Congratulations! If you’re reading this, it means you are or soon will be making money with your music! That’s the good news…the bad news is you now have another thing to worry about (as if trying to make an income, or worse yet a LIVING through music isn’t enough to worry about). Yes, you are also expected to report and file taxes on your new income stream. If taxes are a totally foreign subject to you, you should probably seek the advice of a professional tax preparer as April 15 looms (or even sooner if you think you might be required to file quarterly returns after reading this report). What this article intends to do is to prepare you for that day, and make you aware of some possible deductions you might have otherwise overlooked, and to give you a broad overview of how Uncle Sam views your musical income.
Choice of Entity
For the remainder of this article, I am going to assume that you are filing your taxes as either a sole proprietor or possibly a Limited Liability Company. Though most of the same rules will apply as to what is income and what are potential expenses, the actual filing of the taxes will differ if you are filing as a Corporation (C or S) or Partnership. We will also assume you are receiving a (or several) form 1099-MISC (again, if receiving a from a Partnership or Corporation, you might receive a K-1 which would be reported on Schedule E). You should consult with your accountant for treatment of Partnership or Corporation income. NOTE: Though you may have received payments from someone, you may not neccessarily receive a 1099 – you still need to track and report this income.
Hobby…or Business?
First off, you need to understand the concept of Hobby vs. Business. If you decide to file your musician income as a hobby, you should be aware that you can only deduct expenses up to the amount of your hobby income, and you can do so ONLY if you itemize your deductions. What this means is that if you make $1,000, and spend $1,500, you can only deduct $1,000 worth of those expenses, and you will lose the tax benefit of the other $500. However, if you don’t itemize (which many people do not, because the standard deduction is greater in most cases), then you would still need to claim your hobby income as other income. Obviously, it’s better to be a business.
So what dictates whether you are indeed a hobby or a business? The IRS says you must have a profit motive – you must be able to prove that you are trying to make a profit – not just disguising your hobby as a business to deduct all of your expenses.
A general rule is that you must make a profit in 3 out of 5 years. Then the IRS will view you as serious about making a profit. This is not set in stone however; if you flunk the 3 out of 5 test, you may still be able to prove you are in business to make a profit. Items such as business cards, advertising, business licenses/permits, marketing materials etc. can be used to show Uncle Sam that you are serious about your venture.
The following guidelines are straight out of the IRS code:
1. You carry on the activity in a business-like manner,
2. The time and effort you put into the activity indicate you intend to make it profitable,
3. You depend on income from the activity for your livelihood,
4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
5. You change your methods of operation in an attempt to improve profitability,
6. You, or your advisors, have the knowledge needed to carry on the activity as a successful business,
7. You were successful in making a profit in similar activities in the past,
8. The activity makes a profit in some years, and the amount of profit it makes, and
9. You can expect to make a future profit from the appreciation of the assets used in the activity.
If you are indeed serious about carrying on your music activities as a business, you should do just that by getting business cards (for yourself or your band), a business license (check with your locality for details/requirements), join a performing rights organization, and copyright any of your works if applicable. Most of all, keep accurate records of EVERYTHING in an orderly fashion. Setup a filing system or expandable file, and keep records and receipts of EVERYTHING, especially things you plan to deduct.
Best of luck!
Rich
- Tags: music business, taxes
