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HOW TO KEEP ALL
THAT MONEY
YOU AREN'T MAKING AT ART!!!
aka
How to run your business and do your taxes as an artist
By Green Dragon, Tax Goddess
Aka Christy
Nicholas, CPA, MA
1. WHAT STRUCTURE SHOULD I USE?
The first question to ask in setting up your art business is how you should
set it up - i.e., what structure it should have. This may seem like a silly
question, but it is a very important one, as it determines how you report
your income and expenses. And report them you must!
There are several types of organization to choose
from, and the determining factor is risk. How much risk are you willing to
take? Are you willing to pay more for less risk? I will demonstrate what
this means:
a. SOLE PROPRIETORSHIP
The most risky organization is the sole proprietorship. This is because if
someone sues you as a sole proprietorship, they can, theoretically, take
your home, your car, and all your worldly possessions in a lawsuit. There
is no separation between the business and you, so any lawsuit can take
everything. However, most art businesses have little lawsuit risk attached
to them. I am unlikely to get sued for damages unless I steal someone
else's art. (don't do that!) If I was installing stairs, on the other hand,
I would definitely want to limit my risk. The term for this characteristic
is 'unlimited liability.'
Now, there are advantages to being a sole proprietorship.
There is little to no cost in setting it up, no legal forms to fill out, no
paperwork to file with the state. When you report your income and expenses,
it goes on the Schedule C of your own personal tax return (1040), and isn't
taxed separately.
There are also disadvantages, such as the
aforementioned unlimited liability. There is also the fact that the company
has a limited life - when you pass away, so does the business. (Ask Disney
if this is important!). It is also more difficult to get financing from
banks and therefore difficult to expand.
b. CORPORATION
If you are willing to pay a little more money on a regular basis, you can
get the advantage of limited liability with a corporate setup. A
corporation is a separate entity from you as a person, therefore if it is
sued, only those assets owned by the company can be taken, not your
personal home and possessions. This is the main advantage of having a
separate corporation. It is also easier to expand, as banks are usually
more willing to offer financing for this. It can have a life beyond the
life of the founder, as many corporations have (i.e., Sears, Disney).
Now to the disadvantages; The main one is the cost and
complication of setting up and upkeep. There are fees to setting up the
corporation with the state (none for the federal government), and annual
fees to keep the license in good standing every year. In my home state of Florida, it is about
$75 to set up the corporation, and $150 a year to keep it going. There is
also additional paperwork, as you need to file a separate tax form every
year (1120 or 1120S) with the federal government. You may also need to file
one for your state. And, you may have to pay taxes at a corporate rate,
which is usually higher than your personal rate.
I would like to go into the differences between a C
corporation and an S corporation. C is the corporations we are most
familiar with - corporate monsters like Microsoft, IBM, Disney, Sears, etc.
These get taxed at a corporate rate, which is currently 15% up to $50,000
in profit, and goes up from there. An S Corporation (S stands for Small)
has to have less than 100 stockholders (among other requirements) but does
NOT get taxed at the corporate level. Let me repeat that - no tax is paid
on the corporation itself. Instead, the income gets reported on each
shareholder's tax return, and is paid at their personal rate. This is
usually the better deal for small companies, as personal returns are not
taxed at all for the first $7000 in income.
c. LLCs and LLPs
Many people ask me about Limited Liability Corporations and
Limited Liability Partnerships. These are both fairly new entities,
and as such, don't have (as of yet) their own share of rules
and laws by the IRS. The main benefit is, of course, limited
liability - which means your personal house is safe if someone
trips over your sculpture and sues you. However, you also get
that with an S Corp, and both can be either single member or
joint ownership between spouses. They can also have more members,
unlike a Schedule C, but until they've 'settled' in as accepted
entities, I cannot recommend them as corporate structures. Each
state has different rules for these entities as well, so if
you are interested in setting one up, you will want to consult
with a lawyer or CPA in your state.
d. Partnerships
Usually, art is not a partnership style of business,
but some of us are lucky enough to know the right person, and
trust them enough to go into business with them.
This person could be a spouse, a child or parent, or
a good friend. However,
do PLEASE set up the partnership rules in writing beforehand. Nothing ruins a relationship more easily
than arguments about money!
Partnerships file a 1065, and the business itself is
not taxed. Like an S Corporation, the profits are listed
on the Schedule K-1 and go to the partners' individual tax returns,
to get taxed there.
e. RECOMMENDATIONS
In my personal opinion, most artist would do best as a sole proprietorship,
unless there is a significant possibility of liability (i.e., you do 3D
installations that someone could trip and fall on). In that case, I would
recommend S corporations as the best alternative.
Since sole proprietorship is usually the most
beneficial to artists, I will continue the essay under the assumption that
this is the structure chosen.
2.
WHAT IS INCOME?
In the common usage, Income means (literally) any money coming in - whether
it be a loan from the bank, a paycheck from your job, a gift from Grandma,
or a sale of a painting. However, in the accounting world, many words take
on different meanings. This is one of them.
Income, for someone running a business, derives from
operating the business. If it's an art business, then sales from your art
business is your main form of income.
That income can have several categories, though; You
can have sales of existing art and art products, such as bookmarks, you can
have commissioned sales of art, and you can have sales of excess supplies,
or shipping, or display equipment. The majority of your income should come
from the first two categories, though.
COMMISSIONS
For those that are unfamiliar with commissions, it is
when someone contracts with you to produce a piece of art to their own
needs and desires, rather than purchasing art you created before you met
them.
CONSIGNMENTS
Another form of sales is consignment sales, which
involves placing your artwork in someone else's store, and only receiving
money when it is sold. Sometimes this is a gallery, sometimes a gift shop,
sometimes online - but the portion of income you receive is the only income
you declare, not the total price. For instance, if I have a print on sale
at the local gift shop for $30, and I get $20 from it when it sales (the
other $10 goes to the gift shop) then I declare $20 income from the sale.
SELLING OTHER STUFF
Sometimes an artist has too much of a particular
supply, and decides to sell off the excess on ebay, or doesn't need a table
anymore, or a particular display piece. This is called incidental income -
not something you do on a regular basis in your business. It's not the sale
of art, but it is slightly related. These sales are income, but not always
sales income - sometimes it's called 'gain' rather than profit. It's
reported differently only if you are selling fixed assets, i.e., your computer,
your desk, your display equipment. If it's just paint or brushes, it's
regular income. Sometimes size DOES matter!
SHIPPING
If you also charge shipping on your sales, this too is
considered income. The cost of your shipping shows up in expenses, and usually
these two cancel out. However, with the advent of so many businesses on
Ebay making their profits from outrageous shipping fees, this could come
back to bite you in no return customers if let out of hand!
SALES TAX
Many people ask how Sales Tax comes into play with income.
In reality, we never 'earn' sales tax - we merely collect it
and hold it for the state government. Whenever we make a sale
that is taxable, we collect the sales tax. Once a month, or
once a quarter, or sometimes once a year, we tally up all the
sales tax we SHOULD have collected and pay it to the state.
That SHOULD is a very important word! If you did not collect
sales tax, but should have, you are STILL liable to pay it to
the state, out of your own pocket.
Also, the sales tax is defined by where you are
conducting business in most states. For instance, if I sell
something on my website, and my business is in Florida, I charge
Florida sales tax for my county to someone I sell to in Florida.
If it is across state lines, Florida law says I don't have to
charge sales tax. That may change in the future, though. If
I move my place of business - like setting up a booth in Georgia
- I charge and pay Georgia sales tax. Some states (like Georgia)
have a one-time special event tax form so I don't have to register
to do so. Some don't, you will need to check! If I sell at a
booth in another county, I have to charge their sales tax rate.
Since Sales Tax is not income, when we collect it we
do not include that as income (thus we don't get charged income tax on that
money). It's not an expense that we can deduct, either… it doesn't go
on the federal income tax return at all!
CONCLUSION
All in all, income is any money coming in that is a
result of a business transaction in your business. That sounds complex, but
it helps differentiate between things that aren't income - like a gift from
your dad, or a loan from the bank. Those aren't income, and you don't pay
taxes on it!
We wouldn't want to be paying Uncle Sam MORE than he
is asking for, now, do we???
3. HOW DO I VALUE INVENTORY?
Inventory is one of those mysteries of the accounting world, an esoteric
subject fit to backroom discussions by candlelight and adding machines,
right? WRONG! Inventory is a very simple concept - the cost of the stuff
you have that you can sell.
INVENTORY
Inventory can include any number of things, but they should be things that
can be traced to a particular piece. That means that you can include the
canvas, paper, frame, matboard, and hanging hardware that you bought for
that painting - but not the paint itself. The reason is that this tube of
Titanium White has been used to paint on 12 other paintings, and is still
only halfway used. There is no easy way to attach the cost of the paint to
a particular piece, so it is instead deducted as 'supplies expense', along
with the paintbrushes, turpentine, disposable pallet pages, etc.
If, however, you use 4 buckets of gesso for one installation, that can be
traced to one piece, so you can use that as an inventory cost.
So, the cost of one of my digital prints would NOT
include the computer, or the program, but would include the cost of
printing, the matboard, and the bag. It wouldn't include the ink from the
pen to sign it. Be reasonable, and you'll be ok.
This inventory cost is usually counted at the end of
the year. The amount you have in inventory is the cost of each item you
have that is ready for sale, plus unfinished pieces, which are considered
'work-in-process' inventory. Also include items that will be used for such
pieces, like blank canvasses and uncut matboard, etc.
On your tax return, you list a beginning inventory amount (the amount of
these items you had at the beginning of the year). You add the cost of
purchases during the year, and you subtract the amount of these items you
sold (at cost, not at sale price!). The ending figure should match how much
you have on hand at the end of the year. If not, you make an adjustment so
it does - this is breakage, spillage, spoilage, loss, etc. and can be
deducted as an expense.
By structuring it this way, the expenses for inventory are only deducted
when the item is sold, as opposed to when the items were purchased. This is
an important difference to the IRS!
Here's an example to illustrate:
At the beginning of the year, I had $120 in inventory, mostly matted and
bagged prints. I bought $800 in new prints, $200 in mats and bags, and have
assembled most of those into salable pieces. I have sold $500 worth of
these items (that is the cost, NOT the sale price!). Based on this, my
ending inventory should be $120 + $800 + $200 - $500 = $620
I have on hand at the end of the year $500 worth of
salable items, and an additional $100 in unused mats. That means I have on
hand $600 worth of inventory.
The difference between $620 and $600 is represented by
10 prints that were damaged in shipping, and I can write those off as
Spoilage Expense. My cost of goods sold is $500 (this goes on the tax
return, as well as the beginning inventory, ending inventory, and
purchases).
SUPPLIES
As I mentioned earlier, items that are used for many pieces are supplies,
not inventory. They are deducted when they are purchased, rather than when
they are used.
Supplies typically include items used up over the
course of time, such as paints, inks, regular paper (office supply rather
than photographic paper), pencils, pens, erasers, tape, etc. You get the
idea. Also, these are typically low cost items, where it would take more
time to keep track of the cost than the deduction is worth!
WAGES
One of the quirks of a sole proprietorship is that you, as the owner,
cannot deduct wages for yourself. You can pay someone else and deduct
those, but you simply take extra cash out of the company funds as a
withdrawal - this is not deductible. If you are paying someone wages and
they are directly responsible for creating inventory, you CAN include that
portion of their wages in inventory cost. For example, you create painted
vases - you have three apprentices doing the base work for you, prepping
the vases for your master's touch. Their wages can be added to the
inventory cost for the vases they prepare.
TIMING AND CASH BASIS
Timing is an important concept in the creation of inventory,
and the sale thereof. The IRS likes to see an expense taken
in the same month that the sale it is associated with is made
(thus inventory). If you sell an item in December of 2008, and
the payment is collected in January 2009, then you should record
the sale in 2009 - and the associated inventory cost of goods
sold. This is called 'cash basis' as opposed to 'accrual basis'.
Most sole proprietors and S corporations are on cash basis accounting.
Accrual basis accounting is when you made that sale in
December 2008, reported it in 2008, and listed it as a receivable
- a sale that is made but not paid for yet. When the payment
is made in 2009, it is not a sale, but a payment of the receivable.
Cash basis is much simpler, and therefore much more common
in sole proprietorships.
When you have inventory, you are on 'modified cash basis', and that is the
preferred method for sole proprietorships, and the one I have found works
best with artists.
4. WHAT CAN I DEDUCT AS EXPENSES?
There are several things that people get confused about when considering
what can be deducted on a tax return for your business. I will attempt to
cover those items that cause the most questions.
EQUIPMENT
One of the most confusing areas is equipment. According to the IRS, if a
piece of equipment is a substantial cost (i.e., more than $100) and will
last more than one year, you should 'capitalize' it. By capitalize, they
mean list it as an asset, and take the expense as a deduction over several
years, rather than all in the year you purchase it. This is called
depreciation, and has several rules to follow.
Equipment can include computers, mat cutters, display
booths, desks, software, any number of things. The main point is that it
should last longer than one year. Do not include consumables such as pens,
paint, paper, brushes, even if they last longer than one year - the cost of
these are minimal and it is a waste of time and paperwork to keep track of
them.
For example, I purchased a booth to display my art at
art shows. The booth cost $700. I plan on getting several years worth of
use out of it, and the IRS says it's furniture (ok, sort of!) and
therefore, according to a list they maintain, it should be used up in 7
years. Therefore I take the total cost ($700) and divide it by 7, getting
$100. This is the amount I deduct every year for 'depreciation expense' on
that item.
Many of you have heard of Sec 179 depreciation. That
is a special rule by the IRS that says you can take the whole
cost of such an item in the year you purchased it. That is ONLY
allowed if you are making a profit. For the example given, the
entire $700 would be taken the year it was purchased.
Recently, the IRS has also added a 'bonus
depreciation' rule, where you can take 50% of the cost in the first year
(whether or not you make a profit), and then deduct the rest over the next
7 years as before. For the example given, you could deduct $350 the first
year, and then $350/7 = $50 each year for 7 years thereafter.
Furniture and fixtures are considered 7 year property,
while cars, computers and other electronics are 5 year property. For other
items, you can check out www.irs.gov for the list.
TIME/WAGES
As mentioned previously, you can deduct wages paid to someone else, but not
to yourself. Wages you take yourself are not deductible, and are considered
a repayment on the loan you gave the company to start up.
If you have set up as a Corporation, however (C or S),
you CAN deduct your wages - and you must declare them as income on your
personal return. This is usually a wash.
TRAVEL AND MEALS
This is one of the more controversial aspects of IRS law and business
deductions. The rules are fairly simple - it's the interpretation that's a
bear!
You can deduct the costs of travel if you are
primarily there on business. If there is some business and some pleasure,
you should prorate the costs. For instance, I go to Dragoncon every year.
If I didn't have my art in the art show, I would still go, so there is some
pleasure factor. However, most of my time is spent in or around the art
show, either setting up, tearing down, attending panels, helping the art
crawl, schmoozing with other artists, etc. In my interpretation, I spend
80% of my time on business - so I feel justified in deducting 80% of my
costs (not my husband's costs!!!!) of the trip.
That would include transportation there (we drive, so
it's actual gas expense or mileage at $48.5 cents a mile), the hotel room,
the fee for renting the panel, the fee for attending Dragoncon, and 50% of
MY meals there (again, not husband's!).
This is always a sticky area, as it's hard to prove
I've spent my time in art-related activities. However, the fact that I keep
my receipts, record my mileage, have art at the show, and keep my records in
a business-like manner will prove to the IRS (should I ever get audited)
that I approached the show as a business expense. It is still up to them to
say yea or nay, but I've got a great case, so to speak.
Other expenses you can take in this area are fees for
art shows and galleries, networking club dues, travel to such club
meetings, client meetings, and installations. You can even deduct the
mileage on trips to the craft store! If you are staying overnight on
business travel you can deduct REASONABLE expenses for hotel and meals.
Any deductible meals are only allowable at 50%, and should be directly
related to the business, i.e., entertaining potential or existing clients,
or traveling on business.
HOME OFFICE
This is another area filled with confusion, but the
IRS has gotten more and more lenient in this area over time, due to the
increased popularity of telecommuting in today's work environment.
However, you still need to have an area of your home
devoted to art production to deduct the expenses related to it.
For instance, I have a room in my house that has my computer, my art
supplies, my inventory, and my business records. I conduct most, if not
all, of my art business at home in this area. Let's say it is a 15X15 room
(225 square feet), and I have a 2250 square foot house. That means I have
225/2250 = 10% of my house dedicated to the business - we use that
percentage to prorate the indirect expenses.
Indirect expenses are those that are paid on the whole
house, including mortgage interest, real estate taxes, utilities,
homeowner's insurance, rent, house repairs, etc. All of these get added up,
and 10% of them is deductible.
Direct expenses would include a dedicated business phone line, repairs or
utilities that are for the dedicated work area alone, etc. These are
deducted at 100%. (i.e., the window in your studio was repaired).
If you have a net loss on your business, the
deductions for home office expense can't be taken that year, but can be
carried over to next year's tax return to be deducted when you DO have a
profit.
A small percentage of depreciation on your house is
also deductible, based on the value of the house and the land.
OTHER EXPENSES
There are several other expenses that can be deducted that many people
don't think about. Here are some of them:
Health insurance for the artist can be deducted, and it is usually better
deducted for the business (self-employed health insurance deduction) than
on the Schedule A, where it is limited by your income level. This is one of
those deductions you can only take if you've got a net profit.
Advertising - including mailings to your mailing list,
business cards, etc.
Business insurance - something very important. This is
separate from health insurance!
Legal or professional services - including the costs
of setting up the corporation and doing the taxes each year.
Office supplies or rentals - do you have a water
cooler? Postage machine? How about a credit card machine?
Rent of space or equipment - definitely deduct rental
trucks or space fees. The booths at the art shows, if they are rented, and
the space itself, certainly!
Repairs or maintenance of equipment - yes, this
includes your computer if you use it for business! If it is also used for
personal things, you should again prorate it. If I use my computer for 90%
business, I can deduct 90% of the repairs.
Taxes and licenses - property taxes, business
licenses, those can all be deducted. Sales tax, however, is NOT a business
expense - nor is it income when you collect it. Technically, it is
something you collect and hold in order to pass it on to the state
government.
Taking responsibility for running your own business is
a big step, but it can be done with a little organization and education.
When you are out of your depth, contact a professional and let them help
you. Most artists are afraid of the business side of art, and that is
understandable. However, the more you know the better you can understand
how the business works, and the more you can devote your time, energy and
creativity to forming the art you love.
5. What are some websites that can help me?
a. Small Business
Association
b. Infernal Revenue Service
c. More info on
artist's taxes
d. Should you
be an employee or a contractor?
e. Schedule C for your
Form 1040
f. Email
me if you have any other questions… I do taxes for
artists, and can do everything long distance via
email!
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