Starting a Photography Business

Introduction

Chasing Business Opportunities
(Havana, Cuba)

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.

Following the Leader
(Morocco)

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.

"Let me tell ya about business."
(Greenbrae, California, USA)

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?

Have Fun
(Peru)

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!).

No-No #1: Deducting Vacation as a "Business Expense"
(Nice, Provence, France)

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

Mono Lake Lenticular Sunset (2)
(Lee Vining, California, USA)

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?"

Sole Proprietor

Sole Proprietor
(Palau)

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

Running On Your Own
(California, USA)

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.)

The "C" Corporation

You're Being Watched
(Havana, Cuba)

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.

Dancers a2 (b&w)
(Buenos Aires, Argentina)

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:

The "S" Corporation

Corporations: Big and Small
(San Francisco, California, USA)

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.

It's a Screwy World
(Cork, Munster, Ireland)

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)

Snowy (20)
(Yellowstone, Wyoming, USA)

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

Starting a New Business
(USA)

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.)

Do I REALLY need a business license?
(Greenbrae, California, USA)

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.

Caveat #1: Audits

Risky Business
(Nimes, Provence, France)

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.

Caveat #2: Assets

How to Share Community Property
(Monument Valley, Arizona, USA)

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.

His and Her Barns...
But, Who owns the Windmill?
(Sonoma, California, USA)

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

Love is All We Need
(Dublin, Leinster, Ireland)

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.

Only Hire Serious, Dedicated Employees
(Dublin, Shannon, Ireland)

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

Path and Mountain (2)
(Zion National Park, Springdale, Utah, USA)

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:

You are starting the company with a partner.

You sell the company.

You can't sell the company, and need to write it off.

Sailboat in Bay (2)
(Fethiye, Turkey)

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.

Initial Value

SF Couple
(San Francisco, California, USA)

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.

Nice, France
(Nice, Provence, France)

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.

Selling Your Company

Tower (2)
(Tucson, Arizona, USA)

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.

Good Will

Good Will Gone Awry
(Peru)

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

French Bulldogs (3)
(Paris, France)

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.

Social Security Tax

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.

Your Sales Tax Dollars At Work
(Death Valley, California, USA)

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.)

Sales Tax

Making Turkish Crepes (3)
(Kalkan, Turkey)

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.)

Erdiger Tap
(Dublin, Leinster, Ireland)

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.

Tax Deductible Donations

Jack Playing Piano (6)
(Lake Wawasee, Indiana, USA)

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.

Gastown Flowers Lamp Posts (2)
(Vancouver, British Columbia, Canada)

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

Be Cool
(San Francisco, California, USA)

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:

"© 2000 Corbis"

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

"© 2000 John Doe/Corbis"

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:

"© www.danheller.com"

Children Pulling Shirts (1)
(Luang Prabang, Laos)

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

Work on Self-Portraits
(Amsterdam, Netherlands)

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.)

Photographing a White Pelican
(Mykonos, Greece)

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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