Let’s assume that anyone reading this knows that the sum total of all the money an individual earns is called the gross. It is reported by your employer to the Federal Government in the form of a wage and tax statement called a W-2, and a copy is sent to you each January for the previous year’s work. It shows wages earned and taxes taken out by your employer. In contrast, for self-employed income you receive a 1099 MISC form, but if you are a private music teacher, for example, you will receive no for and consequently you must keep track of your total income yourself. The person or entity who hires you as an independent contractor is required by law to send the 1099-MISC if he paid you $600 or more in the calendar year. Since you are not on his regular payroll, no taxes will be taken out, but nonetheless you will be responsible for them at tax time. It is a misconception that if you do not receive a 1099 and make less than $600 you don’t have to report it. As a U.S. citizen, income from all sources is taxable regardless of the amount and where it is earned in the world. Here’s a case in point.
A former student of mine took a cruise ship job right out of college. He worked on the ship the better part of a year. For some reason he didn’t receive a 1099 from the employer, but the income was reported to the Internal Revenue Service. (My guess is that the cruise ship line had an old address for this person and though it was mailed, the form never got to him.) Anyway—my student thought there would be no tax due, since he was “at sea.” Guess again, Sinbad. The IRS caught up to him and hit him for the tax due on his earnings plus interest and penalties! The amount was substantial and he had to make arrangements with the IRS to pay it back over time. In truth, he was lucky not to have been slapped with a fraud charge.
So, we all have our income reported to the IRS via W-2 and 1099 forms, with copies sent to us. Looking at the W-2 you will see in box 5, “Medicare wages and tips.” The number found there is the gross—the total amount you made from that employer. If you contributed to a retirement account such as a 401K or 403b, that amount will be deducted from your gross (box 5) and the remainder will be shown in box 1(wages, tips and other compensation). There are many benefits to reducing your gross income by contributing to a retirement account, because you get to pay less taxes and the money in the account grows tax-free. (But that’s a subject for another blog.)
In order for you to pay less tax (your goal) you must get your total income down to a lower level. Claiming deductions does this. Some deductions, such as moving expenses, student loan interest, certain retirement plans, etc., directly reduce total income. These deductions are called “adjustments” and after subtracting them from total income, the result is Adjusted Gross Income. Other deductions, like contributions to charities, mortgage interest, loss from fire or theft and medical expenses in excess of 7.5 percent of your adjusted gross income are available to all tax filers, and are called Itemized Deductions. While all taxpayers may deduct non-reimbursed employee business expenses, musicians tend to have more expenses, many of which are unique to them. Here are a few:
• Office in home
• Supplies—items such as drumsticks, reeds, strings, cables and office supplies
• Concert tickets
• Recording costs
• Accounting fees
• Lawyer fees (only business related or to produce income)
• Music books and CDs
• Subscriptions to trade magazines
• Internet access and email (subtract any personal use)
• Telephone—have a separate business line (Your primary phone line is not deductible, but features may be, like call waiting, messaging, etc.)
• Lessons and coachings
• Education expenses—things that will further your career
• Instrument repair
When a musician buys an instrument or equipment that has a useful life of longer than one year, he or she can depreciate it over the tax life of the item—usually seven years. This has the effect of spreading out the deduction over time. An alternate course would be to expense the purchase (deduct the price paid) of the instrument in one year using Section 179 of the IRS tax code. This provides an immediate and one-time write off of the item. Whether to expense the instrument or to depreciate it is a question for your tax advisor, since there are conditions that must be met for both. For example, the Section 179 expense cannot be greater than total earned income.
If you sell something for more than you paid for it, you have a capital gain, on which the IRS requires us to pay tax. The good news is that, at least for now, the capital gain tax is generally less than the taxes we pay on our income. But, let’s say we bought a saxophone for $5,000, and over seven years we depreciate it down to zero. We decide to sell the instrument and we find that these instruments are in greater demand now than when they were new! They have actually appreciated, rather than depreciated! We are pleasantly surprised to find we can sell the sax for $7,000, which we quickly do. But as we walk away, counting our $2,000 profit, a thought stops us cold. We don’t just have a $2,000 capital gain on which to pay taxes. We have to add, into ordinary income, the total depreciated amount—$5,000. That results in a capital gain of $2,000, plus ordinary income (taxed at a higher rate) of $5,000. What’s more, even if the instrument did not appreciate and we sold it for $2,000, we would have ordinary income of $2,000, since we depreciated it down to zero.
Here’s another example of instrument appreciation. If you have old string instruments beware! In William T. Hunt’s excellent article on Polyphonic.org he writes:
In the past, the IRS has taken the position that old string instruments are antiques that appreciate in value and therefore are not depreciable. There have been several court cases involving this issue. The most recent rulings have maintained that antique instruments used in a trade or business are subject to the same wear and tear as any other property used in a trade or business, and therefore are deductible. Based on these court cases it appears, at least for the present, that all musical instruments, including old string instruments, are deductible as long as they are actually used in a trade or business (i.e., having the instrument in a display case or hanging on a wall would not satisfy this requirement). However, the IRS disagrees with these decisions and may still disallow the deduction outside of the judicial circuits where the cases were decided.
This discussion of depreciation has been from 40,000 feet. When you get down to street level there is much more to learn and absorb. For example, there are several methods of calculating depreciation. In my opinion, that is why you seek the advice of a tax professional.No comments
Office in Home
In our homes or apartments, musicians all have a room in which they practice or teach, but for that room to be considered a home office and deducted on our taxes, it must meet certain requirements established by the IRS. For example, that part of your home must be used regularly and exclusively:
• as your principal place of business for any trade or business; and
• as a place to meet or deal with your patients, clients or customers in the normal course of your trade or business; and
• in the case of an employee, the home office must be for the convenience of the employer.
If the room is used for any other purpose like watching television, playing pool or entertaining, it will be disallowed. The space must be used for business purposes only. For the musician who has a space that is regularly and exclusively used for teaching there is little question. It qualifies as a home office. But for a performing musician who uses the
space as a practice room there has been some back and forth—yes, no, yes. At the present time musician’s practice rooms do qualify as home offices. Again on polyphonic.org William T. Hunt writes an informative article detailing the back and forth history that musicians will find very relevant.
A home office can be very benefi cial to the musician. Calculate the square footage of the office then divide it by the total square footage of the home or apartment. That will give you the percentage of the home that is used for business. Let’s say that 10 percent of your home is used as a home office. You can then write off 10 percent of your home expenses to your business. Things like:
• Mortgage interest
• Property taxes
• Casualty or theft losses
• Homeowners insurance
• Rent payments
• Repairs and maintenance
If you make a capital improvement to the offi ce by painting it or putting down a new carpet, those expenses can be fully deducted. Home offices are a good thing. Tax audits are a bad thing! Keep impeccable records and make sure your particular room qualifies as a home office. There are other subtleties beyond what we have discussed here, so consulting a tax professional is advised.No comments