By Gil Kaufman and Dan Reifsnyder
April 15 doesn’t have to be a nightmare.
Though most Americans dread the circled date for tax day on their calendar, we’re here to tell you that if you play your cards right you can actually make the system work for you.
Creating music has unique tax implications, both from how to pay on what you earn, to what you can deduct. While folks with “regular” jobs typically have federal and state taxes withheld from their paychecks, most musicians don’t. So you have to remember to pay taxes on income from royalties, live performances, etc. But to offset this, the list of tax write offs for musicians is long. That’s because all artists, from songwriters to performing artists, have unique expenses that the IRS views as deductible.
If you keep good track of your finances throughout the year and keep in mind a list of the things you can actually deduct legally, tax day doesn’t have to be a headache.
Since we’re not tax experts, and wouldn’t presume to give tax advice, we reached out to a few to get a better idea of what
We spoke to ICON Business Management partner Sally Velazquez, and Adam Edelstein of Echo Tax Management. Sally has worked with artists such as 21 Savage, as well as directors/producers including Gregory Goodman (8 Mile), and a number of other well-known working musicians and models. Adam is one of Nashville's top tax professionals, having managed the finances of Grammy-winning songwriters, to producers, artists, and engineers.
Here’s what they told us about paying taxes, deducting expenses, and planning ahead for taxes as a musician.
What are some of the unique issues that face musicians/songwriters when it comes to tax preparation?
SV: The biggest issue is getting a musician to even talk about taxes. Most musicians are creative thinkers, meaning when it’s time to start discussing numbers, bills and budgets, they tend to avoid these conversations at all cost. I can see the life drain from my client’s faces and their eyes glaze over when I pull out my binder with their tax items.
This avoidance leads to a bigger problem, which is understanding what and why you owe, which would allow them to plan for their tax bill by putting aside funds throughout the year to pay for their taxes. A lot of musicians get into trouble because once they start earning income, they immediately use the funds to expense their lifestyle. For example, they want to buy a new car, home, jewelry, clothes, etc., and they do not put aside money to pay the tax bill. When tax time arrives, they are shocked at how much they must pay, and sometimes unable to afford it because they weren’t planning on paying this throughout the year.
AJE: Royalty advances are considered taxable income in the year they are received. When your label or publisher writes you a check, this is taxable income that must be reported. Typically, royalties received from the work you do are considered self-employment income. These are taxed at ordinary income tax brackets and are subject to self-employment taxes.
What are common mistakes music creators make when preparing tax returns?
SV: Choosing the wrong entity structure for your business and not taking the appropriate expenses on your tax returns. For example, a musician that is making a profit of over $100,000 a year, should consider investing in a loan out company (LLC or S-Corporation) to make sure you are maximizing your deductions, as some of these deductions may not be allowed if you filed without a loan out company.
AE: Failure to plan ahead for current year taxes. This manifests itself in two ways: First, individuals fail to set aside enough money to pay required taxes for the year and/or pay estimated taxes throughout the year. Second, they fail to proactively look at their tax/financial situation and identify the changes they could make to their structure or financial plan to reduce current year taxes.
What do you recommend creators do during the year to make sure they are prepared when tax time comes around?
SV: Set aside a percentage of all income earned and pay this in quarterly to the IRS and State Taxing Authority. The standard is 30% of your gross to account for both federal and state taxes. While this is conservative (you pay taxes on your income after your expenses) it’s a good rule of thumb. Don’t forget you also must pay taxes to the State taxing authorities, and depending on your state of residence, it can be very costly. Generally, it’s better to pay more taxes throughout the year, than get stuck with a large tax bill and get charged with penalties that may arise from not paying on time (late payment penalties, failure to pay estimated taxes, etc.).
AE: Section 162(a) of the Internal Revenue Code defines a deductible business expense as one that is both “ordinary” and “necessary” for the business. Each business will be different and must apply those standards to every deduction. It’s crucial that you maintain receipts and records throughout the year to substantiate deductible expenses for the business.
Section 61(a) of the Internal Revenue Code defines income as all income from whatever source derived. This compensation you receive from songwriting and performance royalties, from producing or mixing a record, from equipment or property you received in lieu of a cash payment, or from any other source, circumstance, product or service provided. If you receive something, cash or property, for work that you perform, you have to claim this as reportable income and pay taxes on those receipts.
Do musicians have any loopholes/tax breaks available to them that the rest of us do not?
SV: As a musician, your livelihood is dependent on your creativity. Musicians are thus able to expense music streaming services in the name of research. Under the new Trump’s administration tax reform, musicians can deduct business purchases, such as musical instruments, sound and recording equipment, computers, office furniture, or certain business vehicles like an SUV or van. Without Section 179, these large purchases would have to be depreciated over several years.
Did any of the changes in the Trump administration’s tax reform bill impact musicians in any specific way?
SV: Unfortunately, yes. Besides the changes to the tax bracket income tax rate change, musicians receiving W2 income (such as crew members, union performers or musicians receiving a paid salary to perform) are directly impacted by the TCJA. The TCJA repeals the Schedule A miscellaneous itemized deduction expenses, meaning you can no longer deduct the unreimbursed employee expenses. The reason why this is detrimental is that W2 employees are no longer allowed to deduct items such as buying an instrument, sheet music, supplies or equipment, required concert clothing, mileage, job search/audition expenses, and your home office expenses.
Additionally, you can no longer deduct agent and manager commissions, tax preparation fees, investment management fees, memberships to professional organizations, or union membership and work dues.
For example, let’s assume a musician pays an agent 10% of their gross income to find them work. If they receive W2 income, after being taxed on the income received, they will need to pay out their agent or manager commissions. When you file your tax returns, your actual income wasn’t 100%.
Another deduction lost is the entertainment deduction. Prior to this bill being passed, musicians deducted 50% of their costs in entertaining someone for business. For example, if you wanted to attend a concert because you were meeting with a music manager, or taking an agent to a sports game, you could deduct the cost of entertaining. The TCJA no longer allows this deduction.
AE: The new tax law lowers tax brackets across the board for all taxpayers, eliminates some deductions that taxpayers used to be able to qualify for, and creates a large number of tax planning opportunities. It’s important to consult with a tax professional with experience in your industry to evaluate specific changes to your specific situation, and to reevaluate your structure and tax plan in light of new opportunities this plan has created.
What is an area of potential savings that most artists might not be aware of?
SV: Artist wardrobe and styling, or “glam” as I like to call it. You can deduct most items if they are a business expense. When you are shooting a music video, you can deduct the costs of all styling, makeup, clothing, and other items related to video.
For musicians who are not employees and receive 1099 income, there is a new 20% deduction for small businesses that are “pass-through” entities. Pass through entities will be taxed on only 80% of their qualified business income (QBI). You do not need to form a loan out company such as an LLC or S-Corporation to be eligible. Anyone who is a sole proprietor and reports on Schedule C can claim this deduction. You do not need to incorporate.
If you tour a lot and have income from many different states/countries how does that complicate filing? Do you still file just one form?
SV: If you tour, most states and foreign countries may require you file a tax return and pay taxes in the state you perform in. I can go into detail on what nexus (or physical presence) in the State would entail, but I do not want to bore you to tears. In general, there may be a filing requirement in any state you perform in based on the amount of income earned in the State and the State’s tax rules.
The good news is depending on the state you live in, you will not be double taxed on that same income, as some states allow for a state tax credit to apply against any tax paid in other states. Double taxation is also an issue when you perform outside of the U.S. The U.S. has international tax treaties that specify how entertainers are to be taxed in the foreign country. Some jurisdictions require the promoters to withhold tax on the performer’s income, which guarantees the performer pays taxes on income earned in the jurisdiction.
The amount of withholding tax paid all depends on the country and treaty that country has with the US. Without going into too much detail, there are forms that can be filed to reduce or eliminate the withholding requirement, specifically if a musician is going on a global tour.
Why do we hear about musicians getting audited or getting into big tax trouble so often?
SV: The most common trigger for an audit is not reporting all your income. As a self-employed individual, you generally receive a 1099 in the mail from all earned income reported to the IRS,” she says. “If you fail to report all income (not just income reported to the IRS), this can raise red flags. You must report cash received, interest earned, royalties, performance salaries, etc. on your tax return.
As I stated above, the problem is avoidance. For lack of awareness or fear of the tax liability due, some musicians wait until it’s too late to file and pay their taxes on time. This includes new and veteran artists who avoid paying their taxes. When it comes to tax time, they are either too busy on tour to think about it, unable to pay the taxes due to overspending and mismanagement of their money or improper reporting of all their income.
What they don’t know is that you can extend your taxes for 6 months (up to Oct. 15) to give you more time to file. And if you find yourself in a position where you are not able to afford paying your taxes, there are relief options out there such as applying for an installment agreement to pay off the debt over time.
What can trigger an audit, and how do you deal with it if one comes?
SV: In the event of an audit, the IRS will audit your bank accounts and investigate your lifestyle to see how you are funding your expenses (see how Capone faired with that). Believe me, you do not want them digging into all your expenses because you failed to report income. That’s a big no no! It’s time consuming, and expensive.
Another item to watch out for is the home office deductions. These are scrutinized heavier, especially if you claim use of a home studio. In order to take the deduction, you need to have set aside a separate area to record (or use for business) that is exclusively used for business. Meaning, if you use your bedroom to record music, but also use it to sleep, get dressed, etc... you will not be allowed to take the deduction.
Another trigger for the IRS is expensing a lavish lifestyle on the return. This means, if the IRS notices you are deducting a lease or depreciating the expense of a Rolls Royce, they may disallow this as a business expense. They do not allow deductions for these types of lavish and luxurious items, as there is rarely a business purpose to have them. Yet, you are renting the car out for a music video shoot; well, then there may be some exceptions.
AE: It’s best to catch a mistake yourself, as this minimizes penalties you could be assessed if the IRS instead catches a mistake. Review your return carefully before filing to ensure it’s accurate, and be sure to compare your return to any outside records you may have, or may have received (accounting records you maintained, 1099-MISC or W-2 forms you received, etc.).
The IRS offers a transcript delivery service (https://www.irs.gov/individuals/get-transcript) that you should consider using each year to double-check income the IRS has received from third parties (Consolidated 1099, 1099-INT, 1099-DIV, 1099-B, 1099-MISC, W-2, etc.) before filing your return. This is a great way to both reduce your audit risk and ensure the accuracy of your return filing before it’s submitted.
Many artists have business managers who take care of many tax and income related detials. For those who don’t here are a few tips worth noting:
1) Use apps such as Mint.com to help budget and keep track of expenses.
2) Save physical receipts. The IRS has not yet caught up with today’s technology and still requires original receipts for all purchases. At the very least, take pictures of receipts with a phone and store them in a folder for easy access later.
3) Create a savings account where you can transfer money to set aside for taxes. Out of sight, out of mind…
4) If you change your mailing address throughout the year, make sure to inform the IRS (Form 8822) so you do not miss any important notices or tax forms. The IRS will usually not give you a call regarding your tax items.
Here are some of the standard tax forms you may need to prepare your return (Hat tip to Soncibids for the summary).
W9: This is the form you fill out as a freelancer. Keep track of who you provide this form to, as they will need to issue a 1099 at tax time that summarizes all the income you received from them for the year. (see 1099 below).
W4: This is what you fill out if you’re an employee of a company, either part time or full time. At tax time, your employer will issue you a W2 (see below).
1099-MISC: If you earned more than $600 of income from your work as a writer or a performing artist—including royalties—you should receive one of these from anyone who paid you. When you get this form, it means the business issuing it also reported they paid you this amount to the IRS. So a) make sure the amount on the form matches what you actually received (and request a new 1099 if there are any inaccuracies), and b) be sure to claim the same amount on your tax filing.
W2: You’ll receive this for if you worked full or part time as an employee, and it will reflect the taxes your employee already withheld.
1040: This form allows you to disclose how much you’ve earned in income from freelance gigs and royalty income. It’s the most common form used by artists and musicians. Others include the 1040EZ (only if you have no freelance income or dependents), or 1040A (like the EZ form for for those who have dependents).
Schedule C / Schedule C-EZ: This is self-employed artists. Delare all income you’ve received… whether you received a 1099 for it or not. Here’s the IRS’ guide that details whether you need to file this form or not.
Schedule E: If you earn income through a legal “partnership” then you’ll need to complete this form. Partnerships are legal business entities with their own tax ID (not your social security number).
Schedule SE: If you filled out either a Schedule C or E, you’ll need to complete this as well. It’s used to pay Social Security and Medicare taxes on self employment or partnership income.