.
This intangible value is called good will. There is no formula
for how to calculate the value of good will; it's all a matter of how
badly someone wants to acquire your business. It's like how you value
an old baseball card. It only has value if someone's willing to pay more
for it. This does not have value in the IRS's eyes; it is only used as a
negotiating token to justify a higher price for the company to the buyer.
Once you sell, you do the math and pay your taxes.
On the other hand, if you're dissolving your company because no one will
buy it, good will plays no role. Sure, someone may buy your old computer,
but this isn't selling your company, it's unloading an asset. When
you finally sell all the assets you can, the total dollars you raise is
subtracted from your cost basis, and the difference between those numbers
is your "capital loss" (as it is unlikely you liquidate your assets for
more than you paid for them). So, if your company was founded with a
value of $25K, and the sale of your assets totaled $5K, you have a
"capital loss" of $20K.
Profit or loss, whatever cash comes out of the company is distributed
to the shareholders in equal proportions to their ratio of ownership in
the company. The profit or loss is also declared on the shareholders'
tax returns in the proportion to their ownership of the company.
Tax
Taxes. Here we go. They're everywhere. You must pay tax on income (salary
and dividends, which are different), sales taxes, social security taxes,
and sometimes other taxes, depending on the complexity of your business,
or what state you live in. Since volumes of books have been written in
attempts to explain, let alone codify, these very complex matters,
I have no intention of rehashing them here. However, I will touch upon
the most basic topics that apply to photographers.
If you ever take cash out of the company to pay yourself, you have to
pay social security tax (a.k.a. "SS Tax"). If you're thinking, "I'm
not paying myself a salary, it's a dividend," I understand. But, the
government wants to collect SS Tax because the system needs the money.
If you have any income, the government is going to try to characterize
that money as a salary, instead of a dividend. It may not, if you do
things right. And the way the government determines whether your distribution
is deemed a "salary" or a "dividend" is, as mentioned several times
before, by looking for patterns.
If you're consistently making money year over year, the government is
going to rule that you've got a reliable income, and that some of that
money should have SS Tax levied on it. How much is meant by "some" is
unclear; it depends on how good you are at convincing them the sums
are unpredictable. For example, if you earn $10K one year, $25K another
year, and $9K before that, and that it didn't come in evenly distributed
throughout the year, but only in chunks, you'll have a better time
convincing them that you couldn't have predicted the income stream.
If you show a profit of $10K one year, but a loss on the next two years,
followed by another gain of $5K, they probably won't even argue with you.
But, if you can show that you earn a regular rate of $5K/month over the
course of several years, they're going to ding you. (And you don't want
to be dinged.)
If you have a business, chances are you're making sales. And if so, there
is a matter of "sales tax" to deal with. Yet, not every kind of sale
involves sales tax. Items sold between businesses are not taxed provided
those items are later sold to a consumer who does pay the tax. That is,
if you sell prints to a retailer, who then resells them to the public,
you do not collect sales tax on your sale; the retailer collects the
tax on his sale to the end buyer.
If you sell direct to the customer, like the retailer, then you need to
collect the sales tax. To do this, you need a resale license. You usually
apply for one from the franchise tax board with your business license (see
below). It doesn't matter whether you're an individual or a corporation;
your "income tax status" has nothing to do with how you pay sales taxes.
If you sell online, you do not charge sales tax, unless the customer
resides in your state. This is the same as mail order catalogs. The big
variance among individual states is what the sales tax rate is, or whether
the state even has a sales tax. (As of this writing, Alaska, Delaware,
Montana, New Hampshire, and Oregon impose no sales taxes. However,
numerous boroughs and cities in Alaska have their own local sales taxes,
which is not an usual practice, and is one that is prone for expansion
to other cities throughout the country as budget deficits worsen.)
Another situation in which sales tax is not charged is when you license
images. (Licensing is when you sell someone a right to use an image,
but you're not transferring a physical asset.) In California, licensing
images is not subject to sales tax, but some states have different
laws on this.
Shipping and handling are taxable, as is the transference of any
physical property, such as a slide, negative, or disk. For example,
if you license an image for $300 to use on a web page, and you send the
client a slide, then you would charge sales tax for the slide, say, $1,
and any shipping and handling charges you may incur, say $15. But, you
would not calculate tax for the $300 license fee. And, you only have to
charge the $1 sales tax if the client keeps the slide. If they return it,
it's not an exchange of property. (Electronic transfer of assets like
this—say, a digital image—is exempt from any sales tax because
there is no physical asset.)
When you apply for a resale license, which is required in order to collect
and pay sales tax, you will be given a booklet with all the state-specific
information.
We Americans hate giving money to the government. (Yeah, like the French
love it.) So, we try to find ways to reduce our tax obligations in
very creative ways. As you know, you can deduct your business expenses
from your company's income, but another way is through charitable
donations. Again, nothing new, but where photographers get into trouble
is when they assume that donating stuff that has "potential income"
is deductible dollar for dollar. This comes in two forms: donating
goods, and donating services, neither of which are deductible in the
manner in which most photographers think. The error stems from this
otherwise correct procedure: if you sell a print for $100 and donate
that $100 to a charity, then you get a $100 deduction. Where
the logic goes awry is when people think that they can short-circuit the
system by directly donating the print and declaring it as a charitable
donation of $100. It doesn't work that way.
The IRS views any donation exactly one way: its physical asset value.
If you donate a print, the deduction you take must be the sum of the hard
costs associated with producing it. That is, the cost of the film,
the paper, and the frame, but no other expenses, including the trip to
Hawaii you took to take the picture. For example, it costs me about $150
to produce a 40x60" print, even though I sell it for $1200. I can donate
that print, but I can only deduct $150, because those were my hard costs
in producing it.
For you alert readers thinking ahead, you may notice that there is
really no tax advantage at all, since the cost of making the print
is already a tax-deduction because it's a business expense. You deduct
it from your income, whether you sold it or gave it away. The fact
that you're donating it to a charity does not qualify you to deduct it
again or for more money.
The IRS has a document that describes all this:
Publication 561: Determining the Value of Donated Property.
But the problem is that people misconstrue the text to try to finagle
their advantage. The text states that donations involving artwork valued
at more than $5000 must be appraised by a qualified appraiser. The
presumption, therefore, is that for those pieces valued at less
than $5000 can be deducted. Not so quick. This is intended not for
the artists themselves, but for those who already own art—usually
collectors and institutions that trade in art. Such places often donate
art and establish their deductions based on their fair market values.
Fair market values are almost always established by a documented track
record of sales for particular pieces bought and sold in the open market.
It's virtually impossible for the artist himself to be able to do that
with his own work because, again, the individual piece must have had its
own track record of sales. Artists don't buy their own works back at
fair market value prices. When an artist donates work, it's almost always
a new piece that has yet to have a sales record.
Another way photographers think they can take tax deductions is by
donating services as a pro photographer. Again, you're out of luck.
The error people make is assuming that, If I bill my photo services
at $100/hour, I can deduct ten hours' work and qualify for a donation
of $1000.
You cannot deduct time—the IRS only permits donation of hard-goods
or actual money. Thus, you can deduct any expenses you incur to do
a photo shoot, like film, auto tolls, gas, or any other cost associated
with performing the service, but your time is not deductible. For the
actual IRS chapter that discusses this, see:
Tax Topic 506: Contributions.
In short, there is almost no way for a photographer to take a deduction
that you wouldn't have already taken as a normal business expense.
Benefits of Incorporating
As if the benefits of incorporating weren't already clear, there are more.
First, everyone from the IRS to your vendors to your clients perceives
a corporation to be a more serious and legitimate business model. You
may find your business relationships with other entities besides the
government to be better, such as banks, suppliers, and the press.
Another benefit of incorporating is kind of subtle negotiating token when
dealing with people who license and print your images. Often, especially
in editorial contexts like magazine and newspaper articles, the photo credit
names the photographer or copyright holder of the image. For example,
you often see this sort of attribution in photo credits:
Even though the name of the actual photographer doesn't appear, the
owner of the copyright on the image is listed (in this example).
Other times, you may see the photographer's name as in
Here, John Doe is the photographer, and Corbis is the photo agency.
Some people assume that the legal name of the copyright holder is what's
used as a photo credit. Though that's not true, you can use this in your
favor if you form a corporation under the name of your web site's URL,
such as "www.yourname.com". As you may have seen in my photos, my
photo credits read as thus:
But then again, so what... As nice as this advantage is, some of the
higher-profile companies (magazines and such) refuse to print my web
address as photo credits for my images simply because it's against
their policy to do so. Their reasoning is that they don't want to
"advertise" someone else in their print copy, nor do they want their
readers to suddenly "leave" their attention span to go to my web site.
If I push the issue, experience has told me, they'll simply not publish
the image at all. But this is hardly a deterrent. Smaller, every-day type
of clients are almost always compliant. And, as you build your career,
as I've been finding, even bigger companies are more willing to comply.
You can see the status tiers: the same publications that refused to
print my web address had no problem printing Corbis's or that of other
well-known photographers. Clearly, status has a lot to do with this. So
keep this in mind if faced with the same issue.
Another reason to use your web site's URL in the copyright notice is to
give a potential user of the image unambiguous information about how
to contact you. If they steal the image anyway, you could sue them for
copyright violation and have a persuasive claim of "willful" infringement,
which carries an extra $150K fine. Here, it's because the copyright notice
leads directly to you—it's not just a "name" like John Doe, where
there may be thousands of them, and the infringer might claim they made
reasonable efforts to find you. Because there's only one domain name,
it's harder to explain to a judge that reasonable efforts were made.
Copyright Your Images
With all that stated about photo credit and ownership, don't forget to
actually copyright your images by registering them with the copyright
office. If you are going to license your photos for others to use, like
magazines, brochures, ads, or any other commercial use (including private
and non-commercial use, like fine art), copyrighting your images strengthens
your case (and financial judgments) against violators. But, there are some
practical realities at hand, so let's get into some of that here.
Formally copyrighting your images is important no matter what, and you
should do it for all your images, as soon as you can. This, preferably
before you hand them over to a client for use. Copyright protections mean
that any violation is now a federal matter, not just a civil one. This
means that you can collect attorney's fees (mandated by federal law)
as well as higher punitive damages (again, by federal law).
However, if you're like most photographers, you usually wait till you
have a large collection at one time before bothering to send in the
one-page form and fee. This means that you're going to shoot a number
of various projects before getting around to it, at which time, there
is a (small?) window of opportunity where infringements may take place.
If you haven't copyrighted your images, or you copyrighted them after an
infringement, you will not be entitled to the federal provisions described
above. (You could for all future infringements, though.) Still, you
own the copyright to the images, and still enjoy legal protections. While
you can still bring a claim against a party for infringement, your damage
claims could be lower if your defendant is sophisticated enough to know
to examine the records at the copyright office to see if, in fact,
you have the strength of the federal copyright statutes. (Of course,
you don't tell them you don't—you leave it to him to discover.)
So, now to the easy part. Copyrighting images is insanely simple.
Go to the copyright office's online registration page, which is
http://www.copyright.gov/eco. You can/should register as many as you
can at one crack, so as to save on the fees. (It's currently $35 per
registration, but there are no limits on the number of images you can
register at one time.)
The most common question people about submissions is: what size should
the files be? The copyright office's official statement says that for
photographs in print form, "the most widely distributed edition" should
be registered. But these days, most photographers upload images to
the web, and display those images initially as a thumbnail, generally
around 200 pixels wide or high, more or less. The real purpose is to
identify the image against another in the event of a claim. If you were
to file a copyright claim against someone for using your image, someone
(such as a judge) would compare the version of the photo you registered
with the one you claim to have been stolen. So, you want to submit to
the copyright office an edition that's clearly and easily identified.
Generally, 250 pixels (in the long dimension) is sufficient for this,
but your images may vary.
It should also be noted that newly emerging technologies are used
more often these days to match "identical copies of images" that are
not necessarily discernible by the human eye, especially when only
portions of an image are used. Such pixel-by-pixel analysis is a better
determining factor than people can do, making the technicalities of the
edition registered with the copyright office even less relevant.
There is one exception to whether you can or should copyright images:
work-for-hire contracts. Here, if you shoot an assignment for a client
with whom you have signed a contract that specifically uses the phrase
"work-for-hire" (or "work make for hire"), then the client owns the
copyright, not you. In fact, you have no rights to them at all. This is
one of those cases where it's very easy to know: you must have a contract,
and it must have used that phrase. If you don't meet both of those
exceptions—regardless of what anyone (such as your remorseful client)
tells you—then the images are yours.
There is much discussion about whether work-for-hire contracts
are inherently good or bad, but this gets into a discussion
beyond the scope of this chapter. For more on this subject, see
Photography Pricing.
Summary
This was a long and involved chapter. But, it was because I covered
all the bases for all the different types of photo businesses that can
exist. At the same time, remember that most photo businesses migrate,
so you aren't expected to "do" or "know" all of this information
at once. As you read through the rest of the book, there may be some
back-references to issues discussed here, because the legal basis of
your company may affect other business activities you do as time goes on.
So, it's best that you understand these concepts so that by the time
you're ready for each step, you've got the basics.
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