Topic: Business Formation
Time Investment: 20 minutes
Suggested Product: BizRevamp®
You’ve got mad skills with your camera and you’re ready to start your own photography business.
How hard can it be? Just start charging a fee for pictures right? Not so fast.
The formation of a business has liability and tax consequences that continue for years to come. It pays to be thoughtful about your business structure from the outset to prevent unnecessary cost and headaches. While the specifics will vary from state to state, there are some generalities that you can consider.
If you simply start charging customers for your work (not recommended!), your loosely formed business structure will likely default to that of a sole proprietor or partnership. Did you know that owners of sole proprietorships and partnerships remain fully liable for the debts and obligations of their businesses? On the other hand, those who own corporations are not personally responsible for business debts. Many small businesses shy away from the corporation form because setting up a corporation can be a bit complicated, is generally more costly, and requires a number of ongoing formalities.
Evaluating Your Options
The sole proprietorship business form is too small and the corporation business form is too big. Like Goldilocks, you need to find a company form that is “just right.” Fortunately, there’s another option. Enter, the Limited Liability Company, or more commonly known as LLC.
The LLC business form provides a flexible compromise between a general business form like the sole proprietorship and the corporation business form. An LLC can be comprised of a single individual, a partnership, multiple individuals, or a corporation.
In addition to the limited liability and the flexible tax options, the LLC is an attractive option to many business owners because it usually doesn’t need to comply with many of the legal formalities that govern corporations such as annual reports, director meetings, and shareholder requirements.
For these reasons and more, it’s one of the most widely used business forms for small businesses.
Benefits of an LLC
The primary benefit of an LLC business structure is that the owner(s) enjoy the same personal protection from responsibility for business debts as owners of incorporated businesses. Forming an LLC takes about the same effort and cost as properly setting up a sole proprietorship or partnership, yet provides owners with the same level of protection as a corporate business structure.
To create your LLC, file articles of organization with the state and pay filing fees. When an LLC is formed, the owners should adopt rules, bylaws, and operating agreements.
LLCs have to follow most of the business requirements for a corporation including maintaining business accounts separate from personal accounts, and keeping up with record-keeping and appropriate licensing. State laws lay out record-keeping and licensing requirements (and those pesky fees!). The requirements must continue to be met for the LLC members to maintain limited liability. If you fail to maintain all of these requirements, creditors may be able to reach your assets to satisfy business debt and liabilities – this is known as “piercing the corporate [or LLC] veil”.
The liability limit of LLCs provides a significant incentive for individuals in partnerships or sole proprietorships. With limited liability, in the off chance your photography LLC goes bankrupt, creditors would be limited to the business assets instead of your personal assets. With an LLC in place, a lawsuit or other financial liability may clean out your business assets, but your family home should be safe. This protection can be lost, though, if the business owners act irresponsibly, illegally, or unethically in certain cases that must be proved in a court of law or an out-of-court settlement.
For many businesses, especially small businesses, the benefits and flexibility make it a better choice than other business forms.
Death and Taxes
One of the greatest advantages of the LLC business form is that they can elect how they will be taxed. The default taxation for an LLC depends on how it’s structured. Most of the time, the base group form decides the default taxation. In other words, if an individual forms an LLC, it’s taxed as a sole proprietorship. If a partnership forms an LLC, it’s taxed as a partnership. For our purposes, let’s assume it’s just you and your camera so you are the sole member of your new LLC. As a sole member LLC, you can decide whether it’s better for you to follow the IRS default and file your photography business taxes as a “disregarded entity” or elect to be taxed as a corporation. A disregarded entity means that the business is treated like a sole proprietorship for tax reporting purposes and income is passed through to the individual tax return on Schedule C. If you choose corporate taxation, your photography business will be taxed at a lower corporate rate for the first $75,000 of income.
Another tax advantage of the LLC form is that it allows you to set up both retirement funds and life insurance policies with greater contribution limits so you can set aside money for your future and your family.
Whether your business is taxed as a sole proprietorship or you elect to have your photography LLC taxed as a corporation, both of these approaches can have big tax advantages, depending on how much income you personally want to take and how much you plan to reinvest in your blossoming photography business.
You may realize even more tax benefits by paying yourself from your LLC by paycheck. By setting up the LLC taxed as a corporation, you may then pay yourself from the company through payroll and avoid self-employment taxes. The company will still be responsible for a portion of the tax bill, so you will want to make sure your LLC budgets for that payment each reporting period.
Because everyone’s situation is unique, you should consult with a CPA or other tax professional to drill down into your financials so you really understand which option is best for you.
No matter how you elect to tax your photography business, don’t forget that business expenses can be deducted. Most importantly, you can deduct the cost of forming your LLC. Make it a habit to hang on to all your receipts and invest in a scanner to organize them electronically (keep the receipt for your scanner purchase too!).
Are family and friends telling you to create your LLC in Delaware or Nevada?
Delaware and Nevada are hot states for incorporation and you might be tempted to consider creating your LLC in one of these states, especially if you are electing to be taxed as a corporation. After all, Delaware offers some of the most developed, flexible and pro-business statutes in the country, and Nevada has become a popular choice due to its low filing fees and the lack of state corporate income, franchise and personal income taxes. However, these benefits are more advantageous to larger companies. Since your photography business is a sole member LLC, incorporate in the state where your business has a physical presence. Otherwise, you’ll be dealing with too many hassles and fees for operating out-of-state, including difficulty opening a business bank account, appointing a mandatory registered agent in the state of incorporation, and fees for operating as a ‘foreign entity’ in your own state.
Ready to start (or fix up) your photography business?
You’ve already mastered the art of the perfect photo. That’s the hardest part. Now you’re ready to set up your photography business for success by establishing it as an LLC.
Now, what are you waiting for?