Stay on Top of Taxes Why Good Records are Important
Taxes make everyone a bit nervous. What can I deduct? What do I have to pay? Did I fill out all the right forms?
With artists and craftspeople, there often are two areas in which that nervousness comes to the fore: The first is proving they are professionals and not hobbyists, which is a real problem for people who do not rely on sales for most of their income. The second is collecting and paying taxes to buyers in other states.
Let’s start with the hobbyist issue. Defining who is an artist is not easy, and it is no easier to determine what makes an artist a professional. Is it seriousness of intent, an art school degree, membership in an artist association, being an art instructor, sales of art, or the verdict of some critic?
There is no one answer, but what helps artists in both instances is if they maintain good records of their work-related expenses. This includes such expenses as price of materials, studio rent and insurance, travel expenses, advertising and promotion, photography, postage, shipping, and sales.
Good records, as well as filing returns with the IRS on time, are the hallmarks of treating artwork production as a business. If the IRS believes someone is just a hobbyist rather than in business, those deductions will not be allowed.
“Unfortunately, when this issue rears its head, the IRS agent often views the artist and Fred’s Corner Hardware store in exactly the same light,” said Peter Jason Riley, a certified public accountant in Newburyport, Massachusetts. “In the same way he or she examines Fred’s hardware store, the IRS agent will look at your career in the arts as strictly a business proposition, so you will need to clearly prove that you have a profit motive. The heart of this matter is that you have to show that you are attempting to make money. It’s that simple. Your records need to show clearly a concerted, consistent, ongoing, business-like effort to land the next acting job, sell the next article, publish the new book, get the gig, land the recording contract, or sell the artwork. Your career in the arts needs to have all the attributes of a business in every sense of the word.”
Riley said most visual artists are considered self-employed regarding the filing of their taxes. “In a legal and taxpaying sense, this means that your business as an artist and you as an individual taxpayer are one and the same. There is no legal separation, such as one would have in a corporation, partnership, LLC, or other legal entity,” he said.
Artists typically file a Schedule C as part of their regular 1040 income tax forms, which is where they would report their art income and expenses. Artists may file a Form 8829 for their home office (studio) deduction and will also be required to pay self-employment tax (Schedule SE) on their net income (profit), as well as federal income tax.
All these forms are part of the year-end 1040 income tax filing. A self-employed artist usually is required to pay estimated quarterly taxes using Form 1040-ES if their federal tax liability is more than $1,000 for the year.
According to IRS regulations, an activity is presumed carried on for profit if it produced a profit in at least three of the last five tax years, including the current year. A profit exists when the gross income from an activity is more than the deductions for it.
The obvious question arises: Will artists be deemed hobbyists if they have had three consecutive years of losses? “Not necessarily,” Riley said.
The Second Circuit Court said in a decision issued in 1995: “Code section 183 [the section where the ‘hobby loss’ provisions live] isn’t designed to punish the inept — only those who deliberately engage in unprofitable activities and with a view to sheltering income.” There are numerous instances where the tax court has allowed folks to write off continual losses against the wishes of the IRS. However, Riley said, “Be prepared for a fight. Complete and detailed records of your ongoing activities can make a huge difference.”
Riley added, “The hobby loss is where you see the palpable difference between the person who opens a local hardware store and the artist. That is because success is obviously and historically far more elusive for the artist than it is for the retail store owner. When Fred opens his corner hardware store, he will quickly close it if he is not making money, whereas folks in the arts will often go on for years racking up losses searching for that ‘big break.’”
