Financial Management for Musicians' Author Offers Tax Tips (Part II)
Cathy McCormack The better your records are, the less the cost. Sometimes we have to find court cases to prove the IRS does not know what they are talking about with our clients.
[Question] Whether you are acquitted or not, those fees are your responsibility and not deducted from your taxes- right?
Cathy McCormack It is tax deductible if you have to pay an accountant to represent you. Cost versus benefit - nine out of ten times you are better off with an accountant on your side. You are not going to know how to negotiate or what to look for when dealing with the IRS.
I had a client recently that if he would have represented himself and not know the laws about schedule E and Schedule C, he would have owed the government about $25,000. Instead, he owed them $1,000. My fee was nominal in comparison of how much I saved him in the audit. I try hard to make the client do the legwork so they do not have to pay me to calculate their receipts, mileage and expenses. You do not want to have to pay me $200 an hour or my staff at $60 plus an hour to run a calculator when you can do that yourself. I am very conscientious about keeping fees down for my clients. It is my job to save you money, even on accountant fees.
[Question] I use Quicken and have my receipts. What do you need to see for my records if I came to you?
Cathy McCormack I do not need to see your receipts unless there is an item that I need to break down, such as equipment that you buy. We sometimes make what we call section 179 election. The tax code that allows you to write off equipment for the full purchase price in the year that you buy it. It is a wonderful thing as they have been increasing the limits as we go along. The limit is getting ready to go up to $100,000.00 a year that you can write off, as long as you have earned income to write off against it.
We have to have the details of your equipment, whether we make that election or not. If you put good details in your Quicken, the report will tell me what it is that you are deducting from your taxes. If you know you are going to have a nice income coming forward, you can go ahead and make the election, knowing it is not going to benefit you until next year. I have clients going to buy these big SUVs that they use for at least 50% business and writing them off on their taxes.
[Question] When I show a positive Schedule C income, what percent of that can I apply to my IRA?
Cathy McCormack There is an algebraic formula when you are self-employed. It is 25% of your income, but because you have to subtract from the income, it actually becomes 20% of your net profit on Schedule C. It used to be 15%, which actually algebraically became 13%. It has recently changed to the new figures on Schedule C.
You can now do a one-person 401K. If you see that you are going to make a lot of money the next year, you may want to go ahead and set up a 401K. That law was new in 2002. If you had up to $12,000 profit for the year, you can put that amount in your 401K. This is ideal when you know you are going to have a huge year.
Cathy McCormack That is probably one of the area that most people are the weakest in keeping records - everyone hates to keep mileage logs. Unfortunately, the mileage logs are the only perfect way to support you in an audit. You do not have to write down your odometer reading every time you are in and out of the car -- just the business miles for the trip. You do need to write your odometer reading on January first and December 31st.
For your business miles, use your trip counter to track the daily miles. If you are going to 10 places in one day, just write the list and your mileage for the day. Write down where you went and the business purpose of the trip. I keep my business purpose written in my calendar and where I went in my mileage log.
There are two ways to expense your car. You can use the standard mileage rate in effect for that year or your actual expenses at the time of your business percentage usage. The problem is you still have to keep a log either way, because you have to calculate how much you are using your car for business. I use credit card for expenses, and import those charges and records to my Quicken program. It can get you in some deep debt too, so be real careful. I pay my credit card off every month and download my transactions enough to know what I am spending to make sure that I do not overspend. You have to monitor yourself or you will get in trouble with the credit cards.
[Question] I use a Day Runner to write down every day where I am going, the mileage logs and gas expenses. Is the OK?
Cathy McCormack There are a million ways you can keep track of your miles and expenses. I have a lot of clients that spend a lot of time and miles on the road. They may get one of those expandable files to keep their expenses and I have some that just won't keep the records. I just give them an envelope and at the end of the year, someone will spread the expenses out. Put them in stacks by category and pile them up. You have to find the method that works for you. The key is keeping the receipts and the proof of your expenses. You have to think that if this is in any way a business expense, that you are keeping that receipt. It is lost money if you throw the receipt in the trash and it can add up over the course of a year!
[Question] Working out of your home office, what should we look for in writing down expenses?
Cathy McCormack Using your home, you can deduct a percentage of your rent and all the expenses in relation to where you are staying. You must have a room that is designated 100% business, cannot be multi-use, and you cannot have a bed in the room. You may also write off a percentage of your utilities, insurance and rent. Those items are what we call operating expenses. If you do not have profit, they are not deducted, but they are carried forward.
With respect to your telephone expenses, they go right on your schedule C for business deduction. The government says that the first phone line in your home is personal because all households have one, and you will have it whether you have a business or not. Any features that you add to the phone are tax deductible 100%. Your cell phone is considered a second phone, even if it is multi-use. It is your second telephone and 100% write off. If you do not have a landline phone, just your cell phone, you will have to allocate it based on business and personal calls. You can ask the cell phone company to give you detailed billing. You go through and highlight the business calls. The key to taxes is keeping records as organized as possible!
[Question] Are there other home office deductions that we can claim for our taxes?
Cathy McCormack If you own your home, the property tax and mortgage interest is deductible regardless of whether you have a loss on your schedule C. There are several reasons that you want it on your Schedule C. One in particular relates to medical expenses. Some of the expenses, such as medical that you deduct on your return the limits, are based on your adjusted gross income. When you have Schedule C, that income or loss impacts your adjusted gross income on page one of your 1040. You want that number to be as low as possible. Whenever you can put something on your Schedule C, you want to do it.
[Question] I have a one-bedroom apartment. Do I need to partition it off to write the deductions on my taxes?
Cathy McCormack Some people use their dining room or a little nook that can be written off as you have your computer and desk in the area. Measure off the space, even though you rent it.
[Question] If you have a DSL line or cable Internet, can you write those off?
Cathy McCormack I have cable and Internet and write 100% off on my taxes. Your cable for your TV is NOT going to be 100% deductible. Most musicians write off 50% of cable and those in the TV production business tend to write of more than 50%. We us usually categorize Cable as research - MTV, CMT, GAC - and those types of programs. The cable for your computer is a 100% write off. Also - if you buy CDs of other artists for research, you may write off 100% of the music purchases. A musician's CD collection is ten times what a normal person would have, and is most definitely used for research.
[Question] Where do you list CDs as expenses?
Cathy McCormack On the second page of Schedule C there is a place to put "other deductions" that do not fit into any other category - write down research.
[Question] Demo costs are astronomical and I list them as professional services. What do you recommend that I list demo cost in what category?
Cathy McCormack If they are not much money, I write them off as demo costs under the "other categories." However there is a rule that demo costs are supposed to be capitalized and amortized over the revenue stream. A lot of people have no revenue stream or no determinable revenue stream. There is what we call a Safe Harbor election that you can make to amortize those costs over a three-year period. You get 50% of the demo cost in the first year, then 25% and 25% the following years.
[Question] What is the category "Professional Services" used for in the tax forms?
Cathy McCormack They are used for a lawyer, accountant, songplugger, or consultant that you hire for your business. You do not want that number to be astronomical or it will go into another category.
[Question] Do you 1099 the songplugger and your accountant?
Cathy McCormack You are actually supposed to 1099 your accountant, lawyer, and song plugger. If you hire someone to fix equipment, you are supposed to give him a 1099 form if he makes more than $600.00 from doing business with you.
[Question] How much is the Quicken program?
Cathy McCormack I just got the 2004 version personal version for about $60.00. Something else that I should mention regarding credit cards. When you charge the item, it is deductible when charged, not when you pay the bill. This applies if you charge an item in November, and maybe pay the bill in January. Write it off for the previous year - when you bought the item. Go shopping on December 31st, put it on your credit card, and pay for it the next year. Health insurance is also deductible if you are self-employed and that comes off before your adjusted gross income. However, you must have profit on your Schedule C or it will have to be reported on Schedule A as medical deductions.
[Question] I have paid my quarterly tax bill late this past year. How does that affect my reputation with the IRS - do they flag me?
Cathy McCormack They do not flag you, but charge you interest for late payment based on the number of days that you are late. I always check the IRS penalties, as I have caught them using the wrong figures to penalize some of my clients.
[Question] If I go to lunch with a co-writer, can I deduct our lunch off my taxes?
Cathy McCormack Yes, you deduct half of it, but keep the receipt, even for meals under $25.00. The only time you do not have to have the receipt is when you are on a per diem. Per Diem is deductible for overnight travel only. Travel days are included if it takes you overnight to get to your destination. The IRS website has downloadable per diem amounts for you to use. Each city has it's own per diem rate, so be sure to use the IRS information. Hotels are fully deductible and meals are only 50% deductible.
[Question] I have events for songwriters at my house. What do I need to show that this is not ordinary household expense for the extra food, paper supplies, and beverages?
Cathy McCormack Keep a record of your invites, print out of the invitations, and take notes on how many you are planning on having for the events. That is fully deductible, it is not entertainment. Call it a networking meeting event. It would go under "Other" on your Schedule C, and call it whatever creative name you want to call it.
[Question] What are the most common mistakes songwriters make for their taxes?
Cathy McCormack Probably not keeping good records. I have one client that it is difficult for her to keep receipts. I tell her that if she does not have a receipt, it does not exist and I cannot pull it out of the air. We dig through her wallet, purse and pockets to find receipts. It is the hardest thing to get clients to do - receipts. You need to develop those good habits to keep your records of your expenses. Seek qualified advice to make your decisions. Peers are good to help conjure up questions, but make decisions from advice of a professional.
The Songwriters Guild of America Nashville Office recently hosted a tax and accounting seminar with Certified Public Accountant Cathy McCormack of Nashville, TN. Cathy McCormack is co-author of the book, "Financial Management for Musicians," (Hal Leonard) by Pam Gaines and Cathy McCormack. Many of McCormack's clients are musicians and songwriters. "Financial Management For Musicians" is the title of the book, but she says it is really more about organizing your financial life for what she calls this business of music.