Recently, there has been an explosion in independent recordings, often made at a musician’s own expense on digital home recording equipment we could have only dreamed of 20 or 30 years ago. Consequently, every March and April, as my firm prepares scores of tax returns for musician clients, the question of deducting production costs is inevitably raised.
The variety, magnitude, and timing of production costs is usually what causes a musician to become confused over the deductibility of production and replication – and with good reason. The answers are not straightforward, and they have been changed over time by the IRS.
There are many costs associated with making your own recording. The following are just some of the costs typically incurred.
- The cost of CD production, like blank CD’s and the cost to burn them either by yourself or through a duplicating service, the cost of graphic design and jacket art, etc.
- Hiring other musicians.
- Hiring engineers or producers.
- Renting a studio by the hour.
- Costs incurred in using your home studio.
- Publicizing and promoting your music by buying advertisements, either print ads or Facebook ads, etc.
- The cost for your recording equipment, including musical instruments, your laptop, ProTools, software, etc.
- The cost of your Internet Service Provider if you use the internet to promote your music.
- The cost of setting up live shows.
- Your cell phone bill if you use it for business.
All of these activities and costs may be deducted under certain circumstances. To go over all of them would be too complex to go into here, but it’s usually well worth it to enlist the services of a CPA, tax accountant or other income tax preparer to assist you. A few hundred dollars could save you literally thousands of dollars and hours of headaches poring over our complex tax laws.
So let’s focus on one aspect of production: making your own CD. Even though MP3 files are becoming more and more popular, many independent musicians still find great value in CD’s, if for no other reason than that it’s a physical product to sell at your live shows.
I used to think CD production costs were somewhat minimal, essentially a one-time investment in recording gear. But production gear is constantly evolving, and naturally that eight-track tape recorder gets replaced by a digital recorder/mixer. Then there’s ProTools hardware and software to buy, higher and higher fidelity microphones, digital effects, cables, racks, and so on. A professional musician can end up spending tens of thousands of dollars.
And that’s only one stage in recording. Those tunes have to be mixed by a professional, and after that, the entire CD needs to be mastered for uniform clarity and volume. Lastly the CD master needs to be reproduced and a CD jacket needs to be designed. The cost of photography and graphic design adds more dollars to CD production, and that’s before it is duplicated for public consumption.
It’s no wonder that any musician producing his or her own CD will inquire about a tax deduction. Unfortunately, the IRS has some different thoughts about you simply taking a “current year” deduction for all of these costs and letting you reduce your taxable income.
Now that you’ve incurred the cost to create the CD master and artwork layout, you have the final task and cost of duplicating and packaging. Here’s where the deductions get a little tricky!
Let’s say you just spent $2,000 for a 1,000-piece run of your new CD – the cost per CD is $2. You start selling your CD online and at your shows for $10 each. At the end of this year you determine you’ve sold 600 CDs, with 400 CDs in “inventory.” Can you deduct the full $2,000 you spent on the CDs? No. But you can deduct $1,200 ($2 cost x 600 sold) against the $6,000 ($10 list x 600 sold) of CD sales income you’ve earned – netting $4,800 ($6,000 less $1,200) in gross profit.
Why can’t you immediately take a deduction for the $2,000 of CD duplication costs? The IRS considers your CD inventory an “asset” (something having future value) until it’s sold. Only upon disposition can you take a deduction for the cost of the CDs sold or disposed of. The good news is, if you give away 100 CDs as part of the promotion of your CD, you can take an immediate $200 ($2 cost x 100) deduction.
The IRS has recently announced some other tax benefits, including a special deduction for certain domestic production activities (including sound recordings) as well as capital gains treatment for the sale or exchange of musical compositions or copyrights in musical works.
By the same token, there are some stringent IRS guidelines that determine whether your musical endeavors are truly part of a “business” or are part of your “hobby.” Although the IRS generally requires a “net profit” (as opposed to recurring losses) to be shown three of the last five years from any musical endeavor treated as a business, there are other factors the IRS considers in determining the tax status of musical endeavors.
Just as most of us wouldn’t do our own plumbing, I suggest you consult with a CPA or other tax advisor familiar with these somewhat complex rules. But just like your investment in a music editing software upgrade or CD mastering services, the benefits from using a good tax preparer will most likely far outweigh the cost.
So keep track of your CD production cost receipts and invoices, as they save you money by reducing tax liabilities and minimize headaches if or when Uncle Sam comes knocking at your studio door.
Alan M. Friedman is a partner in the CPA firm Friedman, Kannenberg & Company, P.C., based in West Hartford, Connecticut. Alan tells us this: “Readers of Allegro who have questions about this article are welcome to contact me at firstname.lastname@example.org. I can’t guarantee I can timely respond to everyone (especially during tax season), but I will try to read every e-mail and get someone in our firm to respond.”
A version of this article first appeared in the February 2007 issue of International Musician. It’s been updated for 2010 by the author.
Also, we didn’t have space to run it here, but Alan Friedman also wrote about a “safe harbor” rule that exists for artists in the tax code. It’s highly technical; readers who want a copy can e-mail Allegro@Local802afm.org.