Taxes can be a pretty polarizing topic, but if there’s one thing everyone can agree on, it’s that the recent tax bill, signed into law in the waning days of 2017, is long. Like, 1,100 pages long.
It’s also confusing.
“The original idea was that this was going to simplify everything so you could file your taxes with a postcard,” says accountant Iryna Stepanchuk. “That’s not happening. Even
accountants are confused.”
The precise impact of the 2017 tax bill will hinge on the unique circumstances of your personal and business finances, Stepanchuk notes, but there are some general changes that every small business owner should be aware of.
Sole Proprietors, LLCs & S Corps Get a Tax Cut
If you operate your photography business as a sole proprietor, Limited Liability Corp. (LLC) or an S Corp (what the IRS collectively considers “pass-through entities”), you will automatically be entitled to a 20 percent reduction in your gross income, provided it was all earned in the United States.
As photographer and accountant Brandon Scott explains in math that even we can understand, if your photo business earns $100,000 in 2018, you will only be taxed as if you earned $80,000. This is before you take any business and personal deductions too, so your taxable income is likely going to be a lot lower than that hypothetical $80,000.
Do note, though, that your ability to enjoy the 20 percent pass-through tax cut only applies to income levels below $207,500 if you’re single or $415,000 if you’re married.
Sole proprietor and LLC income is treated by the IRS as personal income, so photographers who operate their businesses under either of these frameworks will also mostly benefit from the tax bill’s lower tax brackets and higher deductions. (Keep in mind that these cuts will sunset in 2025—they’re not permanent.) The so-called “standard” deduction, which is a blanket write-off of your federal income taxes, no receipts required, has essentially been doubled. Single filers can claim a $6,350 deduction, while married joint filers can deduct $12,700, according to accountant Amy Northard.
That’s the good news. The bad news is that itemized deductions, which include things like mortgage interest, property tax and state and local taxes, have been capped at $10,000. If you live in a state with fairly high taxes (NJ, NY and CA, we’re looking at you), your ability to offset those taxes with itemized deductions will be sharply limited in the new tax bill. Plus, you can no longer write off interest on a home equity line of credit unless you can prove the loan was used to start a business or pay business expenses, Stepanchuk says.
Since you can only select one—itemized or standard—it may make sense for residents in high tax states to take the standard deduction, Scott says.
Also gone are personal exemptions, which filers could take for spouses and dependents and could total up to $4,000 per person. The child tax credit, however, has been doubled to $2,000 and the income level for claiming the credit has been raised.
The tax code quickly gets more complicated if, in addition to the income you’re earning as a photographer, you or a spouse earn additional income through a day job (i.e. you have a W-2) and you pay employees in your photo business W-2 wages, Stepanchuk says. In that case, if your income reaches $207,500 for single filers or $415,000 for married joint filers, your pass-through deduction is subject to a fairly complicated formula.
Here, via Stepanchuk, are two examples to show you how it works, the first with a couple falling below the income threshold, the second with a couple that exceeds it:
A married taxpayer has a sole proprietorship with $100,000 in net business income, while the spouse has $34,000 in W-2 wages from a part-time job. They are taking their standard deduction of $24,000 ($12k per individual), which lowers their taxable income to $110,000. Their pass- through deduction is $20,000 and is derived by taking the lesser of these two numbers: 20 percent of net income ($100,000 x 20 percent = $20,000) vs. 20 percent of their taxable income ($110,000 x 20 percent = $22,000).
A married taxpayer has a sole proprietorship that makes $1,000,000 in net income (whoo-hoo!) and a spouse with $50,000 in W-2 wages from a W-2 job. They are taking $60,000 in itemized deductions. Additionally, the business has $250,000 in W-2 wages paid to employees and $100,000 in assets. Because the taxpayers are above the $415,000 threshold, their business deduction will be $125,000. Here’s how it’s calculated (buckle up). First, take the lesser of these two numbers: 20 percent of net business income ($1,000,000 x 20 percent = $200,000) vs. 20 percent of taxable income ($990,000 x 20 percent = $198,000). Then, compare it to the greater of these two figures: 50 percent of W-2 wages ($250,000 x 50 percent = $125,000) vs. 25 percent of W-2 wages plus 2.5 percent of unadjusted cost basis of assets ($250,000 x 25 percent + $100,000 x 2.5 percent = $65,000). Finally, take the lower number of that comparison, and that’s your deduction.
Alternatively, hire an accountant.
LLC vs. S Corp
Both LLCs and S Corps will benefit from the 20 percent tax cut, but there are important differences between the two legal entities. While any income you earn as an LLC is passed directly to you (and taxed accordingly), S Corps are more complicated, but also generate higher tax savings, says photographer and accountant Jessica Watson.
Owners in an S Corp have to pay themselves a “reasonable salary” from their business earnings. You’ll need to work with a tax attorney or accountant to determine your specific reasonable salary, but operating under an S Corp can lower the amount of self-employment taxes you’re required to pay. That’s because, in addition to your “reasonable salary,” Scott says, you can also pay yourself dividends from the business (i.e. excess money over and above your reasonable salary) that are taxed at a lower rate.
Watson says if photographers are earning over $50,000 a year from their business, they should consider organizing as an S Corp. “It’s no longer a simple schedule C, it’s more convoluted,” she concedes, but the tax benefits outlined above make it an attractive option. You can change your business structure from an LLC to an S Corp to enjoy these extra benefits, though you cannot change from an S Corp to an LLC, a switch that Watson says wouldn’t make financial sense anyway.
Creating an S Corp is complicated and requires a lawyer to draft the documents. That’s why Scott advises forming an LLC but filing your taxes as an S Corp (which, as odd as it sounds, is allowed in the U.S. tax code). This “let’s you enjoy the ease and simplicity of an LLC, but also lets you enjoy the lower overall tax situation of the S Corp’s ability to split the income into wages and dividends,” Scott says.
Some Business Deductions Are Also Changing
While the 20 percent pass-through write-off is likely going to cheered, the changes to business expense write-offs are a bit more of a mixed bag.
On the plus side, Scott tells us that you’ll recoup more for miles driven. Under the old tax regime, you could be reimbursed 53.5 cents for every mile you drove for business purposes. Under the new tax bill, that amount is now 54.5 cents.
Businesses are also now allowed to deduct 100 percent of the cost of their equipment. “Prior to this, the new camera you bought needed to be depreciated over five years,” Scott explains. “Now you can write off 100 percent of its cost in year one.”
Starting in 2018, you’ll no longer pay a tax penalty for not having health insurance if you opt not to insure yourself.
Deductions for entertaining expenses are being repealed, Watson says. You can still deduct 50 percent of business-related meals, so you can still deduct that client coffee from your taxable income, but you can’t take them out to a show, shooting range, or whatever it is people do for fun these days, and expect Uncle Sam to offset your tab.
Iryna Stepanchuk is a CPA and founder of Stepanchuk, CPA, a New York-based accounting firm.
Brandon Scott is a wedding photographer and CPA based in Monterey, California.
Amy Northard is an Indiana-based accountant serving the creative industry.
Jessica Watson is a wedding and portrait photographer, and the accountant/founder of JMW Financials, based in Lehigh Valley, Pennsylvania.