Taxes 101: Five Tips and One Misconception That All Musicians Should Know
Take the worry out of taxes with these easy to follow steps
It's never fun to file a tax return, but for those who work only a regular 9 to 5, the process is at least straightforward. Not so for self-employed musicians. That's why we asked Anil Melwani, the owner of New York's 212 Tax and Accounting Services, a firm that specializes in helping musicians and DJs, for a few tips.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction or filing any tax return.
The United States tax code accounts for the fact that some business expenses—laptops, automobiles, DJ equipment—get less valuable over time. Melwani often reminds his clients not just that there's a deduction for this, but that the entire deduction can be taken in the year that the product was purchased. "There's something called Section 179 which is a part of the depreciation code," Melwani says. "As long as you're profitable, you don't have to write it off or depreciate over three, five, seven years. You can take the whole deduction in the year you buy it.
A note for next year: The 2017 tax bill increased the maximum limit of this deduction.
Beware of the grey areas:
Can musicians write off their subscriptions to, say, a streaming music service like Spotify? Probably, but it gets tricky. "Like most things in taxes, as long as you can prove it's primarily for business use, then, yeah, of course you can deduct it," says Melwani. But what about expenses that relate to both your business and personal life? This is the grey area: "You have to keep track of things like what you play and when you play it, and the gigs you do and what you perform."
Fortunately, the IRS usually understands this predicament. "They're reasonable,” says Melwani. “As long as you have a reasonable explanation of your expenses and what you do, they're usually gonna let it go."
Get your royalties right:
Royalties can be appointed to either Schedule C, where you report self-employed income, or Schedule E, where you report passive income. We'll let Melwani explain the difference: "If you're actively earning these royalties, it would go on Schedule C and it would be subject to self-employment tax. If you're earning these royalties from something you created and produced in the past, it would go on Schedule E and be subject to a lower rate."
Keep track of payments:
This can be a headache for a touring musician or a DJ who plays a new club every night. But, Melwani says, it's worth it. He recommends a book-keeping program like Quickbooks, Quickbooks Online or Xero. The latter two are cloud-based, which might be useful for people who travel or for bands in which different members want access to the books.
What about situations where an artist is paid in cash? "The best thing is to deposit the money in the bank and keep track of it that way. If you don't have a bank record and trail of the cash being deposited, then under audit they could say 'How do we know if you're telling the truth?' Obviously, you have to match the invoice and the tour log and things like that."
Deduct travel expenses, but play it safe:
Hang onto your receipts. "A receipt, invoice, cancelled check, the boarding pass of the flight or the hotel receipt or gas receipt—it's important to keep all those things for at least three years," says Melwani. Also remember to log the tour dates themselves. "If you're Justin Timberlake and you're on tour for three months, it's not hard to prove. But if you're Band ABC that just started last year, these things aren't always publicly available, so you want to keep track."
There is a little leeway on this, however, and for that we can thank a musician from the early 20th century: the Broadway star George M. Cohan. In 1930, Cohan won a case against the IRS that allowed him—and everyone thereafter—to deduct certain expenses even without being able to produce a receipt. Not that you should follow his example. "Most audits come down to a negotiation," says Melwani, "so I try to keep the Cohan rule for when I really need it."
To incorporate or not to incorporate?
"I get that question multiple times a day," says Melwani. His answer? It doesn't really matter. "A common misconception is that if I form an LLC or a corporation I can deduct more things and be more aggressive with taxes and things like that. That's actually not the case at all." Why incorporate, then? "The main reason for forming an entity is if you're expanding, your numbers are going up and you want to protect your personal assets and liability," he says. In other words, this is a discussion you should have not with an accountant but with an attorney.