2009 Income Taxes: Changes for Artists, Performers, and Writers

For many artists, performers, and writers, income taxes are especially loathsome, and in recent years, the Internal Revenue Service (IRS) seems to be making the process even scarier. The IRS has announced that it is starting a special initiative to audit individual income tax returns with Schedule C’s that show a loss. (The Schedule C is the tax form most artists use to report their business income and related expenses). Additionally, the IRS has stated it plans to focus on certain industries in these audits, including craft sales, photography, art, and writing. Therefore, artists, performers, and writers need to be extra diligent in their record keeping.

Thorough Documentation is Key

Let’s start with the basic issue from the standpoint of the IRS. In order to file a Schedule C—or other business income tax return—you must have a profit motive for conducting the trade or business. If the IRS deems that there is no profit motive then what you have is a hobby. The reason this distinction is so important is that if you have a trade or business you can deduct your art-related expenses from your art income, and if you have a net loss you can net the loss against other income earned by either yourself or your spouse (if married), thereby reducing the amount of income subject to taxation. But if you are deemed to have a hobby then you must include any income in your taxable income, but the related expenses are not deductible unless they exceed 2% of your Adjusted Gross Income and you are able to itemize you deductions. Most people will not be able to deduct their hobby-related expenses. 

In general, if your business has a profit in three out of five years, the IRS will allow you to deduct the losses incurred in the other years. But as many of you already know, it can take many years of losses before an arts business shows a regular profit. Therefore, artists are subject to a higher level of documentation than most other businesses. I strongly recommend you keep an annual journal documenting your attempts at making a profit from your art, performance, or writing business. You should note the date and then list all activities you performed that day for your business, along with how much time the activities took. For example, it is not enough to note that you spent eight hours painting or practicing dance. You must also note when you research exhibition, performance and publication opportunities, grant opportunities, and artists-in-residence opportunities. You must also note meetings with potential customers. You should keep copies of all applications, attaching the resulting acceptance or rejection notices. You should keep business cards of agents, gallery owners, museum curators, musical directors, etc. Note on them, and in your journal, where you meet, when, and a summary of the meeting.  Make notes in your journal even when your research time does not produce any applicable opportunities. Document any other activities you engage in to ensure a profit in your arts-related business, including marketing, direct sales, and actual exhibitions, performances, and publications.  Keeping this level of documentation will also assist you in running your business more effectively. 

In addition to keeping a journal and records, you must conduct your arts-related business in a professional manner. You should have business cards printed, promote your business, maintain a website, invoice your clients (this is especially important for those of you who freelance, such as graphic artists and musicians), carry the appropriate insurance, and maintain current accounting and legal records. Like non-arts-related businesses you must review your sales strategies and make changes as needed. 

Business vs. Hobby: Classifying Your Work

The IRS has nine factors for determining if an activity is a trade or business or hobby, so no one factor will determine how your business will be treated. If you are painting one day a week, only submitting work to the same one or two shows a year, and never selling any work, the IRS will view your activity as a hobby. On the other hand, if you are painting several days a week, constantly applying to shows and for grants, re-evaluating your exhibition venues regularly to determine where your work sells, insuring your studio and your work, and performing a monthly accounting of your income and expenses, the IRS will be more likely to view your activity as a business, even if it shows a loss. 

Another area of taxation that is under both federal and state scrutiny is worker classification. The federal government has announced that they will be performing 6,000 employment tax audits over the next three years. In general, they will be looking to reclassify independent contractors as employees. This initiative will impact creative workers in two possible ways. First, if you are someone who works as an independent contractor you will want to review your situation to ensure your independent contractor status is appropriate and documented. If you have worked for someone as an independent contractor and the IRS reclassifies you as an employee, you could lose the benefit of the expense deductions you took on your Schedule C (or related business tax return). This could result in you owing significant back taxes, and possibly interest and penalties.

Second, if you hire independent contractors to assist you in your creative business you must be very sure they qualify as independent contractors. If the IRS determines they were actually employees you could be required to pay all withholding and payroll taxes personally, even if you operate your business as a corporation or a Limited Liability Company. Additionally, you could be subject to penalties of 100% or more of the taxes due. 

The IRS relies on 20 common-law factors established in 1987 to determine of someone is an employee or an independent contractor. These factors fall into three main categories: behavioral control, financial control, and relationship of the parties involved. The burden will be on the taxpayer to show that they are in fact an independent contractor. Whether you are the person hiring the contractor or you are the contractor, you should document your arrangement with a contract. It does not need to be complicated but it should outline the rights and responsibilities of the parties involved. An independent contractor controls where, when, and how they do their work. They may have the right to hire others to do the work or assist in the work. They purchase their own supplies, provide their own tools, and are responsible for their own training. An independent contractor has some financial investment in their business and bears some risk of financial loss. Additionally, an independent contractor works with several clients. If someone works only for one person or company for the entire year they will likely be classified as an employee.

IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the United States Treasury, we inform you that any tax advice contained in this article was not intended or written to be used, and cannot be used, for the purpose of 1) avoiding tax-related penalties or 2) promoting, marketing or recommending to another party any tax-related matters addressed in this communication.  Please consult with a tax advisor regarding your specific situation.

Julie Herwitt is a Certified Public Accountant and a working artist. Thus, she brings a unique perceptive to the tax and accounting needs of her creative clients. Julie has worked as a CPA for more than 20 years. Her practice focuses on the tax and accounting needs of small businesses and individuals with a concentration on artists, musicians, and performers. She can be contacted at 708-890-2545 or julieherwitt@sbcglobal.net. Her artwork can be seen at www.julietteherwitt.com.