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Taking the Sting Out of Taxes
by Mike Grebb.

This article first appeared in The Musician's Atlas' April 2006 Atlas Plugged Newsletter and is used by permission. The Musician's Atlas is a fantastic resource for musicians, containing over 30,000 music business contacts.


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With April 17 now behind us, many of you just looked back upon the last 12 months and exclaimed, "I owe what??!!" Settle down. You should be so lucky to owe taxes. It means you're making money (always a good thing). But for artists, indie labels and other cash strapped music biz entrepreneurs, tax time is never easy-especially when you had to spend most of what you made just paying for living expenses. So here are a few things to consider as you're filing for extensions or making resolutions for next year....

Keep Your Receipts & Write It Off
Many musicians can be especially lax about writing off music-related expenses throughout the year. That's really no different than digging into your wallet and throwing money on the ground as you skip giddily down the sidewalk.
Christopher Knab, a Seattle-based music business consultant, says artists must think of themselves as businesses and take the same write-offs that any business would take. But make sure it's really a business expense! The IRS defines such expenses as "ordinary and necessary" to the business. Here are a few standard write-offs, according to Knab:

  • Instruments, equipment, accessories
  • Consumables (guitar strings, etc.)
  • Subscriptions to trade magazines
  • Sheet music and "How-To" books and manuals
  • Promotional: CD/tape duplication (for demos), photos, bios
  • Office supplies: paper, envelopes, photocopies, stamps
  • Fees related to maintaining your website and e-mail access for your music-related activities
  • Rent for storing your gear and for your practice space
  • Music association and union memberships
  • Professional fees (attorney, manager, agent, accountant)
  • Copyright and registration fees
  • Lessons and instruction
  • Travel expenses
  • Losses by theft

Find A Pro In The Know
Music business books and directories are also fair game as write-offs. Keep in mind that some expenses can be deducted in full, while others can require a depreciation schedule (basically, this forces you to spread the write-off over several tax years rather than taking it all at once). Consult a qualified expert like a tax accountant, to walk you through all the particulars. Never rely on your own intuition or what you've read here or anywhere else. Each situation is different!

Experts are also good at finding write-offs you wouldn't have even known about otherwise. Peter Irvine, a Northampton, Mass.-based musician and attorney, likes to spread the word about some of those little known tax benefits. Did you know, for example, that you can choose to use a "per diem" system that allows a flat per-day meal deduction in each city? The IRS allows different per diems for different cities, and the system can work in your favor if you frequent high-cost towns and eat cheaply. "If you play a show in New York City, you can deduct more food costs than you might actually use," Irvine says. Per diem rates are available at the General Services Administration Web site.

Another one of Irvine's favorite deductions? The home office. He says that even if you're on the road constantly and only use your home office for "administration," you can still write it off. "People are leery of the home-office deduction because it's a red flag to get audited," he says. "But there's a legal way to do it." Of course, a touring band also needs to have an official residence to get these travel write-offs. So while you might be saving some rent by living out of a van, you also might be giving up even bigger tax write-offs.

Beware: Auditors are on alert for anyone associated with the music biz. Irvine says the IRS actually provides agents with an entire pamphlet explaining the "funky accounting" of the entertainment industry. The federal government probably isn't out to get you. In fact, there are countless legal ways to reduce your tax bill-especially for touring artists. But you have to be smart. "Keep track of stuff," says Irvine. "Unless you're on a major label, you shouldn't be having to pay much in taxes."

Invest In Your Future
Experts advise artists of all levels and incomes to spend less time complaining about their financial situation and more time strategizing. That includes not only tax planning, but also ensuring that money is available when times get tough.

In a way, the music business is a crap shoot for most people trying to make a living with their art. No pension. No job security. No steady paycheck. Managers and booking agents, who depend on getting a cut of artist income, have similar cash flow problems. And while labels may get first dibs on that income stream, they often face expenses and delayed payments from distributors-creating many of the same problems.

The bottom line is that everyone-from the incorporated entity to the sole proprietor-must have a plan. "Organization is really the key," says Michael Hamrick, divisional V.P. for the Southern Division in AXA Advisors' Nashville office. He says everyone has to resist the urge to spend everything they make-no matter how small the amount. Always take a little bit off the table before you pay yourself. "It's about getting the fundamentals set up," he says. "You have to make sure there's an emergency fund. The money doesn't always come in when you need it." Savings mitigate risk. "If income is low one month, you've got some resources you can tap," he says.

Okay. I can already hear the chorus of skepticism. Artists get especially offended when people tell them to save more, primarily because many live on a shoestring budget already. But think about it. Are you really making those little sacrifices here and there that will ensure your financial future? Everyone needs a backup plan. Even more important, everyone needs a "retirement" plan as well.

Hamrick can recount stories about songwriters and artists who made it relatively big (at least for a while) and simply wasted that once-in-a-lifetime income rather than devising a smart strategy to make it last. "They had half a million dollars fall in their laps," he says. "They buy the big house, buy the nice car, pay their taxes, and it's gone. Then they're working at Guitar Center. It happens. It really happens." Hamrick is among financial advisors who specialize in working with music-industry types, especially artists. He says too many people don't even know the savings options available to them. Many of these options are great ways to avoid taxes that can eat away at your hard-earned cash faster than you might imagine.

Find A Plan That Can
There's always the Self Employment Pension Individual Retirement Account, or SEP-IRA, which allows self-employed folks (i.e., most artists, managers, etc.) to shelter up to 25 percent of their income from taxes (up to a $44,000 maximum in 2006). That's pretty powerful. Better yet, the plan is a cinch to set up. Any bank or brokerage can help you out. You can either hire a tax advisor to figure out your maximum (the 25 percent thing isn't as simple as it sounds. The actual percentage is usually lower and depends on several factors). And if you can't spare the maximum contribution, SEP-IRA and other plans allow you put in as little as you like. Every little bit helps when you're planning for the future.

And there are other plans that are winning converts because of their flexibility and their ability, in some cases, to shelter more income. Hamrick, is a fan of the recently enacted "owner's" 401-K, which works much like the SEP-IRA or 401-K plans that many people have through an employer. It's specially designed for small business owners and sole proprietors.

The owner's 401-K allows a self-employed person to set aside up to $15,000 of 2006 income as a "salary deferral"-no matter how much money he or she earned during the year. You could theoretically defer every cent of that if you so desire. Better yet, Hamrick says you can devote some of those $$$$s to a Roth 401-K, which gives you no tax benefit now because you can only use money you have already paid taxes on. But when you withdraw it years later, you don't pay any tax on the gains. That adds some flexibility that's not available with a SEP-IRA.

The owner's 401-K also allows you to shelter up to 25 percent of your remaining income as a profit-sharing contribution (20 percent of the net for unincorporated businesses, which covers most musicians and artists). The only catch is that the total deferral (salary and profit-sharing) can't exceed $44,000 in 2006. Not a problem for most of us, right?

Now, for those who find sacrificing $15,000 of income difficult enough, setting aside even more money might not be a realistic goal. But if you're having a good year (or string of good years) and don't really need to treat yourself to a new car or that gold-emblazoned custom guitar, why not defer gratification and put some of that money into a profit-sharing fund? Instead of spending that extra money, you're taking it off your balance sheet, sheltering it from taxes and making sure it's there for your future when money might be quite a bit tighter. If you're over 50, there are catch-up provisions allowing even bigger contributions. And for older artists who are making nice, stable coin, other options-such as defined benefit plans-can shelter even more income from taxes.

Each person needs to carefully consider what retirement plan will work best for them. The owner's 401-K, for example, can involved higher fees and greater restrictions on investment (being limited to certain mutual funds, etc.) than a SEP-IRA. Make sure to ask your financial advisor about all of these things before deciding.

The Bottom line: Get some advice.
No matter how much it pains you, hire a lawyer, accountant or financial advisor to help you figure this stuff out. It's not as expensive as you might think and you'll lower your chances of screwing something up, which can lead to interest and penalty charges with the IRS. "Before you start writing checks," advises Hamrick, "you have to make sure you work with your tax advisor professional" (a good tax accountant might cost you only a few hundred bucks).

Yes, Hamrick and other financial planners have an interest in saying that, but that doesn't make it untrue. This stuff is complex. If you have trouble just keeping track of mileage on the road, attempting to set up your own a retirement plan probably isn't the wisest move.

-

(Mike Grebb is a writer, journalist and singer/songwriter based in Washington, D.C. He has written for numerous publications, including Wired and Billboard. His debut solo record, Resolution, is available at www.mikegrebb.com, as well as digitally on iTunes, MSN Music, Musicmatch, Yahoo! Music Unlimited and other sites. And you can also be his friend on MySpace! www.myspace.com/mikegrebb).


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