Many small business owners, professional photographers included, have questions about the recent tax reforms and what benefits they will see when filing returns this April. Alas, we have to wait until next year to collect on those benefits, but now is the time for self-employed photographers to ensure you’ve established the right business structure to reap the most rewards at tax time. Here’s a look at five of the most popular business structures and the financial and legal benefits they provide, along with some expert insights on how new tax rules will help them or hurt them. Disclaimer: We’re not offering specific advice here and you should always consult your own accountant and legal counsel about your situation.
By default, an independent freelance photographer is the sole proprietor of the business. The moment the photographer goes out to take pictures and collect pay, they’ve started a business of which they are the owner and sole proprietor. All business income in this setup is paid directly to the sole proprietor and reported on federal income taxes as personal income, which makes this setup—known as a “pass through”—simple and straightforward. Unfortunately the sole proprietor is also personally liable for any damages his or her business may cause, or debts it may accrue, putting personal assets at risk.
A partnership is a lot like a sole proprietorship except that two or more people share the responsibility of ownership—meaning they share in the profit or loss of the business as well. A partnership must file an information return every year in order to report its income, but the profit—along with the tax burden—is passed through to the partner owners who report the income (or loss) on their tax returns.
Limited Liability Company
A limited liability company (LLC) can offer some tax benefits, but it’s the legal protections of a big business (the “limited liability” part) that typically make it most appealing to small business owners. The main reason to form an LLC is so that the photographer’s personal assets are protected should he in the course of business damage someone or their property, for instance, or rack up unfortunate business debt. A sole proprietor might risk losing his home, for instance, should a client sue, whereas a photographer who has established his business as an LLC is protected against such personal liability. The business structure is simple, as well, which is appealing to those who want to avoid the record keeping required in corporations. The downside of an LLC is that it doesn’t inherently provide specific tax benefits over a sole proprietorship. Instead, LLC owners (technically they’re called “members”) can file as a sole proprietorship, a corporation or a partnership, depending on factors such as how many employees the business has and how much income it brings in. This varies from state to state. It is often beneficial, according to the experts we spoke with, to structure a small business as an LLC that files taxes as an S corporation. More on that in a moment.
A standard corporation, also called a C corporation or “C corp,”, is usually for businesses with multiple employees, so it may not be ideal for professional photographers. A C corporation is owned by shareholders (C corporations can sell stock) and considered its own legal entity, so it offers both limited liability to those shareholders as well as tax benefits. The corporation pays taxes on its income, then the corporation’s owners pay taxes on any profits paid to them on their individual tax returns. Accountants tend to think of this as a “double tax” situation since the same dollars are taxed twice—once as corporate profit and again as personal income by the shareholders.
“In general,” says CPA Michael E Williams, a partner at Schulman Lobel in New York, “a small company making less than $90,000 in profits (after paying a fair salary to the owner) may be better off as anything but a C corporation. While there has been a lot written about the lower corporate tax rate, the benefits of such do not take effect until there is approximately $90,000 in taxable profits, when compared to the prior law.”
“If one earns under $157,500 (or $315,000 for a married couple) in taxable income,” Williams adds, “I have seen that the ‘schedule C’ may end up with a better result than an S Corporation [see below]. But for legal reasons one may want to consider the single member LLC as a structure. A single member LLC owned by an individual will report its income and expenses on a schedule C form. The owner of such a company may be able take a special deduction equal to 20% of their profits.”
An S corporation (named for subchapter S of chapter 1 of the Internal Revenue Code) also protects owners with limited liability, but mostly an S corp is notable for not paying taxes on income, which is instead passed through to the business’s owners who must report that income on personal income tax returns. Another benefit is that only employee wages of shareholders are subject to employment tax and many other employee-related expenses can be written off at tax time. The business must register as an S corporation in the state in which it is headquartered.
According to Mario Costanz, founder of tax prep franchise Happy Tax, small business owners such as photographers will see benefits from new tax rules if their businesses are structured as sole proprietorships, partnerships, LLCs or S corporations and make less than $157,000 (or $315,000 if married) per year.
“They get to have their cake and eat it too,” Costanz says. “First, small businesses can instantly reduce their taxable income by one-fifth, subject to a minor exemption for high-earning service-based firms like law firms and private medical practices. So if your business earns $100,000 in income during the 2018 tax year, you’ll most likely only have to pay taxes on $80,000 of it. That leaves you with an extra $20,000 to buy new equipment, hire new workers or kick off a marketing campaign.”
“Wait,” Costanz adds. “It gets better. After taking the 20% tax deduction, qualifying small business owners will be charged a much lower tax rate than they had seen in previous years. The corporate tax rate was once nearly as high as the tax rate applied to the highest-earning individuals: a lofty 35%. Now, corporations pay only 21% in federal taxes. This across-the-board tax break mostly benefits larger corporations, with the idea that favorable U.S. tax policy will attract more investment from overseas. However, if you currently operate your business as a partnership, a sole proprietorship, or a single-member LLC, you are not eligible for this lower tax rate. You may want to consider reorganizing as an S-corporation to be eligible for both the generous 20% business income tax deduction and the rock-bottom 21% corporate tax rate created by the new law. Be sure to discuss your decision with a Certified Public Accountant or attorney before you make any big moves.”
Jeff White, a financial and legal analyst for FitSmallBusiness.com, says that in general most small businesses will benefit from the tax changes, but the biggest benefits will go to large corporations that don’t use a “pass through” structure.
“Small businesses that use a pass-through entity (like a sole proprietorship, partnership, or default LLC) will be taxed according to the new individual tax rates, which were lowered,” White says, “but not nearly as much as the corporation rate. These pass-through entities also get a 20% deduction on their individual tax return if they have business income passing through to that return.”
“Most accountants tend to recommend businesses be taxed as a pass-through entity to avoid 'double taxation',” White adds. “Meaning: in a corporation tax structure, you're taxed once for the business and taxed again on everything you receive financially from the business. They are separate taxes, so the money that was originally taxed within the corporation is then technically taxed again when you receive the benefit.”
“So what type of entity should you use with the new tax structure?” he says. “It depends on how much money your business brings in. You'll need to calculate your income as a pass-through entity depending on the new tax bracket you fall into with a 20% deduction. Then you would need to calculate your straight 21% tax rate as an S-Corp (which LLCs can be taxed as). If your business brings in a significant amount of income (more than $157,000 if taxed as an individual or $315,000 if taxed as a married person), then you'll likely benefit the most from using an LLC taxed as an S-Corp. Anything under that threshold should be taxed at a flat 20% rate of your qualified business income (which is just your net income without regard to reasonable compensation).”
“I don’t give legal advice,” White adds as a reminder. “This is just an opinion. But if you're consistently above that number ($157,000) then you'll probably want to be taxed as an S corp. If you're below that number consistently then you'll be fine as a pass-through entity. If you fluctuate from year to year and could be either above or below the limit, then you should stick with the pass-through entity because even if you technically get more income one year, the extra savings would be limited at those levels.”
Read more from financial analyst Jeff White at fitsmallbusiness.com. For information about Mario Costanz and his company, Happy Tax, visit gethappytax.com. CPA Michael E. Williams may be reached at his firm’s website, schulmanlobel.com.
About the author:
William Sawalich made his first darkroom print at age ten. He earned a Master's Degree from The Brooks Institute of Photography in Santa Barbara, California. Along with portraiture, still life and assignment photography, Sawalich is an avid writer. He has written hundreds of equipment reviews, how-to articles and profiles of world-class photographers. He heads up the photo department at Barlow Productions in St. Louis.