If you make substantial income from stock, and don't plan your estate carefully, you may bankrupt your heirs rather than leaving them a valuable gift. You may think your assets are far below the standard $625,000 individual or marital exemption allowable for estate tax purposes in 1998, but your heirs may get a huge surprise when the IRS and your state taxing authorities start valuing your stock photo files.
The IRS may go to your delivery memos and invoice paperwork, and see that every piece of film you delivered was valued at $1500. Based on that they may decide that the true value of your file is $1500 times the number of frames in the file. That could bankrupt your heirs. The real value should probably have some basis to past income, but for photographers earning one hundred thousand a year or more from stock the appraised value can still be significant. When added to the value of a home, and a few mutual funds it can easily push the photographers estate well over the $625,000 level.
In some cases IRS auditors have accepted appraisals by independent Stock Photo Appraisers that placed the value of a stock photo file at three or four times the average annual income from the file. If there are big year to year variations in annual income, it may be acceptable to average the income over 5 or 10 years.
Remember also, that at least one-third of the states do not recognize the $625,000 exemption. Some have lower limits for estate tax purpose and some much higher.
New Law
Don't be confused by the special estate tax exemption for small businesses that goes into effect in 1998. Up to $1.3 million of income from a family-owned business can be sheltered, and if your business owes estate taxes, the tax can be paid in installments over up to 14 years with the first $1 million qualifying for a special 4 percent interest rate. While this may sound like a solution to your problem, few photographers will qualify for this extra exemption. Let me describe a couple situations.
Assume your business assets are valued at $500,000 and the other assets (home, investments, insurance, etc.) are valued at $625,000 for a total of $1,125,000.
The $500 in business assets don't qualify for the extra family owned business exemption because the value of the family-owned business must exceed 50% of the "adjusted gross estate." Chances are your other assets will be greater than your stock photo assets.
Assume your business is valued at $750,000 and other assets (home, investments, insurance, etc.) are valued at $800,000 for a total of $1,550,000. When you die all these assets pass to your spouse who gets an unlimited marital deduction.
However, the spouse does not continue to operate the business, but receives royalty income from it. The spouse dies six years later. Assume the value has remained about the same. In this case the estate of your spouse wouldn't get any benefit of the family-owned business deduction because of the "participation requirements."
This rule says:
"During the eight-year period ending on the date of the decedent's death, there must have been periods aggregating five years or more during which there was material participation, by the decedent or a member of the decedent's family in the operation of the business to which the interests relate."
Is receiving royalties and managing stock agency relationships actually "material participation" in the business? Who knows. We'll have to wait for some test cases before that is determined. One thing is sure. Bring your lawyer or accountant into your planning early as you try to determine how these new rules will affect your specific situation.
If your records are not clear, the fact that there are a large number of transparencies as part of the estate could tie up settlement for quite some time while your heirs and the IRS battle over the real value of that property.
Useful Life
One of the critical questions is useful life. How much will the file depreciate in value per year when no new work is being added? Will the average useful live of a file be 3 or 4 times a single year's earnings? It depends on the type of subject matter in the files and current market trends at the time your estate is being settled. Your heirs will probably need an expert to aid them in this evaluation.
In a recent article in Photo District News, Barbara Roberts, former President of FPG was talking about stock catalog images and said, "Before you could have a great revenue stream for up to five years (from an image in a catalog)." [In other words very little depreciation in value.]
Anything you can do before your death to help guide the taxing authorities and your heirs in establishing value for your particular work is likely to benefit your heirs. But, even then the IRS may contest the value you have placed on the property.
Paying The Tax
Unless you qualify for the "small business" exemption, the tax must be paid before your estate can be settled or any of its other assets distributed. To pay the tax, images may have to be sold, or your beneficiaries may have to pay it out of their own pockets. If your heirs need to raise cash, several problems may arise.
Usually, there are few ready buyers for an entire stock photo collection. This varies with the collection, but as a general rule it should be expected that it will be very difficult to find anyone who will pay cash for a collection.
Anyone interested in the material will probably want to take it on consignment and pay royalties. If your heirs are inexperienced at managing a stock photo file, and the bulk of the material is not already being handled by stock agencies, they may have little alternative but to sell.
Anyone who is willing to pay cash will probably only offer a small fraction of the property's true value. Ironically, if the file has been setting dormant and you have made little or no income from it, your heirs are probably in a good position to avoid tax on this asset -- provided they have some idea as to how to locate an expert appraiser and fight an IRS valuation.
If the IRS "bean counters" have recently settled the estate of a successful photographer who had 100,000 transparencies which were eventually valued at $2 million, they may want to value your 10,000 images at $20 each, even if you've never made a sale. Your heirs are going to have to find a way to prove that is not a reasonable valuation.
Strategies To Consider
Some photographers place their stock business in a separate corporation. The revenues realized from the stock come into the corporation and are disbursed as income or dividends. Upon the photographer's death, the corporation continues to exist and continues to disburse dividends and income to the owners, who may now be your beneficiaries.
However, if stock is transferred to the beneficiaries then the stock will have to be valued. Factors that play into this valuation are goodwill, the value of the photographer's name, and the importance of the photographer's personality in generating continued sales. Thus, determining the value of such a business may be more complex than dealing with a sole proprietorship.
You may choose to donate a portion of your file to a non-profit organization, but this option should be carefully examined with the institution prior to your death. Don't just assume that anyone would be happy to have your work. Not all institutions will accept such donations and some may require a fund for maintenance of the collection. If your work is accepted your estate may qualify for a charitable deduction, particularly if the photographs can be considered to have historical value. But there may also be negative tax consequences so check with your accountant or lawyer before making any firm decisions.
You may donate portions of your file to your children or anyone else prior to your death. You can give any person assets worth up to $10,000 per year tax free. If you and your spouse file jointly, you may give $10,000 each in value.
The property might remain in your studio for storage as long as it has been clearly marked as being gifted. Any attempt to transfer such value to your heirs must occur at least three years prior to your death or it may be disallowed as a tax avoidance mechanism.
It may be advisable to purchase a second-to-die life insurance policy for your heirs that will cover the potential tax liability. If the file is assessed at your estimated valuation your heirs will then have the cash to pay the tax. If the assessment is lower the heirs get a significant cash gift.
Since assets often pass to the spouse with an unlimited marital deduction, people often leave it to the spouse to work out future problems. If the spouse has not been closely involved in the business it is best to do some planning before the photographer dies. Spending a few hours working out the problems now will save your spouse countless days of agony in the future.
If you don't want your spouse cursing you after your dead, don't leave him or her with the responsibilities of solving these tax problems alone.
Steps To Getting Organized
It is important to organize your material so your heirs can easily identify the relative value of different sections of your file.
There are at least seven different categories in which your work should be organized. They are: (1) Material with stock agencies, (1) Inhouse material actively being marketed (3) Work that may be ready for marketing, but inactive, (4) Outtakes stored, but seldom if ever accessed, (5) Fine Art (6) Images that appeared in books of your work, posters or other products that are being actively marketed and (7) Personal or family material.
I will deal with each of these items in a little more detail.
- The material with stock agencies is easily dealt with because you receive regular royalty checks. The value is easy to establish. Your heirs will appreciate historical records that easily establish what you have earned from stock agency sources over the past few years.
If these records can separate the revenue from images in catalogs from the rest of your stock revenue that may also be helpful. The useful life of catalog images may be decreasing according to many estimates.
This could enable your "expert appraiser" to argue that a high percentage of the income from your file has a much shorter useful life than three to four years.
Leave your heirs instructions and data that proves that catalog and non-catalog images are not equal.
- Most photographers have large files of material that they search through whenever they receive requests. Be sure to separate the income from this material from that of your stock agencies. The annual return per image will often be lower for this material than for the images with your agency. There was much tighter editing of the agency material.
The IRS is required to establish value based on the earning potential of the file at the date of death, or no more than six months thereafter.
Every photographer understands the difference between selects and outtakes. Your heirs may not. Your heirs may need to bring in experts to explain the stock business to the IRS examiner.
One of the biggest failings of photographers is in providing detailed captions for their images. Even when they put a two or three line caption on the slide mount, often a lot of necessary historical information may be left out such as where the picture was actually taken and when.
During the photographer's lifetime he or she can often fill these gaps in information from memory. After the photographer's death the heirs will have no access to such data unless it is written down. Absence of such data will markedly reduce the value of the file. This can be good from a tax liability point of view, but terrible in terms of really supplying something of value to your heirs.
Often a photographer's active file is in such bad shape that only the photographer could find anything in it. When this is the case, and the photographer is no longer available, the file really can't be made marketable. However, convincing the IRS of this fact may be difficult, and at the very least require the services of a recognized expert.
The worse case for your heirs is to pay a huge tax bill, assuming they will own something of value, and then get absolutely no value in return.
- There may be new material that has not been captioned or prepared for marketing.
Without proper identification this material may be virtually valueless.
Material in process needs to be in one location so it can be easily identified at any time.
- Often photographers store outtakes rather than dumping them. There are all kinds of justifications for doing this, but the fact remains that a lot of material ends up sitting in one corner of the studio for years without being touched.
There is no great harm here until it becomes part of an estate and the question becomes how much value do we place on this material. To the degree that it can be identified as being separate and apart from the active marketable work, it will greatly help your heirs in establishing a much lower value for this material.
This material could include dupes, test shots and extras that are similar to the bona fide salable stock images.
In the past there has been an argument that dupes have value because they could be placed with multiple agencies. That may be changing as we move toward digital search and digital delivery of images. In the future it may be possible to keep the best frame and make it available digitally to all buyers.
An important aspect in determining the potential value that may be generated by future sales is to have someone working with your heirs who is very conversant with the market as it is changing and who can advise them based on future realities rather than past trends.
- Separate your Fine Art work from your commercial stock. Fine art photographers should also separate work prints from exhibition prints and signed ones from unsigned.
Even if some of your commercial work is eventually judged to be fine art, the fact that you have made some attempt to distinguish between the two bodies of work is likely to help your heirs in establishing future value.
If there is a relatively small number of exhibition prints you may want to consider gifting them to your heirs prior to your death while retaining rights to exhibit them during your lifetime. The more value you can gift to your heirs prior to your death the less estate tax they will have to pay.
If you do both Fine Art and Commercial work your heirs may need two separate experts to assist in the valuation. The commercial expert can assist in the commercial valuation and the fine art expert can place a value on the fine art material.
- Books. This category refers to a book of your work, not when you sell one or two pictures for use in a textbook. Identify all work which has been published in book form. Separate the images included in out-of-print books from those for which you are still receiving royalties. If there is unpublished material that you have set aside for a future book, make it easily identifiable so it has the potential of being marketed after your death. The value of each of these groups of work may be appraised differently.
- Personal or family material is always accepted as having no commercial or monetary value as long as it is clearly identified and clearly separated from the rest of the photographer's work.
Other Preparations
1 - Choose an executor with photo experience. Make sure the executor qualifies under U.S. and state regulations. One important area of qualification under U.S. law is that the executor be a U.S. citizen. Not long ago a well known photographer passed away after having named five executors for his estate. Four of them were disqualified because they were not U.S. citizens.
For estates of high value it may also be necessary for the executor to be bondable. You may have more than one executor enabling you to pool multiple talents. Your primary executor will probably be very happy that you have designated someone to help in areas where certain expertise is required.
Contact the photo executor prior to your death and make sure he or she is willing to accept the responsibility. A small retainer may be required. Selling Stock provides an appraisal service. You can contact us at 301-251-0720.
2 - You may want to employ the services of an expert appraiser during your lifetime to get some idea of the possible tax consequences at your death. Such a consultation might also help you identify those areas of the file where time in cataloging and captioning now might reap the greatest benefit in the future.
3 - Leave records and an inventory of assets that are easily found by your heirs. These should indicate the most recent annual returns from the various sections of the file. If the executor can show that large sections of your file are producing little or no income it should be possible to place a much lower value on that part of the file.
4 - If you don't want to destroy the material and don't have time to go through it, consider gifting certain parts of the property to your heirs prior to your death. You can give up to $10,000 per person/per year tax free. If you and your spouse file jointly, you may each give $10,000 in value for a total of $20,000. The property might remain in your studio for storage as long as it has been clearly marked as being gifted to the children.
5 - Stipulate in your will or trust instrument the disposition of the file. You should stipulate whether it should go to a beneficiary, whether it should be sold and the proceeds given to a beneficiary, or whether it should be held by a trustee. If you plan to use a trustee, get that person's signed agreement to accept the position.
Letters of instruction are not usually legally binding. Therefore, if you want to require certain actions you should deal with those matters in your will.
6 - If you expect the file to continue to earn income provide for professional management of as much of the file as possible. Amateurs cannot be expected to handle this very specialized task. One solution is to get the best material accepted into a stock agency while you are still available to assist in its selection and cataloging.