How to Set Up Your Company to Minimize Taxes: Business Organization Basics

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1 How to Set Up Your Company to Minimize Taxes: Business Organization Basics You want to keep a close eye on everything that impacts the financial side of business. After all, finances determine whether or not you can continue in the career you love! Choosing the correct business entity type can have an enormous impact on the amount and type of taxes you pay, as well as other legal and financial ramifications. Yes, you may already be operating your photography business. However, you may still benefit from changing to a different business structure. Your tax and legal advisors can help you make the best decision, based upon your financial situation, the size and type of business you are starting, as well as other financial and legal factors. But to help you better understand the possibilities, we have defined some of the business types photographers could have. We ll give you a brief description, as well as the advantages and disadvantages of each type. 1. Sole Proprietorship 2. Partnership 3. C Corporation 4. S Corporation 5. Limited Liability Company (LLC) Sole Proprietorship A sole proprietorship does not require the filing of any special organizational paperwork. It simply comes into existence the moment that you decide to be in business as a photographer. Please note that you may have to file paperwork with your state or local government for business licenses check the requirements for doing business in your area! For tax and legal purposes, the business and the owner of a sole proprietorship are one and the same. This means that all business profits and losses are reported on your personal tax returns. No corporate income taxes. You re taxed at the individual tax rate (10-35%). Minimal legal startup costs and formal business requirements. You can write off losses against other income on Federal and State taxes.

2 Disadvantages No liability protection from business debts or legal judgments incurred by the business. There is no legal separation between the business and your personal assets. The owner is subject to self-employment taxes on taxable earnings (15% on every dollar you make). Partnerships A partnership operates similarly to a sole proprietorship, except there are at least two business owners (like two photographers, who are not married, deciding to open a studio together). In this business set-up, each partner is equally liable for all business debts and any legal liabilities that the business generates. Each partner pays taxes on his or her share of the business revenue, which is reported on that partner s personal income taxes. Each partner is required to file a Form 1065 on their separate tax return. And although no paperwork needs to be filed with the state to establish a partnership, it is prudent to draw up a partnership agreement outlining each partner s roles, responsibilities, etc. Better safe than sorry! There are no true advantages to a partnership in a photography business, and in most cases, a different type of business organization is recommended for studios. Corporations Establishing a corporation requires filing special paperwork with the state in which the business is organized. There are specific legal and accounting requirements for operating a corporation. A corporation is considered to be a separate entity for legal and tax purposes. In other words, the corporation stands apart from the shareholders and has equal standing in a court of law. The prime advantage for all corporations is that there is a legal separation between company and personal assets. There are two types of corporations. S Corporation An S corporation (or S Corp) is a corporation that has elected "S Corporation" federal tax status. The term S Corporation is actually named after Subchapter S of Chapter 1 of the Internal Revenue Code. This type of structure is recommended most often by PPA s Studio Management Services.

3 An S corporation provides limited liability for its shareholders. The S corporation does not pay any income taxes but is required to file an informational tax return. Most states don t (although some do) impose taxes on an S corporation; they tax the individual shareholder(s) through the personal income tax process. Losses generated by the business are passed to the shareholders, who are generally able to use them to offset other personal income. You don t have to pay Social Security on part of your earnings. Disadvantages S corporations have specific recordkeeping and reporting requirements. There are legal and filing costs associated with establishing and maintaining an S corporation. The IRS pays close attention to the salaries of the shareholder-employees, including reasonable compensation requirements. C Corporation This corporation type is named after Subchapter C of the Internal Revenue Code. Corporations operating under this designation are taxed separately from shareholders. Shareholders pay only regular personal income tax on the portion of the business revenues that they take as salary, bonuses, etc. This income is reported on their personal income tax forms as regular income. Studio Management Services does not recommend a C Corporation business organization for their studio clients. A C corporation may become a public corporation and sell its shares through the stock market or over the counter. There is no limit on the number of shareholders, and there are no citizenship or residency restrictions. C corporations are permitted to carry corporate losses forward to future tax years.

4 Disadvantages Distribution of dividends can lead to double taxation (both your business and you yourself can be taxed). Recordkeeping and reporting requirements are stringent. Limited Liability Company (LLC) An LLC offers some advantages of a corporation, as well as some advantages of a sole proprietorship. However, establishing an LLC does require the filing of legal paperwork with the state in which the business is organized. A single member LLC, which includes married couples (they are considered one shareholder, due to related party rules), does not file federal income tax. However, if there is more than one member, the LLC may be required to file IRS Form 1065, an informational return, annually. Disadvantages LLCs are often easier and cheaper to set up than an S Corp. LLCs provide corporation-style limited liability protection for members (like you, the photographer/owner). There is a legal separation between company and personal assets. There are no stringent recordkeeping requirements. LLC members do not have to participate equally in the distribution of income from the business. The members are taxed at the individual tax rates (10-35%). Individual member earnings may be subject to self-employment tax (15% on every dollar earned). LLC treatment laws vary among states. A business operating in multiple states may encounter inconsistent tax treatment. For photographers, an LLC may be a good choice in situations when: The existing business has net profits over $250,000 per year. The photographer is establishing a new business, but has already accumulated substantial personal assets. There is a need for a multiple-partner entity (other than married couples).

5 Where to Go for More Information After reading about the pros and cons of the different business entities, do you feel your studio/business organizational set-up is right for you? Even if you are already operating your photography business, you may benefit from changing to a different business structure. Remember, though, that while this article highlights common business entity types, it should not be substituted for professional legal and accounting advice. Your tax and legal advisors can help you make the best decision, based upon your financial situation, the size and type of business you are starting, as well as other financial and legal factors. Steps You Can Take Right Now to determine your optimum business organizational structure: Talk to your CPA, if you have one, about your current organizational structure and whether or not there are advantages in changing to a different type. (If you don t have a CPA, we suggest getting recommendations from people you trust in your local community.) Listen to Scott Kurkian, Chief Financial Officer of PPA, as he explains income tax strategies in terms to which photographers can relate in the PPAedu video, How to Set Up Your Company to Minimize Taxes.