Saturday, April 19, 2008

Blah blah blah Business!!

We had our latest PUG meeting on Wednesday and Eric Foley led an awesome session called "Can we do this forever?" that was all about what it really means to stay in a photography business for the long haul and how much harder we all have to work to plan for the future than people in more traditional employment jobs do. Which really got me thinking about how very little is put out there about the nuts & bolts of actually running a business. I'm not even talking about things like word of mouth marketing or branding because I feel like there is a lot of sharing going on with things like that, which is awesome!! But just all the no-fun-at-all, gotta do it, hate to do it, super unglamorous sides to running a business. Like tax planning. YUM! Incorporation. super hot. And bookkeeping. And well c'mon it just doesn't get any hotter than bookkeeping! So like I said at the meeting, I think we all work really hard to share things about the latest trends, cool new actions, camera settings...and we should be working just as hard to share information that could help (maybe someday save?) someone else's business. So in an effort to get that ball rolling, I just wanted to share a couple things that we've learned for our business over the past couple years that might help somebody else out there.

If you've been around Justin or me in the past couple weeks, I'm sure you've heard about our ginormous tax bill. Yea, Uncle Sam as the schoolyard bully who pushes us down and takes our lunch money kinda big. :) See the funny thing is, we had been of course hoping & praying for our business to just explode this year...but we hadn't been doing anything to plan for that actually happening! Which reminds me of a story:

Two farmers desperately needed rain for their crops. So they both prayed about it. Then one of them went out into the field and began tilling up the soil. His bewildered wife asked him, "What on earth are you doing?" He replied simply, "I'm preparing for the rain."

So when that rain came down, guess which one was able reap the harvest. This is so true in life & business as well. We pray for God to rain down that abundance... but when He does, if we haven't prepared for it it can feel more like a flood. Which brings us back to tax planning! Of course you should go and get your own accountant because everyone's situation is different, but here are a few things to think about in the coming year to prepare for next year's taxes:

Mileage, Mileage, Mileage:
One of the best deductions out there. It's deceiving because it starts out so small, but it can really add up. For 2007, the deduction was 48.5 cents per business mile driven. This year it goes up to a whopping 50.5 cents per mile. So every two miles you drive for business, you get to take a dollar out of your gross income which translates to 10 to 35 cents off your final tax bill depending on your tax bracket. At the end of the year, this can take thousands off your gross income. A word to the wise, keep a detailed mileage log: where you were going, why, how far. This is good for two reasons: a) you can whip it out if Uncle Sam ever comes calling and b) if you keep track of it as you go you are far more likely to get in all those little trips you might otherwise forget about.

Retirement as a tax break!:
To Roth or not to Roth, that is the question. Back in Federal Income Taxation class in law school, I can fully remember the fabulous Professor Anne Alstott singing the praises of the Roth IRA, but I never really thought much about it until it was time to start my own IRA. To get started, I had to decide whether to make it a Roth IRA or a traditional IRA. Now at the time, there really wasn't much of a choice in the matter because I needed a big deduction to offset some summer earnings at a law firm, so we went with the traditional. Ok, so what's the difference? Tax exempt v. Tax deferred

Roth IRA: The money you invest in a Roth is still taxable in the year you invest it. So if you make $50,000 and you invest $5,000 in a Roth IRA your gross income remains $50,000. BUT when you withdraw the money you've invested (and it can be withdrawn at any time penalty free), any of that money you've put in plus all of the growth it has seen over the years can be collected totally tax free. It is really one of the sweetest deals out there for retirement. The Roth IRA is fully available to single people making up to $95,000 and married folks making up to $150,00 jointly (an example of the marriage penalties found throughout our tax system. If there are two people you would think it would be 2x 95,000 right? Not so.) So although you are taxed on the money going into the Roth, you are free from the tax on the money coming back out (which should be dramatically larger if invested wisely) thus making it tax exempt.

Traditional IRA: investments made now are 100% deductible for the tax year in which you make them up to $5,000 for single people, $10,00 for married people (no marriage penalty here). So if you make $50,000 but you contribute the maximum $5,000 into your traditional IRA then your AGI (adjusted gross income) goes down to $45,000 right off the bat. However, you can not withdraw any of this money before age 59 1/2 without big penalties, and it plus any growth it has earned will be fully taxable at the time you withdraw it. Tax deferred

So what's the deal? If you need a big tax deduction right now, traditional is the way to go. But for long term retirement planning, Roth is usually the winner. This will all depend on what you anticipate your tax bracket to be at retirement v. your tax bracket now. If you intend to be wealthy in your golden years, the Roth is your way to go.

Home Office, blah blah blah:
I feel like most people know about this one so I won't go on too much about it. Suffice it to say, you can deduct the percentage of your mortgage/rent, utilities, etc that correspond to the percentage of your home that your business office takes up. For us it was 33%. So we could take one third of our rent, electric, etc. as a deduction. Be careful with this one, I've been told that if an IRS agent came into your home and found anything personal mixed in with the "office" space (lol, Office Space!) they would void the deduction.

LLC v. S Corp
There is a LOT of talk lately about going LLC v. S Corp for your incorporation. First off, why should we incorporate at all? Because it protects your personal assets in the event that your business is ever sued. It basically sets up what is called in Business Law world a "corporate veil" between you the person and you the business. So what are the differences between an LLC and an S Corp? Both offer liability protection. Both offer pass through taxation (members of traditional corporations have to pay tax twice: once as a corporation, once on their own income). But with an S Corp or an LLC you only have to pay tax once, as a sole proprietor would. The real differences between the two are a) flexibility and b) self-employment tax savings. ( I soo should've remembered all of this from taking Biz Orgs at Yale, but actually most of this comes from doing Google searches. Yea that would've been the cheaper way to go.)

LLC: Super flexible in every way. You can set up how profits will be distributed. No formal requirements such as board members, issuing stocks, annual meetings, minutes, etc. And the members can decide any way they want to split profits. But , there is no self-employment tax protection.

S Corp: Much more formal. Requires annual meetings, minutes, the issuance of stock, etc. More restrictions on how profits are split. But it does offer substantial savings on self-employment tax.

As business owners, we are subject to a hefty 15.3% self-employment tax (note that this is on TOP of your federal and state income tax, although 50% of it can be deducted for income tax purposes) that goes toward social security and medicare. More traditional employees split this tax with their employers. For us, this amounted to more than half of our tax bill. The S-Corp, however, offers self-employment tax savings. Here's how it works: only an employee-owner's salary is taxed for self-employment tax purposes. Any other income they receive from the company is deemed a "distribution" from owning stock in the company and is not taxed as self-employment. Ex: Your S Corp makes $90,000. You deem $50,000 to be a fair market price*** for a principal photographer and pay yourself that income. You have self-employment tax of $7,650 ($50,000 x 15.3%) on that amount. The other $40,000 is not taxed for self-employment purposes because it is deemed a distribution. Under an LLC you would have self-employment tax on the whole amount of $90,000 equaling $13,770 ($90,000 x 15.3%). So the S Corp would offer you a tax savings of $6120. However, coming back to its super-formal roots, the S Corp then requires you to set up your tax payments as monthly payroll taxes instead of a one time April 15th self-employment tax payment.

***Note that you MUST set a salary for yourself that is a fair market value or the IRS will eat you alive! So don't try to pay yourself $1 and call $89,999 a distribution.

So what's the deal? Hire a tax professional if you want to get into this murky water, but the tax savings could definitely make it worth it. There is also a third option to be an LLC filing as an S Corp which we are currently looking more into. Ideally it would offer you all the flexibility of the LLC and the self-employment tax savings of an S Corp. We'll see.

Hope this helps somebody out there! Sure beats putting pennies in a jar. :)

Feel free to email if you have any questions!


JAG Studios said...

thank you.

Jacob Bergmeier said...

Wow... that is really invaluable information! Thank you for posting. Every dime helps with the cost of oil soaring.

Rnormfoto said...

a note about the home office thing---my tax lady has warned me for years NOT to claim home office UNLESS you can show that your office is a 'detached' building or the like. The IRS looks for certain deductions that send up red flags for an audit, and that is one of them. She teaches tax law at Fairfield University.
Everyone probably knows this already, but save all your receipts from everything ( office supplies, studio supplies, photo books you buy, travel expenses, cell phone, home phone, gas receipts, etc) I keep them in categorized envelopes through the year so it's easier to separate and account for at tax time.
I am bad however, in that I am just Little Old Me, and am NOT an LLC. I also opened a SEP account for 'retirement' but seem to never put anything in it, which is why I will be looking to move into someone from PUG's house when I can't shoot anymore :)

Blink of an Eye Photography said...

Hey guys,
I too have been told by our tax guy & attorney not to claim my home office because of capital gains when selling our home. I have not researched what that means exactly but I have filed an extension and am checking into it.

Krista Photography said...

That's super helpful Mary! Thanks for sharing!!

Another tip, which seems super obvious, but isn't necessarily. USE QUICKBOOKS or something similar to track every dime coming in and out of your business!! If you don't know what you're spending - a) you can't deduct it, and b) you really don't know what you should be charging. Shocking how few photogs actually track their $$... I'm so thankful I learned this skill EARLY (and often). :)

David B. Hoffman said...

Thank you for this info. I'm doing a little business planning this week and every little bit helps. -D

Studio Foto said...

I know we spoke about this on the phone for almost an hour and I was still..."LLC is good enough" Thank you for writing it out, it the best explanation I have ever read or been told. AWESOME! I am going to ask our accountant about filling as an S-corp for 08 if not 07.


Studio Foto said...

I have heard that also Robert. The "home office must be legitimate and has to be a way to "close" it from the house and NO estimating on the square footage:0)


Kenzie Shores Photography said...

wow, thanks guys for sharing this!

Eric Foley said...

Hey J&M, Thanks for the shout out, I had a great time too! Wow,this is allot of good information, I appreciate the time you spent posting and sharing! I've been thinking about switching to an LLC. Thanks for clearing it up for me!

See you at the next PUG Extravaganza!

Orchard Cove Photography said...

My head hurts from reading this stuff but it is GOOD information. The good news is I'm doing most of these things. The bad news is that I'm not doing all of them :) xo

Mary Marantz said...

Hey Guys! Thanks so much for all the awesome comments! All this is stuff can be so confusing & overwhelming so anything we can do to help we are happy to share!

A coupla things:

1) Yep, the home office deduction is traditionally thought of as a red flag for an audit, but supposedly it's more just like a "pink" flag. The people who usually have problems with this are employees of another company who opt to work at home. But usually if you are

a) self-employed
b) using your home office as your principal place of business
c) using your office area exclusively for business use and
d) do not have another location to conduct business

you should be pretty safe taking the deduction.

2) Carmen that is a really excellent point! First let me explain the capital gains rate for anyone who doesn't know. One of the most interesting things about the tax code is all the social policy underlying it. Somewhere along the line, policy makers decided to give preferential treatment to certain types of assets that were held for over a year before being sold. Now usually the income from that sale would be taxed in your normal tax bracket. Since most people who own these types of assets are in the higher tax brackets, they pushed to get a tax break on them. Hence the capital gains rate, which for next couple of years is set at a much more preferable 15% (most people who hold these assets would be in the 25% tax bracket or higher).

Now Carmen, what your accountant was talking about was an exception to even this preferential rate for people who have:
a) lived in their home for 2 of the past 5 years and
b) are making 250,000 or less for single people and 500,000 or less for married people in proceeds from the sale of the home.

If you meet both of those criteria, you are eligible to sell your home exempt from the capital gains rate. It reflects a social policy that favors home ownership and the buying & selling that accompanies it. But, if you take this exemption then you would have to pay back all of the home office deductions you had taken, which could amount to a hefty tax bill. So the home office deduction is probably best for people who are renting and who meet the criteria I talked about above.

Robert J. Trenske said...

Hey Justin & Mary, you guys rock. Thank you for sharing all of your knowledge on this. Much appreciated!!

Kenzie Shores Photography said...

Hey guys!!! By the way, I've tagged YOU!!! :) enjoy :)

Tina Parsadanov said...

Thanks so much for posting this info! It's Very informative and helpful especially this time of year when we are all sort of "starting fresh". Since we were talking about retirement, I also wanted to mention that ING just started offering 401K plans which is another money saving avenue that us 'self-employed' people miss out on. Just wanted to throw that out.

Vanessa said...

Thanks guys, that was great info! Even though I'm not a photographer, I am an independent contractor, and most all of that applies to my job as well! You hit the nail on the head!

Oh also my experience about the home office thing... My tax preparer (my MIL) said that if you RENT you're golden with deducting your home office space... But that space HAS to be used for business only... (or at least you have to make it appear as such if the feds come calling)... But if you OWN it's a much bigger deal and it sends more red flags when you start deducting business space depreciation etc... that's when the Feds start taking a closer look.

She's not a CPA or anything, just a Tax Prep for H&R Block, and I know she's certified to represent people in a government audit... but that was her opinion on it.

Vanessa said...
This comment has been removed by the author.
Daniel said...

Good info here, but one addition:

When it comes to retiring, a ROTH is unlikely to be enough, in and of itself, to support you. If you start at 22, and put in the cap of $5k per year, you are talking about a principal investment of about $200k over a career (assuming a retirement at 62). Even with big gains, you WILL need something else.

Really what I am saying is that you want to DO BOTH the ROTH and the traditional IRA. Which is both near term and long term tax planning, AND long term financial security/planning.