Tax deductions?

[cyrus]

Just curious - how many US-taxpayers here who do photography as a "side business" in addition to their regular day jobs have been deducting their photography-related expenses from their income taxes? I am just now acquiring the most expensive bits of my LF gear for my new photography-related side business (a travel-related photography site). I have bought most of my 8x10 stuff this year, and have been travelling for my side business too. Considering how much income taxes I pay from my regular job, I am looking forward to deductions this year. Are there any special deductions you've encountered that I may miss or any other pointers? Problems with the IRS? Etc?

I'm really surprised at the number of people who don't realize how easy it is to go into a side business and deduct most of their Ebay purchases as business expenses. That's money that would have otherwise gone to Uncle Sam anyway, so it might as well go for a new lens, enlarger, business website etc.

Did I tell you how much I love the idea that Uncle Sam will pay for the Deardorff I bought this year for my side business?

[Brian Ellis]

Apart from anything else most of the things you mention purchasing (Deardorff camera, lenses, enlargers) are capital expenditures, not current expenses, and are depreciated over a period of time rather than being currently deducted, unless they're eligible for a special election under Section 179 of the Internal Revenue Code. IIRC used property (such as the Deardorff) isn't eligible for that election though I could be wrong, it's been a while since I looked at Section 179.

Second, in order to be able to even depreciate that type of property you have to be able to show that you're engaged in the business of photography and either earn a profit from it or be able to show that you have a reasonable expectation of earning a profit. In other words, you have to operate like a real business from which you can reasonably expect to earn a profit. And even then, if you use your new Deardorff or anything else for both personal and business purposes then you'll have to keep records showing the degree of business use vs personal use and only the portion of the cost allocable to business use will help you from a tax standpoint. Travel expenses have their own set of rules that I won't go into here.

And you should be aware of the fact that Schedule Cs (the form you'll probably use to report your income and expenses from this sideline) showing little or no income and big deductions, especially in areas such as photography that are susceptible of being enjoyed as hobbies, are one of the classic red flags that tend to generate IRS audits. So if you go this route make sure everything else on your return is squeaky clean because if you get audited the IRS isn't going to look only at your Schedule C, it will look at everything. And of course if you don't earn any income or if you generate only a little income relative to your deductions over a period of time you'll likely lose so then you'll get to pay not only the back taxes but also interest and penalties.

Even if you can show that you're engaged in a real business and even if you can show that all of your purchases were used 100% in that business you're wrong in saying that Uncle Sam will be paying for your new Deardorff (or anything else you buy). At the most Uncle Sam will pay the taxes you save by your deductions. Most likely that will be about 15% - 20% of the cost of things like your Deardorff. You'll likely still be paying about 80% - 85% of the cost even if everything else goes perfectly from a tax standpoint in your new side line. And if the Deardorff or other equipment, materials, supplies, etc. are used say 60% in your business and 40% for personal purposes then Uncle Sam will be paying a whopping 9% - 12% of the cost.

[BrianShaw]

I was partner in a small business throughout the 1980's. The business was so small that it was continually in threat of being considered a "hobby business" by the IRS. This was not the intention but it became a money pit due to reasons mostly beyond our control. Since we both had full-time jobs we didn't develop the business as much as we could have (should have). What Brian Ellis says is what I recall as being the story our accountant told. We showed financial loss most years but every third (I think) we needed to show profit otherwise IRS and/or the state revenue folks would shut us down. I had hopes of doing what I saw everyone else doing... buying an expensive car and plastering a magnetic sign on the side so it becomes a business deduction (read that "free car"). Accountant said we needed business income to have business deductions. He was right. My partner wrote off a room in his home as our corporate office. He was audited every year.

[darr]

If you are not operating as a true business IRS can easily determine that. First they will want to see your business occupational license and sales tax certificate. Do you file your local/state tax forms monthly or quarterly? You will need to show bank records for a business account, not a personal one. Legally you should not mix personal funds and business funds together, thus the separate accounts. Are you incorporated or operating as a d/b/a? If operating as a d/b/a there are papers to be registered with the state that shows that (even operating under your real name must be registered) and of course if your are incorporated that is a completely different set of papers and tax forms.

I have been self-employed in graphics related businesses (photography is part of it) since 1985 and have been through one IRS audit. Since my business was setup legally from the start and we still employ the same CPA, we had no problem with the audit; it just took a bit of time and lots of paper for them to examine.

I will give you my 2 cents: it better be a legit business (receipts, invoices, local/state tax records, etc.) or you will pay a price for either being stupid or uninformed. IRS doesn't care about your intelligence level, they just want their tax money. You must show a profit once in five years. IRS cannot penalize you for being a lousy businessman, but they will classify you as a "hobby business" as BrianShaw explained above if you do not meet any of the typical business criteria. My advice is for you to spend the time and money and get sound business advice from a CPA. I can recommend ours in Atlanta if you are interested.

[cyrus]

Apart from anything else most of the things you mention purchasing (Deardorff camera, lenses, enlargers) are capital expenditures, not current expenses,...it's been a while since I looked at Section 179. .

Thanks for the feedback!

Currently small businesses can deduct right off the bat up to $100,000 of capital expenses rather than depreciate it. However, apparently as of 2008, this falls to $25,000 -- which is still plenty enough.

Second, in order to be able to even depreciate that type of property you have to be able to show that you're engaged in the business of photography and either earn a profit from it or be able to show that you have a reasonable expectation of earning a profit. In other words, you have to operate like a real business from which you can reasonably expect to earn a profit. .

This shouldn't be a problem. First you needn't be "in the business of photography" per se - it is sufficient to be in A business (any business) that INVOLVES photography. Your photography expenses need only be a "usual and ordinary" part of the business expenses, but you don't have to be working AS A PHOTOGRAPHER per se. (in fact, working only as a photographer is probably a losing proposition - however there are lots of better businesses which require some photography - businesses that are potentially more lucrative.)

Second, starting a business with the reasonable expectation of earning a profit (that happens to require photography) isn't all that hard.

For example, if you operate a business which consists of a Web site about travel to China, which naturally requires obtaining photographs of China, then the expenses associated with obtaining those photographs are deductible because they're a usual and ordinary business expense. You can hire a photographer to get the photos - or you can go to China and take them yourself. If you also happen to actually ENJOY visting and photographing China, that doesnt' mean that its not a business! And there's a perfectly good reason to expect to make a profit from such a venture eventually - which is why millions of people start website businesses everyday.

And even then, if you use your new Deardorff or anything else for both personal and business purposes then you'll have to keep records showing the degree of business use vs personal use and only the portion of the cost allocable to business use will help you from a tax standpoint. Travel expenses have their own set of rules that I won't go into here.

Again, these aren't big hurdles. Keeping records is not so hard - a notepad with expenses/income is sufficient. Second, I don't use the 'dorff for taking family snapshots so the "personal use" of LF gear is naturally practically non-existent. Third, what constitutes "business use" depends on how broadly you define your business in the first place. So, if your business is "travel website" then the photos you take during your trip to China consititute business use and not personal use. And the travel expense deductions are quite generous.

And you should be aware of the fact that Schedule Cs (the form you'll probably use to report your income and expenses from this sideline) showing little or no income and big deductions, especially in areas such as photography that are susceptible of being enjoyed as hobbies, are one of the classic red flags that tend to generate IRS audits.

The IRS can audit me all they want. That's the beauty of it - I'm not scamming the system; I'm enjoying the benefits of the tax system just as it was MEANT TO BE used.

And of course if you don't earn any income or if you generate only a little income relative to your deductions over a period of time you'll likely lose so then you'll get to pay not only the back taxes but also interest and penalties.

One of the "rule of thumb" tests in determining whether you're engaged in a real business or merely a hobby is whether you make a profit at some time down the road (like in three years - no start up business is expected to make a profit the first year) however there is no absolute requirement that you make a profit OR ELSE you're punished and the IRS can demand back taxes. And remember, the three year test is simply a rule of thumb. It is not determinative.

ANd, making a profit isn't so hard because the biggest expenses are in the acquisition of gear, and after that your photography expenses fall drastically (after all, you only need to buy a 'dorff once. After that, your expenses consist of just film, developer, other consumables) But worst comes to worst, even if you do not actually manage to produce a profit though you really tried, then your business is just simply judged failure (as are millions of other small businesses) but you're not required to repay the IRS anything.

Even if you can show that you're engaged in a real business and even if you can show that all of your purchases were used 100% in that business you're wrong in saying that Uncle Sam will be paying for your new Deardorff (or anything else you buy). At the most Uncle Sam will pay the taxes you save by your deductions.

I didn't say that Uncle Sam would pay for ALL my LF gear - merely that he would pay for the cost of my 'dorrf - which is about 18% of my expenses.

[Brian Ellis]

"You must show a profit once in five years."

Actually that's not quite right, there's no fixed rules concerning the period over which you must earn a profit. As long as you're operating what's clearly a business you can lose money at it forever and deduct the losses (assuming you have other income of a type against which the losses can be offset, which gets into a whole new area way beyond the scope of this thread). For example, if you're an electrical contractor just to pick a simple example, and lose money every year you can still deduct the losses even though you never earn a profit because few people work as electricians for fun. The problem comes in with things like photography, horse racing, breeding, art, things like that, i.e. activities that many people, especially wealthy people, engage in because it's fun but try to claim they're in it for the money so that they can deduct the losses.

The only rules relating to fixed times and profits is the rule that if you make money for three out of five years then you are presumed to be running a business (2 out of 7 years for horse racing and a few other activities engaged in by wealthy people who had real good lobbyists at the time Congress was enacting these rules). Failing to make money in three out of five years doesn't mean you automatically are classified as a hobby rather than a business, it just means the burden will be on you to show that you're actually engaged in photography or whatever as a business.

This whole area is complicated and not susceptible of being throughly and accurately discussed here. For Cyrus or anyone else who contemplates treating their photography as a "side line" business, I'd strongly urge you to sit down with a tax lawyer or a CPA who specializes in taxes, outline your plan, and let them advise you as to whether what you're doing is likely to stand up from a tax standpoint and what you'll have to do to make it stand up. Among many other things, even if your losses are generally deductible, there are certain types of income against which those losses can't be deducted so you'll want to make sure you have the right kind of other income against which to deduct the losses or else the whole thing will be a waste of time.

[darr]

"You must show a profit once in five years."

Actually that's not quite right, there's no fixed rules concerning the period over which you must earn a profit. As long as you're operating what's clearly a business you can lose money at it forever and deduct the losses (assuming you have other income of a type against which the losses can be offset, which gets into a whole new area way beyond the scope of this thread). For example, if you're an electrical contractor just to pick a simple example, and lose money every year you can still deduct the losses even though you never earn a profit because few people work as electricians for fun. The problem comes in with things like photography, horse racing, breeding, art, things like that, i.e. activities that many people, especially wealthy people, engage in because it's fun but try to claim they're in it for the money so that they can deduct the losses.

The only rules relating to fixed times and profits is the rule that if you make money for three out of five years then you are presumed to be running a business (2 out of 7 years for horse racing and a few other activities engaged in by wealthy people who had real good lobbyists at the time Congress was enacting these rules). Failing to make money in three out of five years doesn't mean you automatically are classified as a hobby rather than a business, it just means the burden will be on you to show that you're actually engaged in photography or whatever as a business.

This whole area is complicated and not susceptible of being throughly and accurately discussed here. For Cyrus or anyone else who contemplates treating their photography as a "side line" business, I'd strongly urge you to sit down with a tax lawyer or a CPA who specializes in taxes, outline your plan, and let them advise you as to whether what you're doing is likely to stand up from a tax standpoint and what you'll have to do to make it stand up. Among many other things, even if your losses are generally deductible, there are certain types of income against which those losses can't be deducted so you'll want to make sure you have the right kind of other income against which to deduct the losses or else the whole thing will be a waste of time.

Thank you Brian for clarifying this. I leave all the legal expertise to my CPA who has consistently advised me correctly over the past twenty years. This has allowed me to prosper in my business and sleep well at night.

[cyrus]

If you are not operating as a true business IRS can easily determine that. First they will want to see your business occupational license and sales tax certificate. Do you file your local/state tax forms monthly or quarterly? You will need to show bank records for a business account, not a personal one. Legally you should not mix personal funds and business funds together, thus the separate accounts. Are you incorporated or operating as a d/b/a? If operating as a d/b/a there are papers to be registered with the state that shows that (even operating under your real name must be registered) and of course if your are incorporated that is a completely different set of papers and tax forms.

Again none of this should scare anyone off, though seeing a CPA never hurts, so lets not be so negative!

Remember, the tax laws on this field are designed and intended to HELP you start and run your own business. You're not scamming the system by turning a hobby into a side business, and so you've nothing to fear from the IRS. No tax law says that a business can't be something you enjoy doing. No one is suggesting that you NOT run a "true business" either - What I'm saying is only that you most certainly CAN turn your photography hobby into a true business, and enjoy the tax benefits that come with that. Its not so hard nor scary, nor is it illegal nor immoral nor scamming the IRS nor a cause to stay up at night. These are your RIGHTS, people! Congress is bending over backwards to HELP YOU (for once) to do this. They've made it EASY to do.

Having the right paper work is certainly good evidence of being a real business rather than a hobby, but the paperwork not an absolute requirement nor is it determinative on the issue of whether youre operating a business or a hobby. You don't have to be incorporated, you can operate as a DBA, and in my state registering as a DBA is hardly a burden - you fill out a simple online form with the Secretary of State and pay $50. In my case, I've also trademarked my business name, which is again good evidence of being a "business" rather than a hobby (cost: $350 - again, just required filing an online form) but is not required nor is it determinative. Operating as an LLC is also something to consider - but again, to be a business doesn't require you to incorporate. All you have to have is the intent to produce a profit.

Proving that you're in a business rather than a hobby is not a tough obstacle to overcome; the standard of evidence is low, and the presumptions are in your favor. All you have to have is the intent to produce a profit. You don't even need to produce a profit.

Also, separate business accounts is a good idea, but not required to prove that youre running a business rather than a hobby. If you're running as a DBA, you don't have to have a separate business account as long as you have maintained records of business-related expenses/income (Corporations should have separate accounts) and all this requires is a notebook and a file to keep the receipts. If you can balance your checkbook, you can do this.

Eventually, you will have to produce a business income (note I said INCOME, not profit) - but again, that's not hard. Note that you don't have try to produce the income JUST BY SELLING PHOTOS. You're perfectly free to go into a business other than PHOTOGRAPHY per se, but which only requires photographs as an ordinary and usual expense.

[darr]

Cyrus it sounds like you have it all figured out! Go for it!

[cyrus]

Cyrus it sounds like you have it all figured out! Go for it!

Read all about it yourself:

http://articles.moneycentral.msn.com...nBusiness.aspx