Tax time is coming, but don’t be afraid. If you think that organizing your financial life is distasteful, just remind yourself that paying more in taxes than required by law is even more distasteful. The better you understand the process and benefits of filing your taxes (yes, there are benefits!), the smoother the process will seem to you. Here, I will answer some frequently asked questions, which may also reinforce some of the things you already know.
First, there is a distinct difference between music being a business or a hobby. For our purposes, I will deal with music being your business. Keep in mind that it does not have to be a full-time business. Many Local 802 members have full-time jobs that are not music related.
Q: What is the difference between music being a business or a hobby?
A: To be in business, you must have what the IRS calls a profit motive, i.e. you must be in it to earn a living or to supplement earning a living. That does not mean that you cannot enjoy doing what you do. To demonstrate a profit motive, some of your activities must include keeping adequate records that clearly show your income and related expenses, maintaining your skills, advertising or seeking paying work as a musician and having some degree of expertise in your craft. You may also want to obtain a separate tax identification number.
Q: What business expenses can I claim as a musician?
A: Business expenses must be both “ordinary and necessary” to be tax deductible. An ordinary expense is one that is common and accepted in your trade or business (for example, union dues, music publications or lessons). A necessary expense is one that helps you to perform your trade or business ( for example, the purchase of an instrument or recording equipment). Keep in mind that even if an expense meets the “ordinary and necessary” criteria, it may still be challenged if it appears to be too lavish. The moral of the story? Document everything! Retain original receipts (you can also scan them). Keep copies of bank and credit card statements that clearly show who, what, when, where and how much was paid for items you want to write off.
Q: What should I do if I am audited?
A: First, take a deep breath. Second, don’t panic. Third, read the audit letter thoroughly to understand exactly what is the IRS or state’s area of concern. Fourth, you must respond. Do not ignore it! Once you know what year and what expenses are under review, provide a response to address only what was requested. Do not volunteer anything additional. If the deductions on your return were legitimately incurred for business and you have the proof showing that they are ordinary and necessary – but not lavish under the circumstances – then there is no reason you wont be able to stare down the IRS. If you need more time to prepare than specified in the letter, you can request it. Also, the IRS and the state make mistakes more often than you think, so it is very important to know what they want from you.
If you do not have or cannot obtain records required to satisfy the auditor and cannot pay the amount due right away, then consider one of the available payment options. One is a payment plan. This is similar to a loan repayment. Monthly payments, including interest and penalty charges, are made to the IRS until the debt is paid in full. Another option involves making an offer to partially pay the amount owed in exchange for forgiveness of the balance. (The IRS calls this an “offer in compromise.”)
The IRS and the states share information with each other about your filings.
Q: What are some of the issues I should be aware of when touring?
A: Touring is a great way to showcase your talent and earn a living doing it. But be aware that most states and some cities have personal income tax filing requirements and have the right to tax income that is earned within their jurisdiction. What that can mean to you is having to file tax returns in multiple states or cities depending on the amount earned. Fortunately, all states recognize that double taxation of your income would be unfair. Therefore, your “home state” (a complex definition, but for our purpose it is where you intend to return to live after touring) will give credit for the greater of income taxes due to the other jurisdictions or to the extent that income tax is due to it.
Another important issue is meals and incidentals. Just when you have gotten into the habit of saving and being able to find receipts while working locally, now comes the pesky task of doing it on the road. Well, the IRS will help to ease your recordkeeping requirement. You are allowed to take a per diem determined by locale in lieu of producing actual receipts when traveling takes you outside of your home area overnight. The range is between $46 for small towns to $71 for major U.S. metropolitan areas (see www.gsa.gov). This does not include lodging and you still must keep records to validate tour locations and dates.
Q: What if my tour goes outside of the United States?
A: Some countries require that a set percentage be withheld from your pay and be remitted directly to the appropriate taxing agency by the organization bringing you into the country. In those cases, usually your tax liability is fully satisfied by the withholding and you don’t have to file any kind of foreign tax return in the foreign country. But back in the U.S., when doing your tax returns here, you are required to report foreign income converted to dollars on your returns for the year it was received. Be sure to file Form 1116 Foreign Tax Credit with your federal return to take credit for any taxes paid or claim them as an itemized deduction on Schedule A, depending on which method provides the most benefit. (The foreign earned income exclusion is beyond this discussion. For more information visit the IRS website at www.irs.gov and type “foreign earned income” in the search box).
Per diem allowances may be claimed for foreign cities too. The amounts are actually higher than those allowed for U.S. cities.
Q: You said there were benefits to filing tax returns. O.K., what are they?
A: Other than to say it will keep you out of the crosshairs of the authorities, I won’t bore you with the legal aspects of filing. But, by filing you may find that there are certain credits that can be used to help offset some of your tax liability.
One of those is the earned income credit. As the name implies, you must have earned income to qualify (wages, fees and the like). Based on filing status (single, head of household, married filing jointly but not married filing separately) and the ages of children claimed as dependents, this credit can be worth from a few dollars to over $5,000.
If you have gone back to school to pursue a bachelor’s degree, the American Opportunity credit can be worth up to $2,500 – with up to 40 percent of that refundable even if you do not have any tax liability.
If you are pursuing a post secondary degree or just taking a class here and there, the Lifetime Learning credit can be worth up to $2,000.
If you have children age 16 years or younger at Dec. 31, the Child Tax credit can be worth up to $1,000 per child. This should not be confused with the Child and Dependent Care credit which can be worth up to $2,100 for two children (under 14 years old) or adult dependents.
Each of the above credits is first applied towards any tax liability. They provide an excellent way to pay part or maybe even all of your taxes just by doing the things you would do anyway. Other credits worth looking into include the retirement saver’s, electric vehicle, elderly or disabled, and mortgage interest.
Another good reason to file taxes is that if you are self-employed and have faith that the Social Security and Medicare programs will survive, you need to file tax returns to pay into the system in order to get those benefits out. This is different from those working in an employer-employee relationship where the employer withholds those taxes. Studies have shown that the value of benefits received from those programs far exceed the amount contributed to them.
Q: What is meant by Qualified Performing Artist and how do I qualify for it?
A: Qualified Performing Artist or QPA is a government term applied to individuals who meet certain thresholds:
Performed services in the performing arts as an employee for at least two employers during the tax year
Received wages of $200 or more from at least two of those employers
Had allowable business expenses attributable to the performing arts of more than 10 percent of gross performing arts income
Had adjusted gross income of $16,000 or less before deducting expenses as a performing artist.
The elephant in the room here is the gross income of $16,000 or less. That figure includes both performing arts and all other sources of income, whether single or married filing jointly. If you do qualify, the QPA expenses can be claimed as an adjustment to income, thus reducing income without having to itemize deductions – truly a significant benefit.
Here are some last-minute checklists. Did you remember to:
depreciate your equipment
keep a mileage log if a personal vehicle was used
adjust your W-4 allowances to reflect increased or decreased tax withholdings needed to cover your liability
if self-employed, did you make estimated tax payments so that your cash flow will be less strained
most importantly, did you save your receipts in an organized manner?
Good luck with your taxes! I hope that they will be less stressful and maybe even financially rewarding.
Walter Gowens is an Enrolled Agent. He formerly worked for the IRS and currently represents clients in various disciplines before the IRS and state tax authorities. Gowens earned an MBA in finance from Indiana University and a B.S. in business administration from Arizona State University. He is president of Prudential Vanguard Financial Services, Inc. Its Actors, Artists, Athletes & Authors division prepares income tax returns and provides other services for those in the performing arts. You can reach him at AAAA@PrudentialVanguard.net.